THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA

MACK CENTER FOR TECHNOLOGICAL INNOVATION

Demand Response An investigation of demand-side emerging

technologies of the US electric grid

Kartik Krishnamurthy Rangesh Raghavan

Puneet Rakheja

May 25, 2010

FORD MOTOR COMPANY MBA FELLOWSHIP

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Overview The US electricity system is on the cusp of major change not only because of rising demand and constrained supply but also due to heightened concerns around climate change and energy security. In particular, the cost of meeting peak demand is expected to explode in the next decade. Recent years have seen tremendous activity on the supply side of electricity in terms of solar, wind, and other alternatives to fossil fuel based power generation to solve this problem. We believe the next wave of technological change will occur on the demand side – hence in this study, we assess the future market for emerging demand side technologies in the electricity grid of the United States. The introduction of new technologies in a mature industry like electricity delivery, the massive federal stimulus investment in green technologies, and the influence of regulatory and legislative policy in shaping consumer behavior, can all influence the emergence of technology very differently than what has been observed in other industries. We explore multiple scenarios of demand-side developments over the next 10-15 years including an analysis of the impact of public policy. We conclude with an assessment of the contextual viability of various emerging technologies in the space. We then preview the implications of each scenario from the point of view of a venture investor.

Supply and Demand in the Electric Grid The US electricity system was mostly built in the 1930s and 1940s, and was primarily designed for reliability, universal access and low cost delivery of power. Today it struggles to keep up with rising energy demand and new technologies while maintaining the level of service required. The system is designed to be run mostly as a regulated monopoly because of the huge capital investments required. Such a system has led to a disconnect between the true cost of supplying electricity and consumer pricing. Moreover, most states impose a 10%-15% “spinning reserve” requirement on top of their forecasted peak demand, which leads to a large amount of idle generating capacity, used for only a few hundred hours in the year. Utilities are compensated based on their asset base, and are generally not provided incentives to reduce wasteful consumption. Historically, therefore, demand growth was supported by increasing supply in the form of new power plants, using nuclear, hydro-electric, or coal fuel technology. However, the effect of greenhouse gases on the environment and climate change are increasing the planning horizon and overall operating costs of new power plants. Recently, there have been large utility-scale project developments of alternate energy supply solutions such as solar, wind and geothermal power plants. In some other instances, rooftop solar installations are gaining adoption as a local generation source. However, supply side “clean” alternatives are not yet cost effective relative to traditional sources, and require additional investment in delivery infrastructure and subsidies to encourage deployment. Despite significant advances in technology over the past decade, industry experts agree that coal power plants will continue to be the lowest cost supply choice for many years to come, despite their being the largest generators of carbon emissions.1 Historically, not much was done to manage the demand side of the system, other than some general education about energy conservation and peak load pricing. It is clear that the peak demand problem could be managed more effectively with usage time shifting, price incentives (or dis-incentives), and switching to lower instantaneous cost energy sources such as rooftop solar or onsite generation. Today,

1 Thomas Wiesel Partners - “A Primer on the Smart Grid”, pp. 18

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however, most consumers have little granular visibility into their energy consumption patterns and have little or no incentive to alter their behavior since pricing is still largely fixed However, as in supply chain management, progress can be made with access to real-time demand management information and price signaling systems. These alternatives include energy efficiency solutions such as efficient appliances, smart buildings, local backup generation sources, and peak Demand Response (DR) management systems. The Federal Energy Regulatory Commission (FERC) has defined Demand Response as “changes in electric usage by end-use customers from their normal consumption patterns in response to changes in the price of electricity over time, or to incentive payments designed to induce lower electricity use at times of high wholesale market prices or when system reliability is jeopardized.” FERC is encouraging each of the independent wholesale grid operators and local utilities across the United States to develop DR programs. The state‟s utilities are being directed by the various utility commissions to give preference to efficiency and conservation over new construction. Third-party companies act as aggregators of power for large-scale industrial and commercial consumers. However, residential and Small and Medium Business (SMB) consumers are not being served by any entities at this time, probably due to the low return per acquired consumer relative to larger consumers. It is estimated that up to 20% of US peak demand can be reduced through DR alone avoiding costs of hundreds of billion dollars in new power plants.2

How the grid works today: A taxonomy of emerging demand-side technologies In order to develop the taxonomy of this study, it is necessary to first explore the grid context. The US electricity grid consists of the following primary elements of organization:

2 Federal Energy Regulatory Commission (FERC) - National Assessment of Demand Response, June 2009

SUPPLY DEMAND

Comment [KU1]: Paul, your question here was “(how much do prices vary by season and peak hours in the day?). Actually most consumers pay flat rates for their use of power so pricing is flat. However, wholesale prices can vary dramatically as shown in the figure later on of NY power prices in a typical year. Appendix B.

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SUPPLY-SIDE:

The supply-side of the grid has historically been well managed and regulated since the number of entities or stakeholders are few in number and are federally regulated. This side of the grid has modern technology with continuing investments made by utilities and federal regulators.

Centralized Generation: Traditionally thermal (coal) or nuclear power plants operating 24 hours per day, producing 200 MW – 800 MW of power each. Both coal and nuclear power are relatively cheap sources, but each has their own set of environmental and safety issues. No new nuclear plants built in the US since 1978, and coal plants are the largest sources of CO2 emissions.

Step-up Substations: Use large transformers to step up voltage for transmission (to reduce transmission losses). Run by the utility or IPP which owns the generation plants, usually co-located with the plant.

Transmission Lines: These lines carry electricity over long distances. Historically regulated by the federal government as an interstate system, though many local agencies have influence over siting and environmental clearances. Can take 4-10 years to install new lines. Only 700 miles have been added since 2000.

DEMAND-SIDE:

The demand-side has seen very few changes over the years, mostly due to its complex decision-making structure involving state regulatory agencies, local governments, energy providers, and environmental interest groups. Investment in the sector has mostly focused on the deployment of “dumb pipes” to provide increased access, with minimal investment in intelligent communications. As shown below, electric utilities have the lowest investments in R&D as a % of revenues among many industries

R&D Investment as a function of Sales for various industries. Source: FERC

Distribution sub-stations: Typically located near the end-users, these substations step down the high voltage electricity delivered through transmission lines to lower voltages for local

Comment [KU2]: Paul, you asked “. Does this chart cover supply as well demand-side R&D? “ The answer is Yes

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distribution. Such substations have some minimal controls designed to isolate faults to prevent upstream damage.

Meters: Located at the point of consumption, meters have historically used electromechanical technology to record consumption. Before the advent of “smart meters” in the past few years, these analog meters have required physical visits by utility personnel to record consumption at set frequencies.

A taxonomy of emerging demand-side technologies Future demand management systems will have large scale networks connecting utilities and their consumers with real-time data analysis and response enabling technologies, also known as the „Smart Grid‟. This requires the development of multiple enabling technologies such as IT infrastructure for real-time transmission of data, smart appliances responsive to grid demands, smart meters, dynamic pricing, smart buildings, software for energy data visualization and exchanges for energy options. Thomas Wiesel states, in its report „A Primer on the Smart Grid‟,” that “The smart grid promises a wide situational picture of how the grid operates, rather than a system that attempts to isolate faults with clunky mechanical switches and compensate for voltage/demand spikes by having more capacity than needed (i.e., a grid that is far over built). With a view into real-time supply/demand dynamics down to the customer level coupled with smarter, automated controls at the distribution level, system operators will be able to better utilize their assets. This level of efficiency will further allow operators to generate more profits as well as decrease the cost to society through lower capital expenditure costs and increasing reliability. In addition to sensing controls and demand data, we believe that software that integrates all of the data coming from these new smart systems will be critical in creating a wide situational picture of the grid: one that has the ability to heal itself. Not only could this software act to provide operators with important information in a way that can quickly be acted upon, but also, independent of the operator, could ensure smooth operation of the grid at critical times”. The figure below is a conceptual view of the technologies needed to enable the Smart Grid:

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The key technologies that will drive demand-side reform of the grid are located at different parts of the electricity grid: POINT-OF-CONSUMPTION LEVEL: Various technologies are emerging to address real-time usage information and peak demand power sourcing. The following emerging technologies are the most relevant at the point of consumption:

At-home devices and appliances: In order to respond to real-time pricing signals from the supply side, consumers will need automated devices to deploy load curtailment, such as smart thermostats to cycle air conditioners, or other Direct Load Control (DLC) devices to control energy-intensive appliances. Appliance makers like GE, Samsung, Trane and Carrier are developing smart appliances which can be connected to the smart grid directly for two-way communication and control.

Home Area Networks (HAN): A local network is required at the level of the individual consumer in order to facilitate communications amongst the various smart devices and appliances. Industry organizations are working to develop the appropriate standards.

Energy information portals: Consumers will need some form of information appliances, whether software or hardware to provide a user interface for setup and analysis of usage patterns. Such portals in combination with smart devices can help users optimize their base energy usage patterns and also set up rules for responding to DR or reliability alerts.

Demand Response: DR programs would require that regulatory barriers be removed, and could provide economic incentives to users to adjust peak period usage. This would require at least one-way communication with load control devices. DR programs are currently deployed only on a limited basis, with most programs targeted at emergency usage curtailment of large consumers through advance notifications. It is estimated that in 2009, about 6GW of DR Capacity was available in the system, versus FERC‟s estimate of 188GW in 2019 for a „Full Participation Scenario‟.

Advanced Metering Infrastructure: Smart meters are needed to facilitate two-way communication between energy providers and users in order to support real-time billing, verify DR compliance, and perform remote diagnostics to lower costs. The FERC defines advanced metering as “a metering system that records customer consumption (and possibly other parameters) hourly or more frequently and that provides for daily or more frequent transmittal of measurements over a communication network to a central collection point.”Advanced metering does not just refer to meters, but also includes the additional infrastructure required, such as communication networks and data management systems. This full system is commonly referred to as Advanced Metering Infrastructure (AMI).

Distributed Generation: Many companies are investing heavily in R&D to develop economically viable alternatives to purchasing power from the grid. Roof-top solar is one such technology, which is yet to be cost-effective without subsidies. Advanced fuel cells could deliver local generation in environmentally clean ways.

Local storage: There is no cost-effective technology to store power today, which is the source of the peak period issue. If viable storage technologies were to be available, this might allow intermittent sources of energy such as renewables to become widely adopted.

Electric vehicles: The development of Pluggable Hybrid Electric Vehicles (PHEVs) is both a serious escalation and a potential solution to the peak demand problem in the US. It is conceivable that the addition of a few million PHEVs as demand sources on the grid would

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severely cripple the system at peak periods. However, PHEVs can also be used as storage systems if effective, which would be a positive factor. Implementing an effective solution to the conundrum would require smart charging appliances which would be responsive to grid situations.

DISTRIBUTION-LEVEL: At the distribution level, there are several advances required in order to enable the smart grid and support the point-of-use applications outlined above:

Distribution automation: Thomas Wiesel says “Distribution automation consists of an integrated set of technologies and applications that allow the utility to remotely monitor and control its distribution network, gather and communicate data across its network in real time as well as deploy automated decision making based on the data gathered”. In addition to remote monitoring, control and data gathering/communication, distribution automation incorporates a range of key applications, including alarming, fault detection and localization, fault isolation, service restoration, volt/var optimization, load transfer, reconfiguration and balancing as well as analytical capabilities (e.g., diagnostic, predictive and contingency) to support the automation steps.

Advanced Sensing/ intelligent devices: To enable distribution automation, the industry would need to deploy advanced sensors and intelligent electronic devices such as automated switches. There is a need for host of products to be developed in this area.

Advanced Control & Diagnostics: automation would also require advanced control systems to make effective use of the data from the sensors and intelligent devices.

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GRID-LEVEL: Ultimately, the grid needs to be seamlessly connected at all critical nodes to relay information in two-way communication. This requires the development of grid-targeted communications infrastructure. This technology for the grid would be analogous to the Internet Protocol for the internet. There are several competing visions for standards for the future since most of today‟s grid systems work on legacy architectures which were originally designed for isolated applications, and would not work for grid-level interconnectivity. The technologies would range from the communications protocols to information warehousing and retrieval systems. There will need to be significant investment in these technologies along with application specific software to truly unlock the potential of the smart grid. Finally, all communications architectures need to be developed for interoperability between the various elements in the smart grid. This would require the involvement of industry and governmental organizations in developing standards.

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Scenario Planning Analysis The scenario planning framework is a powerful way to analyze the effect of complex forces which influence outcomes in the turbulent environments seen in emerging industries. Companies need a reasonable vision of the future in order to effectively develop roadmaps and focus their resources in any market. In the case of emerging markets, there are often significant uncertainties (as distinguished from risks, which can be quantified) in a complex system of social, technological, economic forces interacting with each other. In addition, frequent discontinuities occur as new capabilities are developed which find immediate application. As these elements of uncertainty, complexity, and discontinuities overlap, markets can develop along completely unique trajectories. To increase their probability of success in such turbulent markets, firms will need to identify and then position themselves to succeed in the most likely of these unique states, while maintaining “real” options in the others. Traditional strategic thinking processes do well in predicting the most likely, widely anticipated scenarios of the future. However, most processes fail to develop multiple views of the future, leading to poor preparation for unexpected outcomes. The power of the scenario planning framework is that it provides a systematic method of developing scenarios which offer a rich description of the various, meaningfully different visions which could define the future. The process of explicitly considering multiple combinations of varying outcomes of each underlying uncertainty leads to an unbiased prediction of the future, which might otherwise have been overlooked. Given the early stage of development of DSM technologies in the electric energy industry, the scenario planning framework is likely to be the most beneficial analytical framework for the purposes of our study. We first looked at identifying the key forces that affect DSM technologies of the electricity grid. After considerable research into the current state of the industry, we conducted multiple interviews with key players to develop a list of the most relevant forces affecting the industry. Each force was then classified along two dimensions: Predictability of Outcome and Importance. Using a simple two-dimensional map with these two axes, we identified the most important forces with highly predictable outcomes as “Trends”, and those with unpredictable outcomes as “Uncertainties”. The forces encompassed several areas - regulatory policy, economic incentives, demand response alternatives, customer adoption, legislation, and technology standards. For ease of analysis, some of the trends and uncertainties were grouped together to define a key (macro) trend or uncertainty. Finally, the least important forces were ignored in scenario construction regardless of the predictability of their outcomes. RESEARCH METHODOLOGY: Scenario Planning was accomplished by secondary and primary research methodologies. Current assessments and research whitepapers of demand side technologies were first reviewed, including papers from the FERC, the EPRI and Thomas Wiesel Partners. From this review, the study team prepared a list of forces which appeared to have most significant effects on the future of DSM technologies (Please see Appendix D for a full list of the forces).. The forces were then classified as “Trends” versus “Uncertainties” using structured interviews of subject matter experts from the industry. The experts ranged all across the value chain, including utilities, infrastructure technology companies, research scientists and DR / energy management solution providers. The interviews typically comprised of two parts. The first part of the interview was set up as an opportunity for the expert to discuss the state of the industry and to identify the main forces affecting

Comment [KU3]: Done. Please see appendixD

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the future state of demand side technologies. Any previously unidentified forces uncovered in a particular interview were appended to the original list. The second part consisted of asking the experts to rank the set of identified forces along two dimensions:

(1) The importance of the force as it affected the future of DSM technologies AND (2) The predictability of relevant outcomes from the specific force

The two dimensions were chosen to enable the classification of the forces as either “Trends” or “Uncertainties.” Forces with high importance and high predictability ratings were classified as trends, while those with high importance and low predictability ratings were classified as uncertainties. The most critical uncertainties are used to index the scenarios. TRENDS: Through our interview process, we identified the following key trends that will affect the development of DSM technologies is a significant way.

T1 Energy demand growth will continue unabated, placing increasing pressure on the grid. o Most, if not all, of the interviewees we spoke to indicate that end applications will

continue to demand more energy than can be gained from more efficiently performing today‟s human activities. This appears to be borne out by independent research as well.

T2 Consumers become more environmentally conscious. o Increased sensitivity to the harmful effects of climate change on the planet, and large-

scale educational campaigns are leading to a more environmentally conscious consumer across most of the developing world.

T3 Energy projects face increased environmental reviews. o There are continued pressures on project environmental impact reports, leading to a

scarcity of land or site permits for energy projects.

T4 Industry and technology standards for DSM emerge. o While there are a patchwork of different protocols and standards being used today,

players in the industry have agreed to work together on developing common standards, and this is already visible in several areas of the grid, such as the Home Area Networking standard, etc.

T5 Devices and applications become more efficient. o As consumers grow more conscious of energy use and their personal “carbon

footprint”, appliance vendors are developing more energy efficient appliances. The “Energy Star” certification has now become a virtual necessity for products to remain competitive. We expect this trend to continue.

T6 Data becomes transparent throughout the grid. Automated Metering Infrastructure (AMI) is real.

o As the rollout of smart meters and sub-station automation continues, data will become more readily traceable to end-points. Utilities estimate more than $150B in losses due to inefficient responses to outages, and this is motivating large-scale investments in the data communication aspects of the smart grid.

T7 Transmission & Distribution gets modernized. o As a consequence of the same forces mentioned above, utilities have to upgrade their

infrastructure to be able to act on the data generated from the end-points. The T&D

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infrastructure in the US is mostly 50+years old, and needs to be updated. The primary limitation would be financing, which is a key uncertainty.

T8 Utilities will signal real-time prices to commercial customers. o The major issue impacting the economic efficiency of the electricity system in the US is

the regulation of pricing. Many utilities already charge large-scale industrial customers the true cost of providing electricity, but are prevented by regulation from doing so for most other businesses. As commercial & industrial consumers get better technologies to manage their consumption, utilities will likely continue to increase the target customer base for real-time pricing, as confirmed by several of our interviewees.

UNCERTAINTIES: Interviewees repeatedly identified several forces as uncertainties. Some of the forces could be meaningfully grouped into a single, more descriptive force capturing their range of effects. We have identified the following two uncertainties as the key drivers of the scenarios of the future:

U1 Regulations designed to align incentives and create market structure for DSM adoption o U1-1 Energy exchange markets match supply and demand o U1-2 Incentives for utilities to invest in efficiency o U1-3 Time-based pricing to reflect true costs transferred to all consumers of electricity o U1-4 Government subsidies or tax incentives to attract capital into new DSM technologies

U2 Revolutionary new DSM technologies become viable o U2-1 Distributed generation o U2-2 Electricity Storage – distributed or utility-scale

The power industry of the United States has evolved over the years as a regulated industry with guaranteed returns in order to attract the large amounts of capital needed to roll out this social good to all members of society. This goal has been substantially accomplished, but the resulting structure of the industry is not conducive to the needs of society today – cheap, ubiquitous power to meet the growth needs of the future without negatively impacting the environment or causing climate change. Some electricity markets were de-regulated in the 1990s as an attempt at solving this problem, but errors in implementation saw some spectacularly disastrous results (California, in particular), creating political difficulties for future reforms. When power is priced at the intersection of supply and demand, market forces will create more economically efficient models of the industry. To accomplish these objectives, industry needs to attract more capital, and this cannot be done without providing support in the form of subsidies or investment tax credits. While some sources of supply are being given this support (solar power in particular), DSM technologies will also need this support. Due to the highly political nature of such policies, this is considered an important but highly uncertain force. One of the most unique aspects of electricity as a commodity is that there is no cost-effective technology available today for large-scale storage of electricity as inventory. Electricity generated has to be consumed practically real-time, or is lost forever. Most other industries can react to demand volatility with the effective use of inventory management techniques. Several ideas have recently arisen in the electric industry which may be able to address this problem. Distributed generation technologies such as roof-top solar panels or on-site fuel-cells can be used to locally generate peak power when required, instead of maintaining “peaker” gas power plants which are expensive to operate and are rarely used for more than 100 hours per year. High storage capacity batteries could be

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developed to store excess power, either onsite at the power plant, or at the point of use. Such technologies could revolutionize the industry, if cost-competitive with power from the grid. However, these technologies are in the realm of technical invention, and there is significant uncertainty as to the economic viability of such solutions except in a few niche applications. While these two uncertainties have been identified as keystones of our scenario framework, there are several other critical uncertainties which could influence the outcome of each scenario.

U3 Consumer adoption of DSM technologies o U3-1 Consumer education o U3-2 Backlash o U3-3 Inability to respond o U3-4 Ineffective price incentive program design o U3-5 Innovative, easy-to-use personal energy management solutions

The small consumer accounts for ~60% of the power used in the United States. It is not possible to meaningfully impact any of the goals for a long term viable solution without co-opting the consumer, which is a stiff challenge today. Although most consumers are increasingly environmentally conscious, they have proven to resist changes in the system of pricing across most of the US. The key challenge appears to be that consumers are resistant to behavioral changes for small incentives, especially for routine purchases of small-ticket items. With today‟s regulated pricing shielding them from true costs, most consumers have no incentive to change consumption patterns as a function of supply costs.

U4 Widespread adoption of Electric Vehicles (replacing gasoline powered vehicles) o U4-1 Price of oil and other fossil fuels o U4-2 Geopolitical shock to conventional energy sources

Innovations in high torque battery technology have enabled the introduction of Plug-in Hybrid Electric Vehicles (PHEVs). Many consumers would be glad to switch to a “clean” fuel for transportation. Therefore, sustained high oil prices might lead to increased adoption of PHEVs. It is estimated that each PHEV will place a load on the electric grid equivalent to 40% of the load consumed by a single-family home. This will place a significantly increased load on the electric grid, requiring increased spending on infrastructure and supply sources. Unfortunately, conventional coal power plants produce more carbon emissions on a normalized basis compared to automobile engines, which will lead to more pressure for “clean” energy sources (solar, wind, or distributed generation).

U5 Slow decision-making and bureaucratic resistance to change o U5-1 Risk-averse utilities delay technology change due to unfamiliarity and bureaucratic

culture o U5-2 Efficient regulatory oversight (fewer bodies to deal with)

Many utilities are ill-equipped in terms of IT talent to implement modern Smart Grid solutions effectively. As quasi-public entities, this makes the typical utility hesitant to adopt transformational changes in their organizations. Further, too many agencies have regulatory authority over the distribution and consumption-level assets on the demand side of the grid. Often, this leads to extremely slow and political decision-making processes, leading to less than 6000 miles of new infrastructure beyond sub-stations in the past 30+ years. Changes to the oversight structures, such as

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reducing the number of agencies with veto power over projects will be required in order to modernize the grid.

U6 All power sources are penalized for carbon emissions o U6-2 Cap and Trade Legislation enacted on a global basis o U6-2 Carbon taxes imposed on US coal power plants

Conventional energy is still the cheapest form of electricity generation today. Since there is no value or penalty assigned to coal plants for the huge amounts of carbon they generate, this is a hidden social cost not reflected in consumers utility bills. In combination with regulated prices, such a policy leads to little incentive for consumers to switch to new sources of power. However, there is strong opposition to the imposition of carbon tax regulations in the US, and this is a major uncertainty going forward.

U7 Financial sources for development and deployment of advanced DSM technologies o U7-1 Supportive government spending, tax policy, and clean energy incentives o U7-2 Venture capital cycles return to normalcy

The last uncertainty we uncovered is with regard to the sources of capital for investment in the development of innovative new technologies as well as for investment in capital-intensive clean energy projects. After the economic crisis of 2008-2009, traditional sources of funding for many projects have dried up. Most utility-scale clean energy projects require significant capital for initiation which will now need to be backed by government loan guarantees. Meanwhile, the venture capital industry is undergoing a crisis of epic proportions following the effective closure of the IPO market as an exit option. M&A transactions are occurring at far lower valuations compared to 2007, and cleantech investments need much longer maturation periods. While the cleantech sector accounted for more than 30% of VC capital in 2009, the absolute value of such investments is probably insufficient to create the types of innovations needed to address the needs of the grid in the future. VC cycles will need to return to some semblance of normalcy to continue to drive innovation. SCENARIOS: Based on the two main uncertainties, we can construct a 2x2 scenario matrix with the four possible combinations of each uncertainty. We then vary levels of each of the other 5 uncertainties such that, at every addition, each scenario develops explicitly unique characteristics. This method of forcing the development of “bottoms-up” uncertainty-driven scenarios is the most critical element of the process to ensure the active consideration of the widest possible range of outcomes. The resulting scenarios are then most useful for the analyst to evaluate strategic choices and their likely results for individual players in the value chain. One of the problems with this approach is that some of the forces are highly correlated with each other. Ideally, the top two uncertainties of “Supportive Regulatory Policy” and “Technological Success” should be truly independent forces. However, it is clear that a highly supportive policy may drive more investment and therefore increase the likelihood of success in the technology world. Likewise, consumer adoption of technologies may be a function of both regulatory policy and technological success. However, we believe that while somewhat correlated, each of these forces are influenced by more independent sub-forces than correlated ones. For example, the “Regulatory Policy” encompasses actions like the creation of energy exchange markets (U1-1) and the implementation of real-time pricing

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(U1-2), neither of which directly impacts the uncertainty of “Technological Success”. However, government subsidies (U1-4) will have an indirect effect on technology development. We have carefully chosen groupings of forces to minimize the impact of any significant covariance on the integrity of the solution. The following is a graphical representation of the final scenario table. The axes are the top two critical uncertainties identified from our analysis. Each scenario is then developed from a combination of the other uncertainties whose levels (or outcomes) are chosen such that each scenario is unique.

Mostly Failures

Fractured,

regional

policy

Success/Breakthrough

Globally

Supportive

Policy

Reg

ula

tory

/Po

lic

y S

up

po

rt

Technological Success?

The

Consumer’s

Smart Grid

New Age of

Micro-Grids

Nuclear comes

back Business goes

“off grid”

Distributed generation, storage solutions

Energy Demand-side 2020:

Scenario Matrix

Scenario DScenario C

Scenario BScenario A

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The table below shows the chosen combination of uncertainties leading to the 4 unique scenarios we have developed:

Uncertainty Scenario A: The consumer‟s smart grid

Scenario B: New Age of Micro-Grids

Scenario C: Nuclear comes back

Scenario D: Business goes “off-grid”

DSM-supportive regulatory regime

YES YES NO NO

Revolutionary DSM technologies become viable

NO YES NO YES

Consumer embraces DSM technologies

YES NO NO YES

Wide-spread adoption of Electric Vehicles

YES YES NO NO

Efficiently organized oversight agencies and utilities make fast decisions

NO YES NO YES

Carbon emissions costs imposed on generators

NO YES YES NO

Widely available capital for dev. & deployment of DSM technologies

YES YES NO NO

Scenario A: The consumer’s Smart Grid. In this scenario the regulatory mechanism is set up for DSM success, ensuring the alignment of incentives and availability of market structures for the efficient pricing of power. Since revolutionary DSM technologies like distributed generation and/or electricity storage have been slow to develop, the consumer has adopted DSM technologies like Demand Response programs whereby they willingly curtail consumption during critical peak periods. Oil price shocks or political instability in the Middle East has forced the automobile industry to respond by rapidly increasing production of all-electric vehicles, and the government has supported this transition by providing the appropriate incentives. However, since the power grid continues to rely on centralized generation, more sources of supply will need to be found. Coal power plants will continue to dominate due to the lack of imposition of any meaningful carbon taxes, but large-scale solar and wind power projects will also increase. Utilities and local agencies continue to resist meaningful reform in the transmission infrastructure, leading to all the action happening at the consumer end. The wide availability of venture capital and financial help to the consumer will see some proliferation of demand management systems in the home, and a significant increase in roof-top solar installations for environmentally conscious consumers. The highly supportive regulatory regime, coupled with the lack of viable distributed generation or storage will lead to increased markets for Commercial & Industrial DR aggregators.

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Life of a venture investor in Scenario A: This scenario is likely to end up with value appropriation across the entire value chain. Utilities may not dominate outcomes as much as they do today and infrastructure providers may end up with the best market for their products. Demand Response is highly successful, with multiple commercial and industrial aggregators in the market. Venture firms will line up to fund companies with the most consumers signed up for energy management services. The first few firms to enter the home will gain tremendous market value from their power to aggregate demand, and will command high PE multiples with the expectation of rapid future sales growth from delivery of point-of-use energy management. Venture investments will flow towards the first new firms to enter the home appliance space in a long time, with escalating demand for “smart” appliances. Some of the new firms will focus on smart algorithms to connect the user with their appliances, and others will focus on machine-to-machine communications to enable a fully networked set of “smart” appliances intelligently managing energy consumption in response to price signals. The consumer will get educated on the environmental benefits of being a net zero energy consumer with all forms of recycling companies entering the market. Scenario B: The New Age of Micro-Grids. In this scenario, not only is there a highly supportive regulatory environment for DSM, but revolutionary DSM technologies such as storage and/or distributed generation have become viable. The price of a gallon of gasoline is well over $6, and electric vehicles rule the roost. Consumers continue to charge their automobiles at home and in parking garages, leading to increased stress on the electric grid. Although the consumer is resisting personally managing their own consumption due to the lack of ease of use of DSM technologies, there is strong economic pressure on power costs due to the imposition of carbon emission costs and transparency in energy pricing closer to the true costs of generation and distribution from the centralized grid. In this world, regulatory agencies who issue site permits for local generation projects have been re-organized and the process for approval of mini power plants has been streamlined. C&I consumers have viable alternatives for onsite generation of power in clean ways, and often sell back power to the local neighborhood. Investment shifts to the “Micro-Grid” with the widely available capital for investment in local projects. The grid is de-centralized, leading to fewer coal power plants, or any large-scale upgrades of the T&D infrastructure. Communities take charge of their own power needs by forming micro-grid cooperatives, and use the central grid for back-up power. Life of a venture investor in Scenario B: In this scenario, DSM as a whole becomes widely adopted but with an emphasis on distributed generation or storage. This is the most fertile ground for private equity firms, with an entirely new industry springing up to deploy micro-grids around the country. Disruptive new business models for energy creation, localized distribution, and consumer service will develop. New technologies such as fuel cells, efficient car batteries, high efficiency solar cells , waste conversion to electricity, etc. will need to be funded to enable growth in distributed supply. New service firms will be needed to administer and maintain local energy services. Venture firms and their portfolio companies will be competing with established corporations to capture market share in this new age of micro-grids.

Scenario C: Nuclear is back. In this scenario, the government has failed to resolve political differences over how to implement DSM policy through a series of partisan politics. However, the rest of the world has forced the US to adopt carbon emission controls, leading to a higher cost of producing energy from coal powered plants. Revolutionary DSM technologies have

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failed to deliver promised benefits, and the consumer is tired of decades of promise without successful delivery. Meanwhile, the grid does not face major new stresses due to the low adoption of PHEVs. Demand-side regulatory authorities continue to have splintered control over key decisions, and local clashes with environmentalists and conservatives alike have led to an impasse over the use of large form factor clean energy sources such as wind and solar. The lack of adequate venture capital backing is choking innovation in DSM technologies, and the government has to respond by supporting the development of new nuclear reactors with technology from conglomerates like GE or Toshiba. Life of a venture investor in Scenario C: Utilities may have the highest value appropriation under this scenario. Infrastructure providers with strong alliances with utilities will thrive. This resembles status quo in many respects but the supply side of electrical power is significantly different. This is the worst case scenario for venture firms because in this environment, most of the investment required will be in the order of billions, with utilities and federal governments footing most of the bill. There are likely fewer opportunities for investments in this environment for traditional venture capital. Some small-scale investments have been made since 2007 by venture investors in nuclear energy (e.g. Altria group‟s $25M dollar investment in Hyperion Power Generation). However, these investments are quite small compared to what has been invested in the broader cleantech sector. Historically, most of the funding for nuclear energy has come from the government. In France, the country most identified with leadership in nuclear energy, the R&D spending came from the government or Areva, the large French nuclear energy generator. A more detailed study of the investment experience in France or Sweden during the growth of the nuclear energy industry would help the venture investor better understand the implications of Scenario C.

Scenario D: Business goes “off-grid”. In the final scenario, the emergence of revolutionary DSM technologies leads to increased clean alternatives in a world where consumption is increasing and the emphasis on efficiency is reduced. The residential consumer is excited about the many ways in which energy can be managed at the point-of-use. However, they are blocked by the lack of incentives and financial support for the adoption of the new DSM technologies. C&I consumers, however, use rational economic arguments to adopt on-site generation or peak period storage to control their use of grid power in order to prevent losses from the increased outages in the system. The lack of a major usage driver such as electric vehicles ensures that there is no external pressure for reform of the system, and the centralized grid essentially remains unchanged. Smaller companies will form to service the industrial segment to provide economically viable “clean” alternatives to grid power. Life of a venture investor in Scenario D: Utilities may have reduced control over end consumers, particularly on the residential side. Infrastructure providers will orient towards solutions for end consumers to use new demand-side technologies while having limited impact on the centralized grid. The overall value created under this scenario may still be lower than scenarios A and B, however, this environment is still rife with opportunity for venture funds. Deployment of radical, innovative new technologies will need new capital, and the target users will be large commercial and industrial consumers who buy technologies with solid economic rationale. For example, an efficient and economically viable storage technology with storage capacities of greater than 8 to 10 hours can support distributed generation sources such as solar arrays which have generation profiles which are mismatched with usage profiles. Such a

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technology will also need a low footprint in order to be deployed onsite at the ppoint of use. A great example of such a system at work today is the University of California, San Diego. UCSD generates more than 80% of its own energy from clean sources such as natural gas or solar cells, and uses salt baths to convert excess energy into heat for later reconversion. However, this technology is not viable for more than 3 to 4 hours of storage, UCSD relies on the grid for meeting its peak power needs. This advanced micro-grid would greatly benefit from more efficient generation sources or from better storage technologies. Since applications are trending upward, total energy demand can only be reduced by increasing efficiency. Energy efficient lighting technologies such as LED bulbs are already being adopted for certain niche applications today where LED‟s long life reduces service costs (such as refrigerated displays at all WalMart stores). Energy shifting technologies can also be useful to industrial users who are often on dynamic pricing mechanisms.

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Policy Framework Analysis Prof. Gerald Faulhaber‟s framework of assessing emerging technologies is a good lens for studying the evolution of the demand side management (DSM) market and technologies. Prof. Faulhaber examines, through the example of the development of the internet, how government plays a role in every stage of development of an emerging technology and market – from building infrastructure to sorting out complex social repercussions. Based on this framework, the critical impact of public policies on DSM market and technologies are anticipated to be manifold. 1. Government policies play an important role in growth of DSM market by aligning the incentives of

utilities with DSM initiatives.

Public Utility Commission (PUC) and state utilities are key players in driving the growth of DSM market. But financial incentives for state utilities are currently not aligned with DSM and energy efficiency (EE) initiatives. We discuss available financial incentives that public policies are considering to enable this market to grow.

In the United States, the regulation of electric power services is divided between wholesale and retail. Wholesale services are regulated at the federal level by the Federal Energy Regulatory Commission (FERC), covering wholesale generation, inter-state transmission, wholesale energy markets as well as the operation of independent system operators and regional transmission organizations (ISO/RTO). Retail energy services, i.e., services provided directly to end-use energy customers are subject to state and regional regulations. Investor-owned utilities (IOUs) are regulated by the Public Utility Commission (PUC) of each state they provide services to. FERC, PUC and ISO/RTOs all play an important role in development of DSM markets.

Aligning Incentives for Utilities to Promote DSM

Despite the benefits and the success of demand response (DR) and energy efficiency (EE) programs in some regions of the country, DR and EE remain critically underutilized in the nation‟s energy portfolio. The National Action Plan for Energy Efficiency recommends regulatory bodies “to modify policies to align utility incentives with the delivery of cost-effective energy efficiency and demand response programs and change ratemaking practices to promote these investments.” The key challenge in all of this is to address the typical utility financial incentive. Traditional utility regulation favors supply-side resources over DR and EE resources as utilities earn a rate of return on investments in generation, transmission and distribution infrastructure. The absence of a parallel incentive for DR investments creates a bias against demand-side resources. Utility spending on DR programs affect the utility‟s financial position in three ways: (1) through recovery of the direct costs of the programs; (2) through the impact on utility earnings of reduced sales; and (3) through the effects

NERC

Transmission

Grid

Distribution

Grid

Retail

Customers

FERC

NARUC

State Utility

Commissions

Local

Organized Wholesale Markets

Transmission Open Access

Wholesale Prices

Investor Owned UtilitiesRetail Tariff

Distribution Reliability

Public Utilities (Munis, Coops)Retail Tariff

Distribution Reliability

Bulk

Generation

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on shareholder value of DR spending versus investment in supply-side resources. A variety of mechanisms have been developed to address these impacts, as illustrated in figure above. Comprehensive policies addressing all three levels of impact generally are considered more effective in spurring utilities to pursue efficiency aggressively. Ultimately, however, it is the cumulative net effect on utility earnings or net income of a policy that will determine the alignment of utility financial interests with these investments. A recent paper published by the Environmental Protection Agency in connection with the National Action Plan for Energy Efficiency presents a framework that describes three major categories of regulatory approaches to DR investments: program cost recovery, performance incentives, and lost margin recovery.

Program Cost Recovery

Under a cost-recovery mechanism, a utility can recover costs of DR and EE investments on a dollar-for-dollar basis, typically through a customer surcharge. However, there are challenges with this approach. Firstly, cost recovery alone will not address the lost margin revenue the utility will face due to reduced energy sales from DR programs. Secondly, cost recovery does not factor in opportunity costs: DR investments displace supply-side investments for which the utility can earn a profit. Absent a statutory or regulatory mandate, program cost recovery alone will generally not attract utility interest in DR programs. Even with a mandate, the utility is generally not motivated to apply substantial resources to pursue robust programs or foster innovation.

Performance Incentives

Governors, state legislatures, and utility commissions in some states have set specific targets for utilities around demand reduction or energy savings. A financial “carrot and stick” can be attached to the targets to provide increased incentive. Typically, this approach uses bands to determine the incentives or penalties a utility will face. For example, utilities may face a financial penalty if they fail to achieve at least 70 percent of the target, receive a pro-rated percentage of the incentive for achieving 70 to 110 percent of the target, and an additional reward for achieving more than 110 percent of the target. The most successful programs that achieve the desired goals and objectives are those that ensure utility cooperation with properly designed regulatory performance incentives.

Shared Savings

Under this approach, the utility receives a percentage share of the energy savings from a DR and EE investment. The savings are generally calculated as the avoided costs of an additional supply-side resource minus the DR investment. A shared savings approach will generally allow for incentives above a threshold level of DR participation, and may include penalties for failing to achieve the desired DR objective. Typically, a utility will receive an increasing percentage of shared savings as participation or savings levels increase. This structure creates an incentive for promoting cost-effective DR, but also encourages careful cost management because excessive or inefficient spending reduces the incentives available.

Rate of Return

In some jurisdictions, utilities can capitalize and earn a rate of return on their DR investments. Under this approach, a utility will generally accumulate costs associated with investments in DR as regulatory assets, and later recover those costs in the utility‟s next rate case. The primary advantage of this approach is that it puts DR on an equal footing with supply-side investments. In these

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circumstances, utilities will have no embedded disincentives in pursuit of a least-cost, optimally-efficient approach to meeting customers‟ electric needs either through a demand- or supply side solution. A few states have implemented, or are considering implementing, rate of return adders to investments in DR. In these cases, DR investments earn a higher rate of return than traditional supply-side investments. A rate of return mechanism allows the utility the opportunity to earn a profit on DR investments in the same manner as other capital.

Avoided Cost

An emerging model, put forth originally by Duke Energy, proposes that the utility be compensated for demonstrated DR savings by receiving a percentage of the utility‟s avoided supply costs. Under the proposed Duke approach, know as Save-A-Watt, the utility would “recover the amortization of and a return on 90 percent of the costs avoided by producing save-a-watts.” The Save-A-Watt proposal has not received final approval.

Lost Margin Recovery

Treatment of lost margin recovery, either in a limited fashion or through some form of what is known as decoupling, raises basic issues of not only what the regulatory obligation is with regard to utility earnings, but also of the regulators‟ role in determining the utility‟s business model.

Decoupling

The term decoupling is used generically to represent a variety of methods for severing the link between revenue recovery and sales. Ultimately, decoupling updates revenues via a price adjustment when actual sales are different than the projected or test year levels. Currently, sixteen states have adopted decoupling programs for at least one utility and a number of jurisdictions are investigating the advantages and disadvantages of decoupling.

Lost Revenue Recovery Mechanisms

Lost revenue recovery mechanisms are designed to recover lost margins that result as sales fall

below test year levels due to the success of energy efficiency and DR programs. They differ from decoupling mechanisms in that they do not attempt to decouple revenues from sales, but rather try to isolate the amount of under-recovery of margin revenues due to the programs. Simply put, the margin loss resulting from reductions in sales through the implementation of a successful program is calculated as the product of program-induced sales reductions and the amount of margin allocated per kilowatt-hour in a utility‟s most recent rate case. In this sense, the shortfall in revenue recovery is treated as a cost to be recovered. Several states have implemented lost revenue recovery mechanisms in lieu of decoupling as a way to address this barrier.

A challenge for public policy today is to encourage the right level of investment in DR resources as well as traditional utility infrastructure. State utility commissions have the authority to increase utility-sponsored DR by creating a favorable regulatory environment so that utilities will pursue an optimally-efficient strategy to meet the needs of their customers. It is clear that public policies would ensure that utilities receive regulatory signals consistent with these objectives. A properly designed performance incentive mechanism will align a utility‟s corporate objectives with that of ensuring a cost effective level of DR activity. We believe regulation and government policies will eventually lead to an environment where incentives for utilities are aligned with fueling innovation and rapid deployment of DSM technologies,

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but what is uncertain is the timing of such regulation. We discuss this uncertainty in detail and its effect on potential scenarios in the scenario planning section above as Uncertainty 1 - Regulations designed to align incentives and create market structure for DSM adoption and Uncertainty 5 - Slow decision-making and bureaucratic resistance to change. 2. Government as coordinator can help manage the transition of DSM from utilities to CSP

(curtailment service providers) – public to private

Private businesses are best positioned to help DR market grow as they can manage this business “faster, cheaper and better”. FERC regulations and directives play a significant role in working with state utilities and PUCs to help create an environment for private CSPs to thrive.

The vagaries of regulations on state-by-state basis and challenges of setting up correct incentives for utilities to invest in DR still exist. As a result, DR market has evolved at different rates in different parts of the country. In the following section we discuss the current state of DR market and its transition from public to private domain. The Energy Policy Act of 2005 (EPACT) codified that a key objective of U.S. national energy policy was to eliminate unnecessary barriers to wholesale market DR participation in energy, capacity, and ancillary services markets by customers and load aggregators, at either the retail or wholesale level. Further to that, the FERC Order 719-A issued on July 16, 20093, was aimed at improving the operation of organized wholesale electric markets, especially in the area of Demand Response. This order seeks to improve wholesale markets by establishing a more forceful role for Demand Response by directing RTO/ISOs to permit aggregators - curtailment service providers (CSP) - to bid Demand Response on behalf of retail customers. The regulatory support and push is delivering early results - based on a survey conducted by FERC, there has been a significant increase (117%) in the number of private entities offering DR programs: 126 in 2006 vs. 274 in 2008 and about a 10% increase in the number of entities offering dynamic pricing tariffs to retail customers. Among the existing DR resource base, residential customers account for ~6,000 MW while industrial customers account for ~14,800 MW.

Role of Curtailment Service Providers in Wholesale Market DR Programs

The emergence and increasing role of curtailment service providers provides an interesting example of how strong public policy support by FERC has created opportunities for private entrants to obtain a significant foothold and thus expand the DR industry. New entrants, CSPs have gravitated towards incentive-based DR programs (e.g., capacity market, requests for emergency resources) that provide an upfront and ongoing reservation payment for committed load reduction by load aggregator (or customer). These programs provide a significant opportunity for CSPs to aggregate individual customer‟s willingness to curtail into a load curtailment resource, negotiate and share reservation payments with customers, provide energy payments to customers for performance during events, and allow CSP to compete on the basis of price. Adjoining figure shows enrollment by the type of service provider (i.e., CSP or utility) in several DR programs administered by the NYISO. From 2003 to 2008, CSPs increased their share of subscribed load of DR resources from 44% to 77%. CSPs have heavily marketed the DR program to customers by developing

3 http://www.ferc.gov/whats-new/comm-meet/2009/071609/E-1.pdf

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customized service packages and enabling technology that help customers to manage the risks associated with participation. The market share of utilities has steadily declined over this period. CSPs also have been successful in attracting new customers to enroll and participate as DR resources in wholesale market DR programs. Results from ISO-NE‟s Forward Capacity Market auction illustrate this phenomenon. In 2007, ISO-NE filed with FERC its approved Forward Capacity Market (FCM) rules, which would allow any resource, both supply and demand, to commit three years ahead of time to provide capacity to the system. Demand resources in the FCM included both DR and energy efficiency. The results of the first Forward Capacity Auction (FCA #1) were made public in March 2008. Across the six New England states, CSPs were responsible for attracting over 60% (1,681 MW) of the total demand-side capacity (2,553 MW) that cleared in the FCA #1 and 70% of the new demand-side resources. These results suggest that CSP were more aggressive in marketing and/or willing to take the business risk that they could deliver demand resources three years hence. Despite success in some markets, CSPs still face significant institutional and regulatory barriers in many regions of the United States. For example, some states (e.g., Indiana) have precluded third party program providers from directly participating in wholesale market DR programs. The FERC has attempted to address this issue in its recent Order 719 in which the FERC agreed with the principle that load aggregators must be allowed to participate in ISO/RTO markets. In recent years, encouraged (or required) by their state regulators, an increasing number of utilities have issued requests for proposals for „negawatts’ to be provided by CSP on a pay-for-performance basis. These efforts are often characterized as a move toward “outsourcing” provision of DR services, which in some cases are driven by the utility‟s need to meet aggressive demand-side reduction goals established by a state PUC. As more utilities consider “outsourcing” DR programs, existing and new CSPs are now competing to provide this service and many CSPs. Government enablement of private sector to be a player in Demand Response space is a turning point for the industry. Even today some states and utilities have not opened DR opportunities to CSP – but we believe it is only a matter of time. This time of change from public sector to private sector provides opportunities to gain long lasting advantage for private players. 3. Universal deployment of AMI.

AMI is a pre-requisite for large scale adoption of DR. Government policies and push are important factors in successful and timely deployment of AMI

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It is clear that one of the key components of demand side technologies is the Advanced Metering Infrastructure (AMI). For any demand side energy management solution to work, one of the important pre-conditions is to have large scale rollout of smart meters to be able to get granular energy usage data. Given the value of energy demand management to both government and end consumers, we believe AMI would soon be mandated to be universally available. It is already known that government is funding smart meter rollout in parts of the country through the recent stimulus funds. The adjoining figure shows the current penetration of smart meter (AMI) in US. Even though the progress has been slower than anticipated, almost all utilities and states have plans to accelerate the deployment of smart meters. E.g. California has set a target of 100% rollout of smart meter by Q42013. We have treated the rollout of AMI infrastructure as a trend, and as such it is present in all scenarios. 4. Public policies need to incentivize everyone along the value

chain – including utilities, aggregators and end consumers.

DR participation from end consumers, specifically residential, could be better achieved by providing clear economic signal and broadening the scope to convey environmental and security constrains that limit

delivery of electricity at peak times. Public policy and regulations need to ensure that everyone in the DR value chain is equally incentivized to invest and participate in the program. We have discussed utilities and CSPs in the previous sections and now we focus on end consumers. Demand response to reduce consumption at peak times on the network has been largely aimed at and successful with industrial and commercial users. Information barriers and the lack of understanding of residential consumer behavior in responding to price signals has impeded development of effective response strategies and new enabling technologies in the residential sector. Specifically, residential customers in US today are not exposed to real cost of generating power through variable pricing. Only type of DR incentive available to residential customers is capacity based through direct load control. Addressing this economic incentive through policies would help this customer segment become more active in DR programs. In addition, price response models which are used to address peak demand do not consider other factors that enable or constrain consumption. Individual decisions to conserve energy are motivated by internal factors: intrinsic satisfaction, guilt and moral responsibilities for energy use, and commitment to conserve and external influences include socio-economic, environmental, social and legal infrastructure, and supply security [Schipper et al., 1989]. Because the objective to reduce peak demand is broad and includes environmental, security as well as other concerns, effective demand response could be achieved by broadening and possibly targeting the type of information that is conveyed to households to include environmental and security constraints. We have considered the need for public policies to equally incentivize every player in the value chain and the uncertainty attached to such policies become effective in near future in our uncertainty 1 and its sub categories such as U1-2 (Incentives for utilities to invest in efficiency) and U1-3 (Time-based pricing to reflect true costs transferred to all consumers of electricity).

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Implications

In summary, the emergence of DSM technologies can take several trajectories, depending on the interplay of complex forces and uncertainties. These interactions will play out over time, with the strong influence of several key value chain participants can influence the emergence of DSM technologies, and their vision for the future will not always be aligned. The priorities of some of the regulatory bodies - the US DOE, Regional Transmission Organizations (RTO), state governments, public utility commissions (PUC) and municipalities – are diverse and often contradictory. The role of some firms is particularly important - Utilities play the primary role of a keystone in the value chain, by providing the platform for providers of technology to reach their customers. A sustainable ecosystem is dependent on utilities providing incentives for the rest of the value chain to operate in the ecosystem to create and appropriate value over the long term. Additionally, the Commercial and Industrial (C&I) segment will lead other customer segments in adopting DSM technologies, and will have the critical impact in a majority of the scenarios. Provider firms will need to carefully ensure the value proposition for this segment which will have significant influence.

Value Chain Analysis We look at the implications for the value chain participants for each of the four scenarios from our analysis. The expected outcomes are intentionally sharpened to show distinctive worlds that the scenarios represent, and enable companies to analyze their competitive positions more clearly. The actual future may be a combination of several scenarios and thus lie somewhere in the middle.

Scenario A: The Consumer‟s Smart Grid o Demand Response becomes the key DSM technology to emerge, along with efficiency

improvements in end user appliances. o Utilities be critical in facilitating DR programs to drive consumer adoption. o DR aggregators will be successful. The ability to set aligned incentives by regulators

help keep the programs efficient and lead to strong adoption rates. o Strong participation across all consumer segments will drive innovation. Residential

consumer participation will be strongest with this scenario. o Smart appliances will help residential consumers deal with complexity of adoption. o Governments will look at incentives to cut down carbon emissions and fossil-fuel usage.

Scenario B: New Age of Micro-Grids o The value chain will become less grid-centric, and utilities will need to adjust to the

reality of micro-grids. They will not be able to control the emergence of DSM technologies, and their ability to appropriate value will be diminished.

o Infrastructure investments become important in managing supply and demand of energy, and may be the new keystone participants in the ecosystem. This scenario is the most optimistic scenario for technology providers who provide networking equipment, as well as manage energy data.

o The C&I segment will lead consumers in optimizing the match between the supply and demand of energy.

o Government regulators may need less centralization and co-ordination of policy.

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Scenario C: Nuclear is back o The utilities are largely in control. Some regions will become better than others in

structuring DR programs. However, regulatory gridlock, policy differences and the lack of well-aligned incentives may end up favoring some utilities over others.

o Infrastructure investments will be focused on reliability of energy transmission and distribution. Diminished power for infrastructure technology providers.

o Residential consumers are not strong participants. o Government policy will provide incentive structure for non-fossil fuel generation of

power. Nuclear energy will be ascendant.

Scenario D: Business goes off-grid o Utilities lose some control over the emergence of DSM technologies. They are still able

to best handle the lack of efficient regulations to support DSM. o C&I customers adapt off-grid supply options more than residential consumers

Infrastructure providers target solutions for businesses. Their ability to appropriate value is somewhat limited due to the lack of regulatory support.

o DR service providers are not able to find favorable niches. particularly since C&I customers have alternative options to consider.

o Energy efficient appliance makers do not have favorable conditions, as reliance on fossil fuels is reduced.

The advent of demand-side technologies heralds interesting possibilities for the future. The nature of this new world can be very different. Based on our scenario planning exercise, it is possible to plot four distinct end points for how DSM technologies will emerge. A better understanding of the scenarios and key policy decisions can ensure that companies can be ready for the future. The scenarios can help companies place strategic bets, improve competitive positioning, and stay alert to key changes which might suggest changing course. Further, the emergence of DSM will have dissimilar impacts across the value chain, and companies will benefit from identifying and preparing for multiple scenarios.

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Appendix A - References USDOE (2006) Benefits of Demand Response in Electricity Markets and Recommendations for achieving them Report to the United State Congress Pursuant to the Section 1252 of the Energy Policy Act of 2005, DOE, U.S. SCHIPPER, L., et al. (1989) Linking Life-Styles and Energy Use: A Matter of Time. Annual review Energy 14, 273-320. 2009 Assessment of Demand Response and Advanced Metering Staff Report, Federal Energy Regulatory Commission September 2009 Peter Cappers, Charles Goldman, and David Kathan (June 2009) Demand Response in U.S. Electricity Markets: Empirical Evidence National Action Plan for Energy Efficiency, July 2006 USDOE National Assessment of Demand Response Potential, June 2009, FERC Thomas Weisel Partners, “A Primer on the Smart Grid” equity research report Department of Energy EPAct Report to Congress, February, 2006, Introduction Federal Energy Regulatory Commission (FERC), Assessment of DR & AMI, December 2008 EUCI Demand Response Conference Proceedings, San Francisco, May 2010

“The Power of Experimentation: New evidence on Demand Response”, The Brattle Group, May, 2008

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Appendix B – Cost of Peak Power (example)

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Appendix C – Subject Matter Experts The following is a partial list of the various subject matter experts who contributed to this study in person or by telephone. Many of the interviewees did not wish to be identified by name due to the confidential nature of their firm‟s activity in many of these markets, and in such instances we have identified the type of firm alone. Sam Boutros, InThrMa, an energy management devices company Ahmad Faruqui, Ph.D., Principal, The Brattle Group, San Francisco, Consultants Stephen S. George, Ph.D., Director, Energy Practice, Freeman Sullivan & Co, Consultants John Goodin, Lead, Market Design and Regulatory Policy, California Independent System Operator, the CAISO is the operator of the California energy grid Barry Haaser, Executive Director, USnap Alliance, a home energy device technology alliance Bashar Kellow, Senior Program Manager, Demand Response Product Development, PG&E Co. Chris Knudsen, Director, Technology Innovation Center, PG&E Co., utility of Northern California Chris Lavery, Vice President, Powergetics, a small business oriented micro energy storage start up Partner, VantagePoint Venture Partners, a major venture capital firm (Confidential input) Ron Pierantozzi, Principal, Cameron Partners, a consulting firm in Pennsylvania Rich Quattrini, VP of Business Development, Energy Connect Inc, a Demand Response companySagi Rubin, Associate, Virgin Green Fund (Private Equity with investments in clean technology) Costas Spanos, Professor and Associate Chair, Department of Electrical Engineering, UC Berkeley Fred Taylor, West Region Director, Honeywell Utility Solutions, San Diego VP of Marketing at a major distributed energy source company. (Confidential input) VP of Marketing at a leading Smart Grid Communications firm (Confidential input) David Watson, Program Manager, Lawrence Berkeley National Labs David Wechsler, VP of Business Development, EnergyHub, an energy management company

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Appendix D – List of important forces

Energy demand growth will continue unabated, placing increasing pressure on the grid.

Consumers become more environmentally conscious.

Energy projects face increased environmental reviews.

Industry and technology standards for DSM emerge.

Devices and applications become more efficient.

Data becomes transparent throughout the grid. Automated Metering Infrastructure (AMI) is real.

Transmission & Distribution gets modernized.

Utilities will signal real-time prices to commercial customers.

Energy exchange markets match supply and demand

Incentives for utilities to invest in efficiency

Time-based pricing to reflect true costs transferred to all consumers of electricity

Government subsidies or tax incentives to attract capital into new DSM technologies

Revolutionary new DSM technologies become viable

Distributed generation becomes viable ( energy is generated at point of use)

Electricity Storage – distributed or utility-scale becomes viable

Consumer adoption of DSM technologies

Consumer education is successful

Expected backlash from consumers to changes in billing or usage restrictions

Consumer‟s ability to respond to dynamic prices

Effective price incentive program design

Growth of personal energy management solutions

Widespread adoption of Electric Vehicles (replacing gasoline powered vehicles)

Price of oil and other fossil fuels

Geopolitical shock to conventional energy sources

Slow decision-making by legislative bodies and utilities

Resistance to change

Risk-averse utilities delay technology change due to unfamiliarity and bureaucratic culture

Efficient regulatory oversight (fewer bodies to deal with)

All power sources are penalized for carbon emissions

Cap and Trade Legislation enacted on a global basis

Carbon taxes imposed on US coal power plants

VC firms continue to invest in cleantech technologies

Supportive government spending, tax policy, and clean energy incentives

Venture capital cycles return to normalcy