Yes, in My Backyard: Distributed Electric Power

More than four generations of U.S. residents have come to accept the notion that electricity is best produced at large centralized power plants owned by monopolies. As a result, utilities continue to be protected from market discipline, and few people challenge the wildly inaccurate assumption that the United States has already achieved maximum efficiency in producing electricity.

For the first time in almost a century, an array of innovations (including modern generators, motors, and computers) could alter the electricity industry’s basic structure. These new devices offer increased efficiency and reliability in the production and use of electricity, as well as reduced pollution. However, an array of policy barriers, built up over decades to protect utility monopolies, discourages modern technologies and entrepreneurs.

Electricity innovation is critical because the U.S. power system is a rickety antique. The average generating plant was built in 1964 using 1959 technology, and more than one-fifth of the nation’s power plants are more than 50 years old. Utilities have not improved their delivered efficiency in some 40 years, and today’s high-tech businesses demand more reliable power than the current system can provide. High-voltage transmission lines, moreover, were designed before planners ever imagined that enormous amounts of electricity would be sold across state lines, and, consequently, the distribution system often becomes overloaded, resulting in blackouts.

The consequences of the system’s inefficiencies and stresses are little noticed, yet staggering. The industry’s stagnant efficiency means that two-thirds of the fuel burned to generate electricity is wasted. Meanwhile, deficiencies in the quality and reliability of the power supply—ranging from millisecond fluctuations that destroy electronic equipment to the summer 2003 blackout that left 50 million people without power—are hurting the nation’s high-tech industry and annually costing residents $119 billion, according to the Electric Power Research Institute. Power production also is the nation’s largest source of pollution, spewing tons of mercury, sulfur dioxide, and other contaminants into the air and waters.

The efficiency limit

In fact, the U.S. power system began moving away from centralized generation almost 40 years ago, but the transition went virtually unnoticed. For the previous several decades, electrical engineers had developed boilers that could withstand enormous and increasing amounts of heat and pressure. Boilers could reach temperatures exceeding 1,050ºF and pressures above 3,200 pounds per square inch, turning water into dry steam. Utility companies had employed an array of new alloys to protect a power plant’s metal from corrosion and fatigue. They also met rising power demands with larger turbines, and they demanded that equipment manufacturers build bigger and bigger units, often without taking the time to test and learn from each incremental increase.

But progress stalled in 1967, which represented the peak in power plant efficiency. Despite continuing efforts by utility engineers, no longer would new generating equipment be more efficient than the machinery it replaced. Continued expansion would no longer mean lower prices for the consumer.

Scientists, using thermodynamic theory and calculating the limits of materials, long had predicted a steam generator’s maximum efficiency to be approximately 48%. Thus, for every 100 units of fuel burned, a power plant could generate at most 48 units of electricity. The remaining 52 units would become low-temperature heat, usually disposed of as waste into adjacent rivers or the air.

Yet even before efficiencies reached 35%, utility managers began to realize that their larger systems were not performing well. Turbine blades twisted frequently, furnaces could not maintain high temperatures, metallurgical problems became apparent in boilers and turbines, and a slew of other defects retarded reliability and performance. Large plants, because they tended to be custom-built on site rather than prefabricated in a factory, also required expensive construction techniques. A General Electric manager later admitted that the rapid growth in the size of generators and boilers caused “major failures leading to the need for costly redesigns, costly rebuilds in the fields, and the additional costs involved for purchased power.”

Power executives slowly became skeptical of giant generators, and the era of centralization waned. “Central thermal power plants stopped getting more efficient in the 1960s, bigger in the 1970s, cheaper in the ‘80s, and bought in the ‘90s,” says the Rocky Mountain Institute. Reflecting centralization’s efficiency limit, “smaller units offered greater economies from mass production than big ones could gain through unit size.”

Compared with the decades-old, efficiency-stagnant generators protected by tradition-bound utility monopolies, an array of modern equipment offers opportunities for new and innovative players to enter the electricity market. Most discussions of alternative energy strategies tend to focus on wind turbines, fuel cells, and solar photovoltaics, but numerous less “sexy” generators are challenging centralization and providing increased efficiency and decreased emissions.

One of the hottest options is cogeneration. This ingenious approach, a primitive model of which Thomas Edison employed at his Pearl Street power plant in New York City, taps the low-temperature heat that remains after electricity is generated and directs it to other uses. A cogenerator captures the usually wasted heat to warm buildings, power chillers, dry paints and materials, and run a variety of industrial processes. The benefit of cogeneration—sometimes called “combined heat and power”—is efficiency. The hybrid machines more than double the deployment of useful energy. A typical power plant producing only electricity is approximately 32% efficient, whereas a cogenerator producing both electricity and heat can be as much as 80% efficient. Despite the economic downturn between 1998 and 2002, the United States added some 31,000 megawatts of cogeneration capacity during this period— an amount equal to approximately 60 large coal-fired power plants, each producing roughly 500 megawatts. Cogenerators now supply some 82,000 megawatts of capacity, which is approximately 8.6% of U.S. generation. The Department of Energy has set a 92,000-megawatt goal for 2010 and has determined that the potential for cogeneration nationwide exceeds 200,000 megawatts.

Innovative generators also create opportunities for energy recycling. At U.S. Steel’s Gary Works along Lake Michigan, for instance, a 161-megawatt cogenerator (enough to supply a small town) is powered by the heat once released from the giant blast furnaces. At Ispat Inland’s steel-making operation in East Chicago, Illinois, a similar unit provides 95 megawatts of electricity as well as process steam. Sixteen heat-recovery boilers capture and use the waste heat from Ispat’s metallurgical coke-making facility, and a desulfurization process and fabric-filter system make the company the steel industry’s environmental standard. According to Primary Energy, the company that operates the cogenerators, recycled heat could generate a substantial 45,000 megawatts of electricity nationwide and reduce carbon dioxide pollution by 320 million tons. Says company chair Thomas Casten: “It is every bit as environmentally friendly as heat and power from renewable sources, including solar energy, wind, and biomass.”

Small generators have been used for decades, but recent technological advances have made possible a new generation of clean and highly efficient units. Improvements in truck turbochargers and hybrid electric vehicles have spurred the development of a slew of microturbines, which feature a shaft that spins at up to 100,000 revolutions per minute and drives a high-speed generator. Because microturbines use devices called recuperators to transfer heat energy from the exhaust steam back into the incoming air stream, they are far more efficient than other small combustion turbines. The recuperators also lower the exhaust temperature to the point where little nitrogen-oxide pollution is formed. Mass production should soon lower costs and make them attractive to the residential market. Microturbines range in size from 24 kilowatts (enough to power a home) to 500 kilowatts (enough to power a McDonald’s), and their operating costs are about a third of a comparable diesel generator’s. Maintenance costs also are relatively low, because microturbines have only one moving part: the high-speed shaft spinning on air bearings.

Most of these modern innovations allow for onsite, non-centralized, and relatively small-scale electricity production. Such decentralized generation avoids the typical transmission and distribution losses of 10 to 20%. It also offers consumers the opportunity to optimize their power systems, increase efficiency, lower costs, enhance productivity, and reduce emissions. Today’s dominant utility approach— centralized power plants for electricity and separate units for thermal energy to heat or cool buildings—might have made sense with the state-of-the-art generation and distribution technologies of the 1950s, but smaller and dispersed electricity systems now provide economic and environmental advantages.

The interplay of advanced technologies and inno-vation-based polices could take the power industry down divergent paths. Clarity on the dominant trends may be a few decades away, and the intervening years may witness numerous regional experiments. The Dutch, for instance, are advancing distributed generation. Iceland is moving toward a hydrogen-based economy. U.S. northeastern states are considering a trading program for carbon dioxide emissions, whereas Texas is becoming the nation’s wind-energy capital.

Differing paths notwithstanding, the most likely trend favors dispersed over centralized generation. Most of today’s technological innovations suggest a continuing shift away from an electricity system based on giant generators linked to customers by a vast transmission and distribution network. More promising is a more efficient grid that links decentralized turbines, cogenerators, energy recyclers, fuel cells, or renewable technologies. If there is no economic advantage to building giant 1,000-megawatt plants, then the flexibility offered by small facilities becomes a significant advantage.

Localized power avoids or reduces distribution bottlenecks and curtails the need for massive investments in long-distance (and unpopular) transmission lines. Some 10% of electricity is sacrificed during the typical high-voltage transmission process as a result of resistance and heat loss. During peak hours, that number rises to 20%. Thus, congestion-related losses require the construction of extra generators and lines. Although regional power grids remain needed for wholesale exchanges, the costs of line losses would shrink if electricity producers were located close to power consumers.

Harsh weather, terrorist attacks, and simple accidents have highlighted the vulnerability of the centralized power system, with its large power plants and far-flung transmission wires. In contrast, smaller dispersed units provide more security and resiliency. To state the obvious, a destroyed microgenerator has smaller impacts than damage to a nuclear reactor or high-voltage line.

A plethora of distributed generators also can provide the highly reliable and high-quality power demanded increasingly by the array of businesses that cannot afford energy disruptions. Similarly, onsite units can avoid most power outages and surges that result from problems with the grid, as evidenced in summer 2003 when Kodak’s factory in Rochester, New York, continued to operate during the massive blackout that left 50 million people without power in the Northeast and Midwest.

Perhaps decentralization’s key benefits are financial. Simply put, smaller modules are less risky economically because they take less time to devise and construct, obtain greater efficiencies, and enjoy portability. Small generators, which can be built in increments that match a changing electricity demand, allow for more reliable planning. Large units, in contrast, take several years to complete, during which time forecasts of electricity demand can shift dramatically, perhaps eliminating or reducing the need for the investment. Big plants also invariably “overshoot” by adding huge supplies that then remain idle until the expected demand “catches up.”

Even fervent distributed-generation advocates, however, do not envision the total abandonment of today’s centralized generators or long-distance transmission lines. Rather, the goal is a more equal mix of central power and distributed energy. Compared to the present system’s virtually total reliance on large plants and long lines, a mixed approach would provide substantial economic, environmental, and security benefits. The American Gas Association forecasts that by 2020, small distributed generators will account for 20% of the nation’s new electric capacity.

Although the U.S. market for distributed generation is substantial, perhaps the greatest potential is with the world’s 3 billion poor people who have no reliable access to electricity. Onsite generators can save the $1,500 per kilowatt that developing countries would be required to spend on transmission lines. They could enable those nations to leapfrog the power grid, eliminating the need to build an expensive system based on giant generators and high-voltage wires, much the same way in which some countries are using cell phone technology to leapfrog the need to string expensive telephone landlines. If electricity consumption in developing countries continues to rise rapidly, then dispersed technologies, including gas turbines, recycled energy, wind turbines, and fuel cells, also may be the best means to minimize carbon dioxide emissions and limit demand for oil and natural gas from the world’s volatile regions. From the U.S. perspective, developing countries also could become a large export market for innovative companies.

Removing policy barriers

Despite the many and varied benefits that modern technologies can bring to the nation’s electric system, scores of laws and regulations protect old-line monopolies and lock out the most promising innovations. What is needed is a policy revolution that removes the barriers to these technological advances and obtains innovation’s benefits.

The chief barrier-busting proponents have been independent generators (who want to enter the electricity business), industrial and commercial customers (who want to shop for lower-priced power), and economists (who favor the marketplace over regulation). Some of the manufacturers of onsite generators and some industrial customers, such as Caterpillar and Dow Chemical, respectively, are huge and enjoy substantial political clout, yet these innovation advocates have not been able to match the muscle of well-funded and well-positioned monopolists and their supporters. Relative to the innovative new companies in the telecommunications, airline, and trucking industries, independent generators have made only limited progress on the policy front.

Competition advocates enjoyed their first success in 1978 with passage of the Public Utility Regulatory Policies Act, which enabled cogenerators and renewable energy suppliers to sell electricity to regulated utilities. In the mid-1980s, deregulating the natural gas market lowered the price and increased the availability of that relatively clean fuel. The Energy Policy Act of 1992 and subsequent rulings by the Federal Energy Regulatory Commission (FERC) allowed unregulated independent generators to sell wholesale power over the grid to distant customers.

Competition opponents, however, point to California’s 2001 electricity disaster, when prices skyrocketed and the state’s largest utility declared bankruptcy. Yet that state’s power industry “restructuring” resulted largely from ill-considered political deals made in the mid-1990s that tried to appease virtually every interest group. The compromises may have produced a unanimous vote in the state legislature in 1996, but in hindsight, according Paul Joskow, an economics professor at the Massachusetts Institute of Technology,“getting it done fast and in a way that pandered to the many interests involved became more important that getting it right. The end result was the most complicated set of wholesale electricity market institutions ever created on earth and with which there was no real-world experience.” According to the Congressional Budget Office, “Deregulation itself [in California] did not fail; rather, it was never achieved.”

In trying to prevent any one company from obtaining too much market control, for instance, California politicians restricted long-term power contracts and forced all generators to deal in the volatile spot market. Electricity suppliers, therefore, had to hash out prices daily in a centralized power exchange, which mandated that utilities pay the highest price offered on any given day. Clever marketers soon learned how to “game” the system, concocting “round-trip” trades that sent power back and forth across state lines in order to inflate sales volumes and artificially drive up short-term prices. Unable to pass on the higher costs, Pacific Gas & Electric, the state’s largest utility, filed for bankruptcy, and the state’s other two utilities teetered. Rolling blackouts became common, forcing motorists to navigate intersections without traffic lights and consumers to use flashlights at grocery stores.

Other states, in contrast, have realigned their power industries and obtained positive results. Texas, for instance, allows distribution utilities to purchase power through long-term contracts as well as on the spot market. That flexibility and the efforts by state officials to resolve constraint points have produced a vibrant electricity market that embraces innovative technologies. In 2004, independent suppliers in Texas offered 60% of the electricity used by commercial and industrial customers and 14% of the power demanded by residential consumers. Pennsylvania officials, who also allow long-term contracts and attack barriers to competition, calculate that the state’s restructuring efforts have saved residential and industrial customers some $8 billion.

The shift to innovation will take time, and establishing market rules will require a good bit of trial and error. Electricity markets do not occur naturally; rather, they are developed. With natural gas deregulation, the FERC went through numerous revisions over seven years before effectively opening access to alternative natural gas suppliers.

Innovation-enhancing markets will require the elimination of numerous regulatory, financial, and environmental obstacles. Current rules designed to support the status quo—centralized steam-powered generators controlled by regulated monopolies—include restrictive standards regarding interconnection standards and outmoded equipment-depreciation schedules. Dominant power companies, for instance, often block competitors from connecting to the grid or impose obsolete and prohibitively expensive interconnection standards and metering requirements that have no relation to safety. Depreciation schedules for electricity-generating equipment (which are, on average, three times longer than those for similar-sized manufacturing equipment) discourage the introduction of innovative technologies that spur efficiency and productivity.

Today’s utility monopolies, moreover, enjoy the sole right to string wires. Although private firms can construct natural-gas pipelines, and developers can build telephone lines, steam tunnels, and Internet extensions to their neighboring buildings, anyone running an electric wire across a street will be sent to jail. If the rules changed, few businesses would be likely to construct their own electric lines, just as there are few independent gas pipelines. But the threat of competitive wires would transform the power industry and end the monopolies’ ability to block entrepreneurs from generating their own electricity.

Utilities, in order to protect their monopolies, also impose exorbitant rates for backup power, which most entrepreneurs need because they regularly buy and sell on the grid. Distribution monopolists typically assume that every single independent generator will be out of service at the very same time, thereby having independent generators demand backup power when it is most rare and expensive. The monopolist’s high backup rates are comparable to a home insurance company trying to set its annual premium at a house’s full replacement price.

Environmental laws must change as well if energy efficiency is to be achieved. The United States currently measures air emissions based on fuel inputs, usually stated as pounds of pollutants per unit of fuel. Unfortunately, this input-based approach rewards power plants that burn a lot of fuel, regardless of their efficiency. In contrast, output-based regulations would calculate emissions based on the amount of electricity generated, thereby rewarding innovative generators that supply more electricity with reduced emissions.

With assets exceeding $600 billion and annual sales above $260 billion, electric utilities are the nation’s largest industry. No doubt restructuring such a behemoth is difficult, the obstacles to change are formidable, and most utility monopolies are working aggressively to remain protected from entrepreneurs.

But given its rickety nature, the U.S. electricity system must change. Innovation’s environmental benefits alone are critical, because power plants spew almost half of all North American industrial air pollutants, and 46 of the top 50 emitters are electricity generators. In contrast, new gas turbines emit 500 times less nitrogen oxide per kilowatt-hour than today’s older power plants.

Businesses also increasingly need more reliable power than the status quo can provide. Hewlett-Packard estimates that a 15-minute outage at one of its chip manufacturing facilities would cost $30 million, or half the plant’s annual power budget. According to a microchip executive, “My local utility tells me they only had 20 minutes of outages all year. I remind them that these four five-minute episodes interrupted my process, shut down and burnt out some of my controls, idled my workforce. I had to call in my control service firm, call in my computer repair firm, direct my employees to ‘test’ the system. They cost me eight days and millions of dollars.” No wonder more and more corporations are installing their own onsite generators in order to control costs and increase security. The First National Bank of Omaha, for instance, purchased stacks of fuel cells after the local utility’s one-hour power outage shut down its data processing network at a cost of $6 million.

Many other developed countries have promoted entrepreneurs over monopolists, and they are enjoying numerous benefits. In the four years since Australia restructured its utilities, wholesale power prices fell 32% in real terms, and air quality improved. Six years after the United Kingdom began to deregulate electricity sales and to shift from coal to natural gas, carbon dioxide emissions from power generation fell 39% and nitrogen oxides 51%. Even limited competition in the United States since the Public Utility Regulatory Policies Act of 1968 helped prompt a 32% drop in wholesale electricity prices.

Unless the United States further alters today’s centralized and monopolized paradigm, when the rest of the world electrifies and begins to enjoy the drudgery-reducing benefits of modern appliances, the resulting environmental damage will be staggering. The nation has a moral obligation, therefore, both to help provide power to the world’s poor and to radically alter the ways in which electricity is generated and delivered.

Timing is critical if the United States is to capture additional economic and environmental benefits. In the next several years, much of the nation’s aging electrical, mechanical, and thermal infrastructure will need to be replaced, offering a unique opportunity to substitute efficient generators for outmoded power plants and old industrial boilers.

Maintaining the status quo is no longer an option, in part because the current monopoly-based structure has forced U.S. residents to spend far more than needed on outmoded and polluting energy services. Achieving the benefits of innovation requires the elimination of numerous regulatory, financial, and legal barriers. If policymakers can restructure the electricity industry based on the principles of technology modernization, market efficiency, and consumer choice, they will bring about immense benefits for both the economy and the environment.