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Mandated Texas Reserve Margin Would Waste Investment in Smart Meters; Make Customers Subsidize REP R&D

September 10, 2013

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Copyright 2010-13 EnergyChoiceMatters.com
Reporting by Paul Ring • ring@energychoicematters.com

Mandating a minimum reserve margin in Texas, meaning an administratively determined reserve margin which has to be met, runs counter to the compact made with Texas customers who were compelled to invest in the ubiquitous deployment of advanced meters, and would essentially turn that investment into a subsidy for competitive retail electric providers.

If Texas elects to adopt a mandated reserve margin, it would essentially waste the billions of dollars that Texans are paying for the ubiquitous deployment of smart meters, especially since the use of advanced meters to support resource adequacy in an energy-only market was one of the main drivers of advanced meter installation, and the only one justifying immediate and socialized cost recovery of smart meter deployment.

Making Texans pay for a mandated reserve margin on top of ubiquitous AMI deployment, instead of relying on scarcity pricing and the attendant price responsive demand to assure resource adequacy, would mean Texans will no longer get the largest benefit from AMI deployment -- the ability to avoid the risk and billions of dollars associated with guaranteeing cost recovery for excess capacity to meet a forecast and administratively determined reserve margin.

Stepping back, there were generally 3 main benefits from ubiquitous deployment of advanced meters which justified an upfront, immediate investment recovered through a separate rider, which absent specific legislative approval, are normally prohibited as single-issue ratemaking.

These were:

1. Improved outage restoration time;

2. Support for retail electric providers' innovative products; and

3. Ability to use price responsive demand to ensure resource adequacy

When considered individually, only the third benefit of territory-wide AMS deployment -- the ability to eschew a mandated reserve margin because Texas is creating a dynamic, price responsive grid -- justifies the immediate, socialized investment in advanced metering through the unconventional use of a single-issue rider.

As a side note, operational savings from AMI are also a benefit of smart meters; however, based on the fact that operational savings were only a fraction of the $2.5 billion cost of AMI deployment across the five major ERCOT TDUs, we do not consider the savings to have been a major driver of AMI deployment, or one which justified accelerated deployment through the unusual rider mechanism, rather than recovery through the normal rate case process.

Before we discuss why the first two benefits listed above do not justify ubiquitous deployment of advanced meters, and why removal of the third benefit -- the ability to move forward without a mandated reserve margin -- wastes ratepayers' investment in smart meters, we first want to highlight that not only was the use of price responsive load -- enabled through AMI -- a major driver of smart meter deployment, it was often the most cited benefit.

Take for example the Public Utility Commission of Texas' September 2010 Report on Advanced Metering, part of a series of legislatively required updates.

In that report, the PUCT, said (all emphasis in this story is added):

"The Commission believes that the deployment of advanced metering is a critical component of the evolving Texas electric market and over time will help to balance the dynamics of supply and demand. As deployment occurs, it will enhance reliability and facilitate grid restoration, give customers more choice and control over their electric bill, enable market-based demand response, help the market to mature, yield savings for utilities, and create efficiencies in market processes for REPs and ERCOT."

In that same 2010 report, the PUCT said:

"One of the key benefits envisioned from smart meters is that by giving customers better information about their consumption and retail rates that reflect wholesale costs, customer demand will be reduced, as customers become more efficient in their use of electricity and shift consumption to lower-cost hours, thus reducing the need for investment in new peak capacity."

These benefits will be severely reduced and eliminated in a world with a mandated reserve margin, particularly one where a capacity tag is placed on the individual customer. Specifically, with a nonbypassable capacity tag, based on prior-year consumption, the customer will have little incentive to engage in real-time load management, because they will not see an immediate benefit in a reduced bill, because their capacity cost will still be based on their year-ago peak load contribution.

Moreover, to the extent, as is being claimed, a mandated reserve margin ensures resource adequacy and therefore reduces the intervals of scarcity pricing, customers will be less inclined to actively manage their peak consumption, because the costs of meeting the mandated reserve margin (in essence, the peak costs of the system) have been socialized. Customers are no longer penalized, as through scarcity pricing in the energy-only market, for drawing on the system at the peak, and therefore, will be less inclined to actively manage their load and reduce peak usage. However, this will only lead to "peak creep" -- a steady increase in peak load as customers no longer receive direct signals to curtail at peak times. This only further increases the socialized costs paid by Texans.

Back to the 2010 PUCT report:

"In the process [of AMI deployment], the electric system of today will move from a centralized, producer-controlled network to a less centralized, more consumer-interactive, more environmentally responsive model. Over time, benefits will encompass the broad areas of reliability, power quality, health and safety, national security, economic vitality, efficiency, and environmental impact."

Again, a mandated reserve margin stands the notion of moving away from a "centralized, producer-controlled network" on its head. Clearly, the intended "consumer-interactive" model envisioned under AMI deployment meant customers would be freed from administrative determinations, such as how much reserve capacity to carry in order to meet some government-set reserve margin.

Continuing to quote from the 2010 PUCT report:

"To deliver AMI's full benefits to Texans, economic signals must be delivered to the retail customer in the form of prices that are differentiated by time of day, either as time-of-use prices that are based on price trends in the wholesale market or as real-time prices that are based on real-time wholesale prices."

The report envisions that with AMI, "Customers may reduce demand by installing more efficient equipment, or participating in a demand response program or simply by deciding to turn off appliances when retail prices are high. Demand flattens over time as customers reduce consumption or shift it to off-peak hours, thereby reducing the need for investments in peaking generators. This demand response behavior is expected to lead to a lower clearing price for electricity."

Most notably, the PUCT AMI report concludes:

"Shifting load to off peak hours may also obviate the need to build additional peaking power plants."

On this vein the report continues that, "Texas has much to gain from increasing participation in demand response programs. Benefits to utilities, ERCOT and customers include reducing the need for expensive peaking capacity, improving system reliability and lowering power costs."

Simply put, these benefits of reduced peaking capacity -- fueled by price responsive demand under AMI -- cannot be realized in a world with a mandated reserve margin. By shifting and reducing load through AMI-enabled products, customers would be eliminating the need for thousands of megawatts of generation. However, these customer actions are taken in real-time -- but the mandated reserve margin was set and procured years ago, likely three years ago under the most common capacity market model. Because of the forward nature of the mandated reserve margin, customers would be robbed of the largest and most important benefit of AMI and the attendant price responsive demand -- the ability, as noted by the PUCT in its 2010 AMI report, to avoid the need to build new peaking generation.

Because of the forward nature of the mandated reserve margin, the new generation capacity would already be built -- and paid for -- before customers have the opportunity to avoid the need for the capacity by reducing load!

When the government sets a mandated reserve margin which must be met, by regulation, customers would have already been forced to pay for this new peaking capacity, and the load shifting enabled through AMI would serve no benefit.

Even if some proxy forecast of price responsive demand were baked into the demand and supply forecast used to set the demand used to calculate the reserve margin, customers would still be deprived of the full benefits of AMI-enabled dynamic supply and demand balancing. No proxy could accurately determine the amount of future price responsive demand, and due to forecasts typically being conservative in this area, the proxy would underestimate the amount of price responsive demand actually available, raising the amount of capacity needed to be paid for by customers, but which isn't actually needed.

To continue with the PUCT's 2010 AMI report, the Commission said:

"To ensure reliability and competitive functioning of the electricity market, Texas must rely upon an integrated approach that combines the traditional solutions of making infrastructure investments in new transmission and generation facilities with demand response solutions made possible by the deployment of AMI infrastructure that give customers the ability to better understand and control their usage. Demand response programs have the potential to permit customers' needs to be met with lower levels of investment in generation, transmission and distribution facilities. As customers choose to participate in demand response programs that reduce usage during periods of high demand and prices, fewer additions to generation, transmission and related facilities will be required than would otherwise in the absence of such a program. Besides reducing peak demand, demand response programs such as dynamic pricing provide a substantial benefit that as demand for expensive peaking energy declines, so does the price. This benefits not only the customers who choose to participate but also those who do not."

The 2010 PUCT report reiterates: "The Commission believes that the deployment of AMI is a critical component of the evolving Texas electric market. As deployment occurs, it can enable market-based demand response, help the market to mature, yield savings for utilities, and create efficiencies in market processes for REPs and ERCOT."

The PUCT's own report said that AMI can enhance service quality to retail customers in several areas including, among other things:

• "Giving customers the tools to help manage energy costs"

"Helping balance the dynamics of supply and demand"

If you think we are over-emphasizing general statements in support of demand response as showing specific support for the use of price responsive demand, rather than an administrative mandate, to meet resource adequacy, think again.

Even more damning is a treatise in the PUCT's 2010 report concerning the importance of AMI in an energy-only market:

"In times when reserve margins are tight, having customers who can reduce usage at peak times adds additional security to the system. For instance, under an energy-only market, spot electricity prices in ERCOT markets can increase sharply, reaching over $1,000 per MWh when almost all available generation is being deployed to meet 'super peak' demand. These high prices would signal to retail customers that ERCOT has very little available generation to maintain system reliability, and could prompt customers that have the flexibility, such as customers running oil and gas pumping jacks, commercial freezers, and residential water heaters, to voluntarily reduce their energy use. Large retail customers participate in operating reserve markets today, through voluntary curtailments, and the Commission and ERCOT are exploring additional opportunities for loads to provide reserves to assist ERCOT in maintaining system reliability. Enhancing the opportunities for demand response can provide improved levels of reliability for customers who do not participate in the programs and financial benefits for customers who do."

Likewise, the PUCT's 2008 Report on Advanced Metering made a similar conclusion:

"As Texas continues to grow, the Electric Reliability Council of Texas (ERCOT) predicts that the state's electric demand will increase. Diverse electric generation is necessary to supply that growth, but Texas residential customers must also have the tools necessary to make informed decisions to control their electric demand; advanced metering provides that tool. The ability for retail customers to respond to the dynamics in the wholesale market will help facilitate the maturation of the Texas electric market."

The 2008 report continues:

"AMI can help the electric market to mature, yield savings for utilities, and create efficiencies in market processes for retail electric providers (REPs) and ERCOT. Although AMI has a cost, that cost becomes less of an issue in an environment of rising electric prices and increased generation demand where the investment can be offset by a combination of operational savings realized by the utility and electric savings by retail customers ."

More from the 2008 PUCT report:

"Demand response and advanced metering should play a crucial role in the state's energy portfolio, especially during times of higher energy prices. AMI gives customers the tools to help manage their energy costs, and, over time, it has the potential to reduce peak demand. The Commission believes that AMI should be ubiquitously deployed give Texas retail electric customers an increased ability to control their electric use."

While of course mandating a reserve margin still allows Texans to "control their electric use", it DOESN'T allow them to control their electric costs, which is what the PUCT really means when it talks about controlling use. In a mandated reserve margin world, the reserve margin is already paid for -- customers can't reduce or shift usage to cut their bill, and the largest benefit of AMI deployment is wasted, essentially making Texans pay twice for two different approaches to resource adequacy.

Moreover, these findings in the PUCT's own reports concerning the importance of using price responsive demand from AMI to achieve a supply/demand balance at a lower cost are not just aspirational policy. No, the Commission has actually implemented this policy in precedent-setting decisions.

We refer, specifically, to Oncor's 2009 rate case, when the Commission adjudicated the issue of cost recovery for early advanced meters -- call them proto-advanced meters -- that didn't meet the final AMS definition later adopted by the PUCT, mainly because they didn't have remote disconnect/reconnect capability. These proto-advanced meters, did, however, allow interval readings and communication, and were deemed critical by the Commission at the time they were being deployed due to out-year resource adequacy shortages (shortages which did not materialize, we might add, because as always, the market responded with new supply)

In that 2009 Oncor rate case, which was Docket 35717, certain parties were seeking to disallow recovery of the costs of those proto-advanced meters, which included power line carrier (PLC) and broadband over power line (BPL) technology, as these parties argued that deployment of smart meter technology in advance of a Commission final rule on advanced metering, and what features AMI would be required to have, was imprudent.

However, the Commission disagreed, finding that it previously encouraged Oncor to continue with installation of these PLC and BPL advanced meters due to resource adequacy concerns, because the meters could facilitate price responsive demand and demand response due to their collection and communication of interval data.

As noted by former PUCT Chairman Barry Smitherman at the July 2, 2009 open meeting when discussing the rate case, "There was a lot of interest in getting these meters in as quickly as possible."

Smitherman explained that at the time that Oncor undertook installation of the BPL and PLC meters:

"There also was at this time, and shortly before this time, reserve margin issues, and I had spent a lot of time talking about the fact that if we don't get some more stuff built, we're going to be looking at very thin margins and, if that is the case, one of the only tools that we may have is a meter that gives the customer some demand response capability. The BPL meters would do that."

At the July 30, 2009 open meeting, Chairman Smitherman continued this explanation:

"When you go back to where we were in 2006 and 2007 ... our reserve margins were looking pretty thin."

"Part of our urgency for getting these meters out was we were unsure about the ability to build more baseload, the ability to get more supply, and so one of the only tools that we had at our disposal to try and keep the lights on was to get these advanced meters in the hands of the normal residential customers as soon as we can."

"We were pushing, diligently, to get these meters out," Smitherman said.

Based on the need for these proto-advanced meters for resource adequacy, the Commission granted Oncor $93 million -- the full amount of the cost recovery requested -- for the meters. This granted cost recovery was in recognition of the fact that advanced meters are relied upon to meet resource adequacy in place of a mandated reserve margin.

Moving to a mandated reserve margin now would make customers not just pay double -- but triple. First, for the proto-advanced meters -- which outside of certain loads like traffic lights were used and useful for only 7 years or so. Second, for the full deployment of fully compliant advanced meters. And now third, for a mandated reserve margin. Of course, customers can't get a refund for the billions paid for full advanced meter deployment -- an investment which no longer seems prudent if a mandated reserve margin is adopted.

Finally, a few last points on the clear policy that the legislature's and PUCT's decision to allow accelerated deployment of advanced meters was driven in large part by the view that this was an investment in resource adequacy, and was in place of alternative mechanisms, such as a mandatory reserve margin.

The preamble to the PUCT's advanced metering rule, in Project 31418 holds:

"The purposes of this section are to authorize electric utilities to assess a nonbypassable surcharge to use to recover costs incurred for deploying advanced metering systems that are consistent with this section; increase the reliability of the regional electrical network; encourage dynamic pricing and demand response; improve the deployment and operation of generation, transmission and distribution assets, and provide more choices for electric customers.

"The information presented in this proceeding suggests that advanced meters can provide enhancements in meter reading and data management to utilities, and that requiring modest additional investment in meters will provide more and more timely consumption information to customers and REPs, which will allow REPs to deploy products and services that will permit customers to better control their consumption of electricity."

Finally, House Bill 3693 of the 2007 session held:

"[I]t is the intent of the legislature that net metering and advanced meter information networks be deployed as rapidly as possible to allow customers to better manage energy use and control costs, and to facilitate demand response initiatives."

Note what is lacking in House Bill 3693 -- any sort of emphasis on operational or distribution system reliability benefits of advanced meters -- no, the legislature sought accelerated deployment of AMI to control energy use and costs and to support demand response -- the hallmarks of resource adequacy policy.

And this is why instituting a mandated reserve margin -- essentially robbing Texans of the savings made available by dynamic load and peak management -- wastes the billions of dollars invested in smart meters.

That's because the other benefits of smart meters -- outage restoration improvement, operating cost reductions, and enablement of innovative products from retail electric providers -- do no warrant the socialization of AMI costs among all customers, especially through a unique legislatively-enabled surcharge that departs from traditional ratemaking.

First, with regards to outage management. We do not deny that ubiquitous AMI helps outage management; however, it is less clear that ubiquitous deployment of smart meters is required to obtain these, or substantially similar, benefits.

If the goal of AMI deployment was solely to improve outage restoration time (or better yet, prevent outages), there were likely much more cost effective measures to reduce outage times (or outages themselves) rather than placing a two-way meter at each end user's point of delivery. Indeed, the only benefit to outage restoration from having each customer connected to a two-way meter appears to be that the utility can automatically tell when each individual customer is on/off. However, much of the same benefit can be achieved by just having the same infrastructure placed further upstream on the system, such as at the feeder level, which can tell if an outage is affecting the feeder and multiple customers and should receive priority.

This would cut the cost of achieving the outage restoration benefits drastically, as it appears to us that the largest costs of AMI were (1) physically replacing a meter at each point of delivery and (2) building a communications infrastructure robust enough to carry the voluminous 15-minute AMI interval data, as the communication network could be much smaller (or not needed entirely if other communication methods were used) if it only had to report binary status of a feeder or line (on/off), rather than interval usage

While having smart feeders or other non-meter smart distribution assets obviously cannot get to the end-user level of granularity, is such granularity really worth the investment, when considered by itself? If outage restoration was the sole benefit from smart meters (as will be the case if a mandated reserve margin is instituted), would Texans have been better served by funneling that $2.5 billion in AMI costs to a combination of self-healing grids and other smart non-AMI distribution assets, plus storm hardening, instead of two-way communicating advanced meters at every delivery point?

Turning now to the operational benefits of AMI. Again, we do not doubt the cost savings from two-way communicating advanced meters, but question whether the savings alone, which were a fraction of the upfront costs, could justify the $2.5 billion investment recovered outside of a base rate case.

Finally, AMI also benefits Texas retail electric providers. However, considering this as a benefit to customers is repugnant, especially considering the stance taken by the PUCT regarding an AMI opt-out.

In essence, through the AMS surcharge, Texas customers have subsidized the offering of time-based and other smart-meter-enabled retail products, to select customers, by retail electric providers. This socialization of costs is justifiable -- if the goal is to create a system relying on dynamic load to maintain resource adequacy, rather than administrative mandates placed on customers.

However, if Texas walks back its commitment to allow customer choices to drive resource adequacy, then the full deployment of smart meters was nothing but a huge gift to retail electric providers, whose costs of offering new products and services have been subsidized by ratepayers. It's also a gift to the customers choosing these innovative products who now get to free ride on their neighbors' investment in the infrastructure to support the specific electricity choices of certain individual customers.

Consider that, until legislative changes encouraging AMI, Texas always allowed REPs to offer time-based or other innovative rates dependent on the specific usage of customers, and even created competitive metering protocols to facilitate these offerings. However, outside of certain exceptions (REPower's proprietary prepayment system), REPs found the cost of offering these products too high -- implementing the required metering technology by the REP itself would have either produced an uncompetitive price (if costs were passed onto the customer), or would have resulted in insufficient profit (if costs were absorbed by the REP).

But just because such innovative products were costly doesn't justify forcing all Texans to pay for the costs of facilitating the offering of such products, unless Texans received some other benefit from this subsidization. But now, under the current system of full AMI deployment, Texans who were perfectly satisfied with a flat rate, settled on a load profile, have been forced to pay an AMS surcharge so that their neighbors can buy some innovative AMI-based product. Why should customers uninterested in these offerings pay for them?

This subsidization is particularly galling given the stance that the PUCT has taken regarding customers seeking to opt-out of AMS meters, which is that such opting-out customers should pay all incremental costs arising from that decision, and other Texans should not "subsidize" the decision to opt-out. Well, why were Texans not wanting an AMS meter forced to pay for full AMI deployment and required to subsidize, paying all of the incremental costs for, those customers who wanted a time-based rate, when a REP always could have offered a time-based rate for years as long as the desiring customer was willing to pay all incremental costs of the product (including interval metering installation and servicing).

Obviously, the reason customer subsidization of AMI installation was appropriate was because it was sold as benefiting all customers (not just those choosing an innovative REP product), with the largest of those benefits being from peak management and the reduced need for new generating capacity. In short, through dynamic interaction between loads and supply, AMI would enable the Texas competitive market to ensure resource adequacy without the need to meet a costly administrative mandate, which requires Texans to pay for more generation than needed. Thus, it was fair to spread the costs of AMI deployment over all customers.

When that fundamental benefit of AMI deployment is removed, through the introduction of a mandated reserve margin, the case for socialization of AMI deployment evaporates. The distribution-related benefits are too small (and achievable at a lower cost from non-AMI solutions) to have justified AMI deployment through an extraordinary measure like a monthly surcharge. And the other benefit -- the enablement of innovative products from REPs -- isn't something customers should be paying for through a nonbypassable charge to a monopoly utility-- the competitive market and customer choices should dictate what innovations are cost effective, and who should pay for them. In other words, adopting a mandated reserve margin would simply waste the billions paid by Texans for smart meters, eliminate the justification for the AMI socialization imposed on customers, and simply layer additional costs on customer bills.

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