Utilities can meet customer demand and reap new revenues by finding ways to deliver distributed energy resources (DER), but there is a more urgent reason for them to buy in.
At present growth rates, five types of DER — distributed solar, combined heat and power, smart thermostats, electric vehicles and battery storage — will provide enough cumulative capacity by the early 2020s to flatten power sector peak demand, according to 2018 data from GTM Research. Capitalizing on this growth of customer-owned generation through their unregulated subsidiaries, utility holding companies can transform their business, according to Boston Consulting Group (BCG).
"This growing but fragmented market represents a huge opportunity," a March 2019 BCG white paper reported. "With few DER market leaders so far, power companies that strike quickly" through unregulated subsidiaries "can rapidly realize a competitive edge."
The core regulated utility business of selling electrons "is already being eroded by DER growth and the resulting declining loads," BCG Partner and paper co-author Thomas Baker told Utility Dive. "Utilities need to look at the potential value streams in new DER opportunities because those that focus solely on central station fossil fuel generation will not survive."
Utilities are clearly beginning to see the opportunity and the need to seize it. What is not yet clear is whether utilities and DER providers can overcome the cultural differences between innovative startups and cautious institutions to work together effectively.
An unproven strategy
A utility buy-in on DER may be an idea whose time has come, but the best way to do it is far from clear.
Utility holding companies can form unregulated subsidiaries alongside their regulated utilities and use merger and acquisition (M&A) strategies to acquire established DER providers, Baker said. But "it remains to be proven that this M&A strategy will deliver success," he acknowledged.
Using M&A strategies "is not a new idea, but it may be a good idea for utilities," Raj Prabhu, CEO of Mercom Capital Group, which has provided clean energy market research and consulting since 2010, told Utility Dive.
"They can develop technologies on their own, but that has risk," he said. "The alternative is investing in technology providers, either through M&A or by funding a pilot. It is not yet clear which works best."
"[R]egulated utilities have monopoly thinking deeply embedded in their DNA, and will inevitably crowd out competitive market actors, which is not good for customers or for markets."
Co-founder, Revision Energy
It is also not clear that DER providers and their customers will welcome utilities.
"If I were a utility shareholder, I certainly would want leadership to make these investments rather than ride last century's business model down in flames," Fortunat Mueller, co-founder of Revision Energy, a DER provider in Maine, New Hampshire and Massachusetts, emailed Utility Dive.
And utilities willing to compete "on a level playing field" are welcome, Mueller said. "But regulated utilities have monopoly thinking deeply embedded in their DNA, and will inevitably crowd out competitive market actors, which is not good for customers or for markets."
The best path for utilities
Utility leaders know their customers want DER, surveys of executives show. Strategic acquisition of DER providers is the surest way for them to deliver DER, according to BCG.
The DER market is "wide-open," BCG reported. About 75% of the roughly $80 billion in U.S. and EU market revenues come from companies other than the leading DER providers. In this "still immature and fragmented" marketplace, utilities can get "first-mover advantages and become dominant in a segment that promises to soon become as palatable to consumers as the traditional power segment."
For most utilities, "acquiring DER players that already have a market footprint is the only option that makes sense," BCG added. Things are changing too much and too fast for "homemade solutions" and most power companies "lack the capabilities" to market and deploy DER technologies.
"Most DER providers would welcome an acquisition as an exit for investors at a profit that gives the DER company access to skill, technology, and capital they often struggle to have."
Partner, Boston Consulting Group
Through M&A deals, utilities can acquire DER providers with "complementary offerings" that allow them to "aggressively grab market share."
In today's DER marketplace, many of the important innovators "are ripe for acquisition because they don't have the size or maturity to defend against an acquisition," BCG's Baker said. "And most DER providers would welcome an acquisition as an exit for investors at a profit that gives the DER company access to skill, technology and capital they often struggle to have."
Examples that appear to be working are the 2015 Duke Energy Renewables acquisitions of commercial-industrial (C&I) solar installer REC Solar and C&I energy management system provider Phoenix Energy Technologies.
Duke acquired these companies "to gain knowledge of the DER space" and as a way to get "a foothold in this growing market," and they have "met our objectives," Duke spokesperson Jennifer Garber emailed Utility Dive.
The distributed businesses have proven "complementary" to the unregulated division's utility-scale renewables business, Garber said. And they have "opened doors with new large corporate customers" to "new opportunities that may not have been available to us."
Duke continues to look for new opportunities but is not planning further acquisitions, she added. "We believe we have the right portfolio for where and how we want to compete in the DER market."
Minimal data is available to validate the profitability of M&A transactions in the DER space, Mercom's Prabhu and BCG's Baker agreed. Once acquired, smaller companies tend to be folded into the larger companies' financials.
"DER M&A is about acquiring new technologies."
"Most DER acquisitions are less than three years old, which is not enough time to make the case" that they will be profitable, BCG's Baker said. But the value is not purely financial. Synergies should allow the acquired company to scale and lower costs through the holding company's balance sheet. And the holding company should gain an understanding of emerging technologies.
REC's partnership with Duke has delivered those synergies, including "better pricing for our parts and services by leveraging Duke Energy Renewables' economies of scale," REC Solar spokesperson Ann Kroll emailed Utility Dive. REC can also now provide "a wider set of solutions," including utility-scale renewables and solar-plus-storage, and can "recruit and retain" top tier personnel.
The best example of success in renewables acquisitions is NextEra Energy's transformation from a holding company for Florida Power and Light, Baker said. As much as 60% of its income now comes through deregulated investments in utility-scale renewables, transmission line development and publicly traded bonds.
But those are not DER acquisitions, they are acquisitions of large-scale renewables generation and the transmission projects to serve them, Mercom's Prabhu said.
"DER M&A is about acquiring new technologies" and it is "not yet clear" that M&A is the most cost-effective way for utilities to deliver new technologies to their customers, he added.
Prabhu offered some data to show the lack of clarity about DER M&A.
Distributed solar M&A deals "are increasing a little every year," Prabhu said. They went steadily up from 68 in 2016 to 82 in 2018, globally. Early 2019 data suggests this will continue.
But M&A deals in battery storage bobbed from 10 to 3 to 16 from 2016 to 2018. Smart grid technology M&As zoomed from 15 in 2016 to 27 in 2017, then flopped to 12 in 2018. In energy efficiency, deals fell steadily from 14 in 2016 to 7 in 2018.
These sectors are made up mostly of new and small companies and few are mature enough or valuable enough to be acquired, Prabhu said. He speculated that the M&A numbers in smart grid technologies and energy efficiency went down as M&As in battery storage increased because deals with potential in the first two areas were exhausted "just as battery companies became ripe for acquisition."
"Funding a pilot, in partnership with others, to see if the technology works, is low-risk and methodical. For utilities who see themselves as behind the curve, M&A might be a faster way to catch up."
Utilities, like venture capital companies, rarely invest alone, but instead acquire technology providers with other utilities or private equity investors, Prabhu said. "They prefer spreading the risk."
An example is Energy Impact Partners, a multi-hundred million dollar fund created by a group of utilities in 2018, he said. It includes Southern Company, Xcel Energy and many others and has acquired 18 DER providers.
An alternative is to fund, or co-fund, a pilot project, Prabhu said. "Funding a pilot, in partnership with others, to see if the technology works, is low-risk and methodical. For utilities who see themselves as behind the curve, M&A might be a faster way to catch up."
Acquisition doesn't guarantee success, BCG's Baker acknowledged. "The DER market is incredibly competitive and immature and there are winning and losing business models."
The Hawaiian Electric Industries (HEI) plan to market distributed solar at the turn of this century was not a clear example of a winning or a losing business model, according to two people who participated. But it is a clear example of challenges utilities face in the DER space.
Reasons M&As might not work
Differences in culture and market perspectives between utilities and DER providers have often kept mergers from working smoothly. And there is evidence the trend toward greater regulatory oversight will make them more difficult.
Beginning in 2000, HEI added ProVision Technologies, an unregulated subsidiary, to enter the incipient off-grid distributed solar market on Hawaii's big island, according to Marco Mangelsdorf, who helped start the subsidiary. Mangelsdorf is now President of the private sector ProVision Solar, which he acquired from HEI and renamed in 2009.
"The plan was for ProVision to eventually expand into the Pacific Rim area," Mangelsdorf told Utility Dive. "That was before Hawaii offered net energy metering (NEM) in 2001 and before grid-tied solar picked up in Hawaii after 2008."
The subsidiary lost "over $200,000 per year, and after two years, HEI decided to cut its losses," Mangelsdorf recalled. "They did not seem to see that losing money can be part of the path to profitability for acquisitions."
Solar industry consultant Steve Burns was head of integrated resource planning for HEI's regulated utility on the big island and worked with ProVision. Solar in Hawaii "could have been different" if HEI had waited longer, he told Utility Dive. "It is a successful private company today, but it doesn't have the same financial backing. Big things could have been done."
"Now, a holding company can bury a subsidiary's losses for some time, but smaller installers may not let regulators give that kind of advantage to a utility in today's highly competitive solar market."
Mangelsdorf's Provision Solar was recently underbid on a project in Hawaii by REC Solar, he said. "I need a certain profit margin to survive but REC has Duke's much larger balance sheet and can afford to make a leaner, meaner bid."
HEI may also learn with Pacific Current, its new deregulated venture, that regulators are now more cautious about the potential for anti-competitive abuses when a company has both regulated and unregulated subsidiaries, he added. "Now, a holding company can bury a subsidiary's losses for some time, but smaller installers may not let regulators give that kind of advantage to a utility in today's highly competitive solar market."
Former utility executive Burns likes the idea of utilities investing in distributed generation. But deals must be scrutinized by regulators because utility subsidiaries "probably have ten times the capital of their private sector competitors," he said. "Finding ways for utilities to participate can be a win-win, but it will be challenging to figure that out."
Another obstacle is that "smaller, newer DER providers with startup cultures may not plug in easily to the 120-year-old utility industry's organizational culture," BCG's Baker said. "That tension can hamper success."
And "there may be something structural about some DER businesses that prevents scaling, because national rooftop solar installers often do not always beat strong local installers," he added. Rooftop solar "may be more like the plumbing and roofing businesses" in that they can be more effective at a smaller scale. And the residential battery storage business "may be like rooftop solar when standardization makes it more plug and play."
"Putting a toe in the water of the DER market, as many large utilities and even oil and gas companies are doing, is unlikely to deliver sustainable success in the competitive DER segment."
Boston Consulting Group
Some pitfalls can be avoided. Before an acquisition, both parties should be clear about their goals and have a plan to integrate the DER provider's "innovative spirit" into the acquirer's more rigid culture, BCG said. "Putting a toe in the water of the DER market, as many large utilities and even oil and gas companies are doing, is unlikely to deliver sustainable success in the competitive DER segment."
The biggest obstacle may be the kind of opposition from incumbent private providers during the regulatory process which Mangelsdorf foresees in Hawaii for Pacific Currents.
Customers are better served by free DER market competition because it "leads to more dynamic markets, more creative solutions, and ultimately to superior customer value propositions," Revision Energy's Mueller said. Utilities have "the capital and expertise to move the market," but regulators must "protect markets from their unfair advantages."
Until recently, dominant power market incumbents "could afford to be casual onlookers," BCG reported. "That wait-and-see period for large power companies has ended — perhaps sooner than anyone expected."
DER providers interviewed for this story agreed.
Rapid evolution has made DER technologies more capable at lower costs, and "power companies must drastically change their strategic calculus," BCG warned. DER disruption is coming, and M&A is "a weapon that's too powerful for smart, established power companies to ignore."
Correction: An earlier version of this article misnamed the unregulated company that HEI founded. HEI founded ProVision Technologies and Mangelsdorf changed the name to ProVision Solar in 2009.