Who Wins with the Smart Grid?
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Economics Policy Aug 3, 2012

Who Wins with the Smart Grid?

Uncertain economics cloud the grid’s future

Based on the research of

Luciano de Castro

Joísa Dutra

The phrase “smart grid” connotes an alluring, wired, high-tech future. A future pulsing with the promise of a better tomorrow slickly packaged in cutting-edge technology—technology that seems to offer something advantageous for everyone.

The smart grid promises to transform our country’s hodge-podge of aging electrical infrastructure into a sleek twenty-first-century entity, one complete with computerization, communications, and sensors to regulate and monitor the production, transmission, and consumption of electricity.

The anticipated benefits are magnetizing: consumers expect the smart grid will free them from fears of blackouts and sky-high electrical bills through improved reliability and real-time feedback about their energy use. Electricity producers and distributors expect to see costs shrink while efficiency and profits swell. Even environmentalists are happy with the expectation that the smart grid will more easily accommodate renewable energy sources like wind and solar.

Sounds like everyone will win, right? Not so fast. A new study predicts that the shift to the smart grid may generate some losers—some of which may surprise you.

Who Loses?
Luciano de Castro, an assistant professor of managerial economics and decision sciences at the Kellogg School of Management, and his co-author Joísa Dutra, an economist with the Getulio Vargas Foundation in Brazil, say demand response initiatives—key components of the smart grid—may not benefit some consumers and may even harm some electricity producers.

Demand response encompasses a system of sensors that alert consumers when peak energy demands are placed on the electrical grid. These sensors may display real-time or next-day pricing that informs the consumer as to the best time for running the laundry or dishwasher. Some sensors may even shut off unnecessary appliances during peak demand hours.

This may not be a boon for everyone, though. Because consumers are not homogenous, they are not equally flexible when it comes to scheduling hot showers or turning on all their lights. As a result, some consumers will likely see no benefit from demand response initiatives, de Castro points out, and they will lose out.

In theory, demand response technologies will help shave the peaks off energy demand curves by shifting that demand to the valleys, or the times when energy needs are lower and the cost to produce energy is cheaper (Figure 1). But de Castro says this will also take away the most profitable part of energy producers’ income—electricity produced at peak demand is the priciest—while increasing demand for energy priced at its lowest.


Figure 1. Energy demand curve showing peak demand loads (top), and the shift of demand from peak to base with implementation of demand response technologies (bottom).

“With demand response, the shift in demand from peak to base energy is not enough to recapture what they lose from the reduction in peak demand energy consumption,” de Castro says. This means the energy-saving demand response sensors, which will be a boon to consumers, translate into lost profits for electricity producers.

“With demand response, the shift in demand from peak to base energy is not enough to recapture what they lose from the reduction in peak demand energy consumption,” de Castro says.

“If you talk with people in the industry, they seem to expect to win with all this technology,” de Castro notes. “But what this result tells them is producers can gain more but only from increasing the general consumption.” For example, at a large enough scale, the addition of plug-in electric vehicles or hybrid cars that need to be charged would result in an overall increase of non-peak electrical consumption.

In other words, by shifting demand from the costliest to the least-costly generation times, electricity producers will need to increase overall demand, especially for their base electricity. This counterintuitive result surprised de Castro. He says that when he first saw the flattened curve under demand response technologies (Figure 1), he assumed that electricity generators operating during periods of lower loads would be better off because of increased demand—and sales—in the valleys. But because the price of this energy is lower, his calculations revealed that this transition lowered profits.

So while smart grids improve the entire system, not everyone is better off.

Who Benefits, and Who Pays?
Paying for a nation-sized upgrade to a smart grid presents still another hurdle. While all the stakeholders involved agree on the smart grid’s allure—they all want it—debates flare over who will foot the bill. To delve deeper, de Castro modeled costs and benefits for the major stakeholders: consumers, electricity distributors, electricity generators, and society.

He shows with his model that though most consumers desire the smart grid’s promise of increased reliability, they are willing to pay only so much. And what they are willing to pay is always lower than what is optimally needed to shift to a smart grid. The model also showed that for electricity distributors, providing reliable service is a public goods problem because consumers’ unwillingness to pay what is necessary clashes with the wider benefits that a reliable smart grid would yield.

Putting a dollar sign on reliability was quite difficult, de Castro found. Other studies have shown that the increased reliability of smart grid technologies is valued sixfold more than that of the smart grid’s perceived environmental benefits, and three times more than its perceived security benefits against cyberattacks. Clearly, reliability is highly valued.

“But they need a mechanism for evaluating and pricing reliability,” de Castro said. Which points to another of the paper’s findings: that most of the perceived smart grid’s benefits do not translate easily into profits.

Some studies show that the largest investments will need to be made in systems that distribute electricity and that these could tally between $231 billion and $339 billion. Such a high price tag means that companies alone will not be able to pay, de Castro notes, which means public funds would be required. But regulators and policymakers have also long signaled that they will not allow all of the costs to be passed on to consumers.

“In the end, this is a public goods dilemma,” de Castro said. “It is a good thing that we would like to see happen, but we should watch out for the distribution of its benefits and costs.” Otherwise, the sexy future promised by the smart grid may turn out to be less seductive.

Related reading on Kellogg Insight

Driving Biofuel Adoption: Brazil’s consumers offer a peek at attitudes towards alt-fuels

Buy Coal? Purchasing the dirty fossil fuel could help fight climate change

Featured Faculty

Faculty member in the Department of Managerial Economics & Decision Sciences until 2015

About the Writer
T. DeLene Beeland is a science writer based in Asheville, North Carolina.
About the Research

de Castro, Luciano, and Joísa Dutra. 2012. “The Economics of the Smart Grid.” Working paper, Kellogg School of Management.

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