Assessing the Challenges Confronting Distributive Electricity Generation

What role will distributive electricity technologies play in meeting future demand? Policy makers are divided on the answer.  For some, these technologies represent the foundations from which a decentralized electricity system could be established––one in which small, clean generating systems gradually replace the existing system of large centralized power stations. To others, they represent an alternative to the siting and permitting problems that have plagued the construction of new transmission systems, while simultaneously realizing the high reliability standards required in an era of growing reliance on computing and communication technologies. To others still, distributive generation is seen as simply an economic alternative to meeting power needs. Finally there are skeptics who believe that smaller generators will never be as efficient or cost effective as larger centralized technologies.

To determine which of these scenarios is more likely to emerge, the paper poses two questions. What are the factors that will determine the competitiveness of distributive generation technologies, as opposed to electricity purchased from the existing centralized system? What do these factors tell us about the role of distributive generation technologies in the electricity commodity market over the near and mid-term?

The paper concludes that distributive generation technologies will have to dramatically improve their efficiency and reduce their costs if they are to become competitive with power purchased from the grid. Furthermore, even if over the next decade these technologies can be dramatically improved, centralized power technologies will also improve. In other words, distributive generation technologies are competing against a moving target.

But is the electricity commodity market the competitive battleground for distributive generation? The probable answer is no. There are several niche markets that are evolving quite rapidly and these could provide significant opportunities. Combined heat and power systems are already being installed by commercial and industrial users in many parts of the country. However, their competitive advantage is that they produce both heat and power simultaneously, not that they produce either one more economically. Another possible niche is ancillary electricity services such as increased reliability, emergency back-up power, and voltage support.  The demand for these services is growing, and distributive generation could play a significant role in each.  However, this marketplace is characterized by fierce competition from other emerging technologies, including demand-side management tools and new types of power storage equipment.

Finally, in some localities the proposed changes in the design of electricity markets could have far-reaching effects on the seasonal and hourly price of power. These prices will be volatile and will fluctuate in both the long and short term as demand patterns change and new investments are made. These new market rules could provide interesting opportunities for distributive technologies, but investors will have to examine power markets in a much more sophisticated fashion in order to evaluate the potential benefits.

Why Are Distributive Generation Technologies Unlikely To Be Competitive In The Electricity Commodity Market?

First, distributive generation technologies have capital costs that are approximately double those of the newest central generation stations.

Second, today’s gas-fired distributive generators, such as microturbines, have an efficiency rate that is about half that of a new gas-fired central plant.  For microturbines to be competitive with grid based retail power priced at 12 cents, they would have to improve their efficiency level by approximately 50%. Some emerging technologies, such as fuel cell technologies, are likely to reach––if not exceed––those efficiency levels. But these technologies are not presently available.

Third, distributive technologies are small and thus operators must purchase their natural gas as commercial or small industrial customers. Central stations can buy their gas in bulk at much cheaper rates and often can bypass the distribution system and obtain their gas directly from the main transmission line.  Anecdotal evidence suggests that this price differential may actually increase as gas companies upgrade their distribution networks to meet both growing demands and the requirements of new gas-fueled equipment.

Fourth, while newer fuel-based distributive generation options emit conventional pollution at levels that are comparable to those reached by new central stations, their low efficiency levels result in much higher carbon emissions per unit of electricity generated.

Finally, regulators and public officials are likely to resist any effort by customers to bypass the social costs of providing electricity to the broad population. These costs are embodied in electricity rates as a surplus charge on the wires. Thus efforts to leave the system and self-generate will require some type of payment to cover these “social costs.” This additional cost must be factored into any comparative economic analysis.

Additional Research

Fuel cell technologies may change this competitive balance, but their potential must be assessed not in comparison with today’s central generating stations, but in comparison with generating options that will become available in the next decade. What will be the likely capital costs, efficiency levels, and emissions levels of central electric generation alternatives for facilities built in 2010 and what improvements would be needed if distributive technologies were to be competitive with these facilities?

While there have been many studies of future gas supplies and needed improvements in the interstate gas transmission systems, there has been very little analysis of the capability of the gas distribution system to meet the needs created by the emergence of new technologies, such as fuel cells.

Finally, assuming the Federal Energy Regulatory Commission is successful in persuading the states and the electricity industry to adopt its recommendations for new transmission pricing rules and a standard market design, how will these changes affect future markets for distributive technologies? Under these new rules both suppliers and consumers will face new incentives. The character of these incentives and how the parties will respond to them will have a significant impact on the future market for distributive generation.