How much thought have you given to your electricity consumption? If it hasn’t gone beyond “I flip the switch and the light comes on,” you’re not alone, which is one of many reasons electricity usage in the United States is inefficient. But that’s beginning to change.

The digital communication technology revolution that has created mass productivity gains throughout the economy during the last 20 years is finally creeping into the electricity industry as well, under the broad moniker of the “smart grid.” The basic concept of the smart grid is to replace the faceless, impersonal “grid” of networked electricity delivery with a transparent, interactive system that allows users to see and select from pricing choices in near-real time. President Barack Obama included
$4.5 billion in smart grid subsidies in the stimulus package Congress enacted in February. But absent substantial regulatory reform, mostly at the state level, such federal spending may simply reinforce a century-old model that is all but obsolete.

Imagine a future in which your home has a system that connects all its appliances, entertainment systems, heating and cooling, laundry, and lighting into one communication network. The network would be accessible through a computer screen or a Web-based portal. Through this interface, your electricity company would communicate real-time information about how much electricity you’re consuming, the price you’re paying at different times of the day, and whether the juice is coming from renewable or conventional sources.

Using that information, you could change the settings on your various devices in response to prices. If you knew that you could save money by lowering the temperature of your water heater five degrees when the price per kilowatt hour increases from nine to 12 cents, you would be more likely to lower the temperature of your water heater. Furthermore, if you could program your appliances to take care of the price response work for you, you’d be even more likely to do it. And once plug-in electric vehicles become more widespread, you could set up your home network to charge the car during less expensive, off-peak hours, and maybe even sell your excess energy to neighbors when prices are high, since electric vehicles are essentially energy storage devices.

Such systems are becoming increasingly feasible as information technology costs fall. Intelligent devices such as your thermostat, water heater, television, and plug-in vehicle all have digital communication capabilities and can be programmed to respond autonomously to data, including price signals. An in-home system networking these machines could cost as little as $250, with costs going up as sophistication and functionality increase. Having extra intelligence embedded in devices could add, say, $25 to the price of a clothes dryer, to judge from estimates from the production of such dryers for the GridWise Olympic Peninsula testbed project. Home electricity management systems are being developed and will be on the market in the next several years.

The key piece of network infrastructure that’s making it easier and cheaper to get data to and from such in-home systems is a “smart meter.” A simple digital meter that communicates only with the utility company can cost as little as $50. More sophisticated meters that talk with both the utility and individual customers can cost as much as $300.

The ability to communicate from customer to utility and back will benefit consumers by helping them save money, buy new energy-saving products and services, and reduce their environmental impact. But to make this vision a reality will require regulatory reform, particularly at the state level. Utility regulation has long been based on the now-obsolete idea that electric power generation and delivery is a natural monopoly. Consequently, state regulators have granted most utilities a monopoly over the retail sale of electricity products and services within a geographical area, as well as a monopoly over the construction of distribution wires across public rights of way.

The most crucial regulatory reform would be eliminating the single, fixed retail rate for most consumer electricity consumption. In February, Obama pledged to install 40 million smart meters in homes. But it doesn’t matter how smart these meters are if homeowners are going to get charged the same old flat rates. Customers need to know how prices vary over hours, days, and seasons. With that information they can decide how much energy to buy and when. Smart technology makes responding to changes in price as easy as scheduling your DVR to record your favorite TV show.

Some regions already have a rudimentary form of a smart grid in which customers can respond to some prices. One variant called “time of use” lets consumers know in advance what prices will be during certain hours. But the pricing choices offered by real retail competition is rare. In a large number of pilot projects, including the California Statewide Pricing Pilot and the GridWise Olympic Peninsula project, customers typically save 10 to 20 percent on their electricity bills and reduce their peak electricity consumption by 12 to 15 percent. But the bulk of residential customers still pay fixed prices that are calculated by regulators to cover the costs of the utility plus a profit margin.

In such a heavily regulated environment, smart devices offer little if any value to consumers. Technological innovation and regulatory innovation must go hand in hand.

In fact, regulation is the chief reason why the electric power industry is so technologically backward to begin with. Since utilities are regulated monopolies, they don’t usually receive strong price signals telling them whether an investment is a good or bad idea. Instead, regulators decide which investments are prudent on consumers’ behalf. Regulators can decide that a utility’s investment in a groundbreaking new facility or technology is imprudent after it’s already been built. Naturally this process makes utility executives (and regulators) conservative; it’s just safer to build what has been previously approved.

The long time frame over which utility assets depreciate reinforces that conservatism. Many utilities, for example, still use analog electricity meters that are more than 50 years old, despite the many advantages promised by two-way digital communication. While electric utilities remain mired in regulatory backwaters, many other industries, from travel to retail sales, have been embracing new technologies to enhance communication with customers. The result has been the creation of new products and services, faster economic growth, higher profits for producers, and improved wellbeing for consumers.

Regulated utilities are also accustomed to having control. As owners of power generation plants and electric distribution wires, they have been managing the power network using top-down hierarchical control for almost a century. Not surprisingly, they want to use the new smart grid capabilities for “direct load control”—shutting down your air conditioner from afar during peak hours, in return for which they would offer you a rebate.

Keeping the electricity grid physically balanced in terms of frequency and voltage prevents blackouts (which cost about $160 billion per year) and is the primary performance metric on which utilities are evaluated. While some consumers are OK with having the power company manipulate their air conditioners, others find it downright Orwellian. But the same outcome could be achieved by allowing consumers to receive and respond to real-time price signals themselves, instead of just leaving it all up to the producer. Decentralized coordination is ultimately more efficient and empowering than imposed control.

So what about Obama’s smart grid funding? It’s likely to be spent as wastefully as your average government subsidy for technology and industry (see “It’s Alive!” page 22). But the plan might have two benign effects. First, it will induce utilities to make technology investments that might be profitable if not for the perverse incentives created by regulation. Using government spending to achieve this outcome is a way of remedying one policy-induced distortion with another, but in the existing regulatory environment this might be a politically palatable way to overcome the stifling, regulation-induced inertia of both the regulators and the regulated. Second, by reducing the cost of information flow to and from consumers, smart grid subsidies may contribute to the erosion and ultimate disappearance of state-level regulatory barriers to retail competition. Telecommunication deregulation sprang from similarly modest roots.

The obsolete electro-mechanical electric power network, built by and for a monopoly industry, cannot support the kind of growth experienced during the last 20 years in so many other industries. All that stands in the way of vibrant, customerfriendly electricity products and services is an outdated infrastructure run by hesitant monopolies and regulated by bureaucrats with little incentive to improve things. We can do smarter.

Lynne Kiesling (lynne@knowledgeproblem.com) is a senior lecturer in the Department of Economics and the Kellogg School of Management at Northwestern University, and a member of the GridWise Architecture Council. She blogs at knowledgeproblem.com.