Economics of Grid Defection II

Is it more feasible, and more likely?

Last week I wrote about the grid defection discussion circa 2014, motivated by Elisa Wood’s webinar with Seyyed Ali Sadat and Joshua Pearce of Western Ontario University on their new paper in Solar Energy. Let’s pick up the story from 2014 and discuss the research leading up to their paper.

Economics of Grid Defection I

Evolution of the Research

In the ensuing years, additional research built on the analyses I discussed previously by addressing the practical and economic limitations of grid defection. Hittinger and Siddiqui (Utilities Policy 2017) argued that full defection was still uneconomic for most customers, emphasizing the inefficiencies and high costs associated with designing off-grid systems that meet 100% of energy needs. To ensure reliability, such systems often require substantial overbuilding of generation and storage capacity, leading to high upfront costs and inefficient resource utilization.

Gorman et al. (Applied Energy 2020), who examined the role of electricity rate design in shaping defection decisions, reinforced this critique (and with a title like "Should I Stay or Should I Go?" they channel an early GenX British punk invasion vibe that I endorse heartily). Their analysis suggested that low-demand customers were the most likely to defect when utilities imposed high fixed charges as part of their rate structures. By shifting cost recovery from volumetric charges to fixed fees, utilities inadvertently made grid electricity less attractive for low-usage customers, especially in regions with favorable solar resources. They also emphasized the importance of maintaining reliability standards, noting that customers willing to accept lower reliability might find defection more economically feasible.

Now let's return to the new paper. Sadat and Pearce's research evaluated hybrid systems combining solar PV, batteries, and diesel generators, concluding that grid defection had become economically viable in solar-rich areas with high electricity prices, such as Hawaii and California, as well as Connecticut, Massachusetts, and New York. Federal tax incentives played a crucial role in improving the economics of hybrid systems, reducing upfront costs and accelerating payback periods; I'd like to see a counterfactual analysis of how much grid defection would occur in the absence of such subsidies, and/or how much defection would cost compared to grid-tied DER (which are themselves distorted due to federal, state, and local subsidies). They also cautioned that poorly designed rate structures—such as those that discourage grid-tied solar—could unintentionally drive more customers toward full defection.

Analysis

Over the past decade, the evolution of grid defection economics has been shaped by three primary factors: the rapid decline in technology costs, shifts in regulatory and rate structures, and changing consumer preferences. Solar PV costs have decreased by more than 60% since 2010, making it the cheapest source of electricity in many parts of the world. Battery prices have similarly fallen more recently, with lithium-ion technology leading the way. These cost declines have made solar-plus-storage systems more accessible to a broader range of customers, and would still do so even in the absence of subsidies, reducing the economic barrier to entry for off-grid solutions. Technological improvements have also enhanced system efficiency, reliability, and lifespan, further improving the value proposition of self-generation and storage.

Regulatory and policy developments have played a dual role in shaping grid defection trends. On one hand, net metering policies and federal tax credits have historically incentivized grid-tied solar adoption, delaying widespread defection. On the other hand, reductions in net metering compensation rates and increases in fixed charges have made grid-tied solar less attractive in some regions (e.g., California), inadvertently pushing customers toward considering off-grid solutions.

Consumer preferences have also shifted. Customers increasingly value the environmental benefits of renewable energy and the independence offered by self-sufficient systems. The growing frequency of extreme weather events and grid outages has motivated some customers to seek resilient energy solutions, such as solar-plus-storage systems capable of operating independently during disruptions.

Grid defection threatens the traditional utility business model, which relies on spreading fixed costs across a broad customer base. When customers defect, utilities face stranded assets and revenue shortfalls, necessitating higher rates for remaining customers and exacerbating the defection cycle. To address these challenges, utilities must adapt by embracing new roles and business models that align with the evolving energy landscape.

Regulatory and Business Model Evolution

Regulatory reforms are essential to managing these changes effectively. One potential strategy is for utilities to transition into wires companies that focus solely on operating and maintaining the distribution grid, while allowing competitive markets to handle generation and retail energy services. This "quarantine the monopoly" approach minimizes conflicts of interest and encourages innovation by enabling third-party providers to compete in delivering distributed energy solutions. In such restructured frameworks, utilities are wires companies that retain responsibility for the operation and maintenance of the distribution grid, while independent entities manage generation and retail energy supply. This unbundling aligns incentives with the goals of reliability, efficiency, and innovation.

We could embrace the contestability concept and reduce entry and exit barriers, in other words, enable competition. Competition encourages efficiency and innovation by creating a marketplace where non-utility energy providers, such as third-party solar installers, battery storage companies, and demand response aggregators, can serve customers directly. In a competitive market, these providers offer diverse and cost-effective solutions tailored to customer needs, such as solar-plus-storage systems or energy management tools. For utilities, competition can be a catalyst for modernization, driving them to invest in advanced grid technologies and services that add value for customers who remain connected.

Over the past decade, the economics of grid defection have undergone significant changes. While grid defection was once a fringe possibility, it is now an economic reality in specific regions and a looming challenge for utilities and regulators more generally.