The Energy Market Faces Creative Destruction

As more people get their power via solar, public utilities are threatened because the cost of the old energy system will fall on a diminishing number of people

Never underestimate the power of creative destruction—what economist Joseph Schumpeter called capitalism's "essential fact." The pages of history are littered with the skeletons of industries left behind by innovation.

Public utilities certainly are not underestimating it. As a recent Washington Post story put it, power company executives consider rooftop solar systems "a grave new threat" to the electricity industry.

In theory, the threat is simple: As more people get their energy from solar power arrays, the cost of the old system—all the generation plants and transmission lines and fuel and so on—will fall on a diminishing number of utility customers. Those customers will then have a rising financial incentive to go solar themselves, cutting the number of ratepayers even further, and so on—a death spiral for traditional utilities.

Scenarios like that lead to stories like this, from Forbes: "Distributed Generation Poses Existential Threat to Utilities." And this, from Business Week: "Why the U.S. Power Grid's Days Are Numbered." That article quotes David Crane, the CEO of the wholesale power company NRG Energy, who predicts that "utilities will continue to serve the elderly or the less fortunate, but the rest of the population moves on."

Two years ago, the Edison Electric Institute, the trade group of the power industry, produced its own report on the "Disruptive Challenges" posed by distributed generation (i.e., the production of electric power from lots of little sources rather than a handful of big ones). It noted, among other things, the precipitous decline in the cost of solar photovoltaic cells, as well as policies such as net metering, which allows solar-power users to sell any extra juice back to utility companies—often at rates far higher than the utilities would have to charge for the same number of kilowatts.

When might all of this happen? Not tomorrow. At present, the biggest impediment to solar power is its intermittency: Sometimes it's sunny, but mostly it's not. And power storage is a huge problem. Without quantum leaps forward in battery technology, solar users will always have to be plugged into the grid.

But quantum technological leaps happen all the time. Hence even Edison "can imagine a day when battery storage technology or microturbines could allow customers to be grid independent." After all: "Who would have believed 10 years ago that traditional wire-line telephone customers could economically 'cut the cord?'"

Given the rise of micromarkets in information (think blogs), lodging (think Airbnb) and transportation (think Uber), it's even possible individual homeowners might someday buy and sell electricity among themselves without using the utility companies as intermediaries. Possible, yes, but how likely?

That would depend on a number of factors. Power generation and distribution are immensely complex, and Virginia's last effort to deregulate the system, in 1999, didn't turn out so well. (This was partly owing to the way Virginia went about it—e.g., by imposing rate caps and artificial walls between generation and distribution.) And that deregulation effort was ridiculously simple compared to a system that would allow every consumer to be a supplier as well.

There are also big technological hurdles. Utilities have to be able to ensure that every consumer receives precisely the amount of electricity she needs at every moment throughout the day—and to be able to make supply adjustments instantaneously as she turns lights, appliances, and devices on and off. They have to switch from one constant load to another, perfectly and instantly, every time.

That's hard enough to do for one customer, but utilities have to do it for everyone. What's more, the electricity has to be delivered in the proper form, or it could damage appliances. And solar power makes delivering it even more difficult by increasing the variability of consumer demand. As a piece in Foreign Affairs points out, a quarter-century ago, peak electricity demand was 55 percent higher than average demand. By 2030, it will be 90 percent higher.

But the real obstacle is economic. As the Foreign Affairs article notes, at present going off-grid "would require four times as many (solar) panels as a net-zero household has and tens of thousands of dollars in batteries." Still, assume for the sake of argument that battery technology improves even faster than, say, computing power has. Eventually, it could become economical for at least some homeowners to cut their power cord completely.

But this also assumes that the power companies will stand still while the competition evolves. That's highly unlikely; Verizon didn't just stick with landline telephone service as cellular service blossomed, after all.

If non-subsidized solar and battery technology become cheap enough for widespread consumer use, then presumably they will be even cheaper for industrial utilities, owing to economies of scale. In that case, buying solar-generated power from Dominion or another power company would involve far less hassle than installing your own solar panels, batteries, inverters, and so on.

Some consumers, of course, will want to get off the grid anyway—just as some consumers prefer to grow their own vegetables, or buy them at a farmer's market, rather than buy them at the grocery store. Many others will prefer to stick with their old, reliable utility service. Neither option is inherently superior. But it will be nice to have the choice.