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2019 Strategic Directions:

Electric Report

Wholesale Markets: Decentralization Abounds, More Customer Focus Needed

By Lisa Fewins, Paul Maxwell and Brad Hardin

Utilities have traditionally followed load, investing in assets when demand required it. Today’s wholesale energy markets are starting to push them in a different direction. Instead of load, utilities are being forced to follow their customers, and load doesn’t always come along with them. That’s leading to a wholesale energy market that pivots on decentralized energy production. Essentially, wholesale energy markets are becoming as decentralized and disaggregated as generation itself.

Where are utility customers focused? They’re increasingly intent on being strategically and sustainably focused in their energy use choices that are tied to community, financial and environmental considerations. This is likely why more than half of respondents — 53 percent — to the 2019 Strategic Directions: Electric Report survey said they see growth ahead for power purchase agreement and leases by nontraditional energy companies over the next five years. Nearly four of every 10 respondents saw power purchase agreement growth remaining neutral or static but, given the recent rise in such arrangements, that’s actually a nod to a continuing strong power purchase agreement market.

Fig 21

“Corporate customers signed an eye-popping number of renewable offtake agreements in 2018,” Greentech Media reported in December 2018, dubbing the year as “the Year of the PPA.” “Rocky Mountain Institute’s Business Renewables Center logged 6.43 GW of deals, and the year’s not over. That’s already nearly double the previous record: 3.22 in 2015.”

Environmental and Social Sustainability

What’s driving this?  Strategic customers, such as large C&I customers and many technology companies, are taking a different approach to their energy these days. Reliability and resiliency are crucial for companies with data centers or those that provide services needed during disaster events. Consider the value of electricity at ATMs or gas stations. If people are evacuating in advance of a hurricane, they need to be able to get gas and cash.

Resilience isn’t the only reason companies are choosing to procure their power in different ways.  Environmental and community considerations are other significant drivers. More than 7,500 firms now produce sustainability or corporate responsibility reports in accordance with the Global Reporting Initiative, and sustainable power is a critical element of these strategies. As of the end of 2017, about half of Fortune 500 companies had at least one sustainability goal. Today, 16 percent of all Fortune 500 companies and 35 percent of all Fortune 100 companies are on the Environmental Protection Agency’s (EPA’s) “Green Power Partnership” list, together using nearly 21 billion kilowatt hours of green power annually.

To attain these strategic corporate social responsibility and environmental sustainability goals, these green-minded corporations also have more options for purchasing sustainable power that aligns with their sustainability or carbon-reduction strategies. In California, for instance, we’re seeing a rise in community choice aggregation (CCA), a power procurement approach in which local governments can secure the electricity on behalf of residents or businesses. Through CCA arrangements, cities and counties effectively take the load away from utilities and serve that load themselves. Meanwhile, the local utilities must deliver that energy through their transmission and distribution systems.

In deregulated markets such as Texas, entities such as Facebook, Google and Microsoft are signing power purchase agreements with independent power producers (IPPs), with the prices settled at regional energy hubs and often with certain hedges put in place to protect the price from rising significantly. There are also sleeve arrangements, which are a form of power purchase agreement. Through sleeving, the C&I customer contracts to receive energy that’s purchased and supplied by the utility, while the customer gets pricing nearly equal to what the utility pays for purchasing the power directly from the resource.

Michigan has its own twist on such arrangements. Customers there with loads of more than 200 MW at one site can sign contracts to purchase power that is based on a resource in the utility’s portfolio and pay a rate closely aligned with the utility’s cost of operating or purchasing power from that resource, regardless of whether it’s wind, solar, gas or another technology.

Power Purchase Agreement Solar, Wind and Other Renewables

Choice of generation is another reason for power purchase agreements, and so is economics. Many companies view these contracts as a hedge against rising costs because they provide some predictability in what the organization’s power spending will be for the next 12, 15 or more than 20 years. It makes sense from an operating expense perspective.

It also makes increasing sense from an energy cost perspective. Renewables, particularly solar, are becoming some of the cheapest sources of sustainable power connected to the grid. These economics are driving decisions to engage in a power purchase agreement or install on-site self-generation resources.

Given the drivers for customers to consider other energy sources, as well as the increasing ease with which they can do it in certain regions, survey respondents identified independent power producers as the best-positioned group to offer energy-as-a-service contracts next to the utilities. That means survey respondents recognize that IPPs may someday effectively step into the role that traditional utilities play with respect to energy supply. An IPP may come to the customer with delivered energy shaped to meet the customer’s need under a standard rate schedule, much like a utility. More than half (52 percent) of survey participants said utilities are best suited to fill that role, but 41 percent said IPPs could do it, too. Only about 30 percent chose energy traders and developers to perform this function.

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These results indicate that today’s survey respondents think utilities will continue to be primary providers of energy-as-a-service going forward. If this question was posed 10 years ago, it’s likely that 80 percent of respondents would have said this, another demonstration of this increasingly disaggregated market.

When it comes to funding utility assets, some investor angst may be underway. Investors are looking for more than output megawatts. They’re looking at solar, storage, wind and – potentially -- emerging technologies, provided that the sustainable power economics shake out.

Like C&I customers, investors consider the entire realm of sustainability, from financial considerations through environmental impacts. Power plants are complex, expensive things to build, with significant fuel costs as well as operations and maintenance bills attached. There aren’t many moving parts to a solar plant, making it a less expensive facility to maintain.

That’s good for third-party IPPs, and it’s perhaps one more reason survey respondents are a bit spooked by market happenings. Nearly three-quarters of respondents — 73 percent — said they view the adoption of behind-the-meter energy supply options by customers or third parties as a threat to the utility business model.

After all, times are changing. Customers want more sustainable options, more reliability guarantees, more price stability and less of the rate-based exposure that utilities continue to escalate. If utilities want to remain relevant in business, they’ll need to respond to their customers’ wants and adapt their business models to help commercial customers pursue their strategic corporate social responsibility and environmental sustainability goals.

Going forward, disaggregation in wholesale energy markets will require more focus on the retail side of the business. Utilities will need to become more customer-oriented to maintain their customer relationships because they may not end up battling other utilities or IPPs.

The good news is that utility survey respondents seem to have an optimistic view of the wholesale energy market, meaning they can address the challenges they see. Ultimately, market disaggregation can be good for the industry. Like distributed generation, it can lead to new ways to provide cleaner sustainable power with greater reliability and efficiency.

There may be some wince-worthy moments ahead for the utility sector. But in the end, utilities have the opportunity to be smarter, more flexible and more customer-focused.

Lisa Fewins is director of environmental services for Black & Veatch’s power business. She specializes in environmental regulatory analysis and supports clients in understanding and managing risks and opportunities facing their businesses and projects.

Paul Maxwell is a managing director with Black & Veatch’s management consulting. He has more than 25 years of broad experience providing energy markets advisory, power procurement, project development, integrated resource planning, due diligence and expert witness testimony services to private and public sector clients around the world.

Brad Hardin is the president of Diode Ventures, a turnkey asset development company that is wholly owned by Black & Veatch. He leads a team that develops specialized infrastructure projects, such as renewable energy assets and data centers for the commercial, industrial and technology sectors. Hardin formerly served as chief technology officer for Black & Veatch.

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