Bringing a Distribution System Operator to Life

""On August 22, New York State took a big step forward in what is arguably the most ambitious initiative in the country to define the future of the electricity grid. The regulatory staff at the state’s Department of Public Service (DPS) reached a major milestone in its Reforming the Energy Vision (REV) proceeding, releasing the Track One Staff Straw Proposal. The straw proposal provides recommendations for key structural policy questions, design principles, and near-term steps towards a fundamentally new retail marketplace for electricity—one in which distributed energy resources (DERs) compete on a level playing field with traditional grid investments and where innovation will be unleashed to empower customers and creative entrepreneurs.

The centerpiece of REV is the development of a “distributed system platform” (DSP) that will be the integrator of distributed generation and other DERs, including energy efficiency, demand response, energy storage, and electric vehicles. The DSP will also provide the interface between the wholesale bulk power system and increasingly diverse retail markets that are a mix of customer load as well as new sources of supply and energy services. By pursuing a DSP-based market, New York will be the first in the nation to institutionalize the concept of a distribution system operator (DSO), as has been proposed in various forms, including in eLab’s paper New Business Models for the Distribution Edge.

The straw proposal is different from that growing body of reports and articles about the “utility of the future” in a critical and immensely consequential way: in writing this procedural filing, DPS staff did not have the luxury of describing these issues in a hypothetical or idealized fashion. Rather, the straw proposal considers what is needed to actually create a highly distributed and service-oriented electricity grid based on the very real practicalities of the system as it exists today. That means describing not only an end-state market vision, but also the steps that are needed in the near term to get there.

The straw proposal addresses a number of critical questions, including:

  • What will the DSP do and what entity should play this role?
  • How to build a transactive market that attracts competition and innovation?
  • What degree of transparency and information exchange is needed?
  • How will public policy goals be achieved, including addressing externalities that historically have not been monetized?
  • How can any market power issues that may arise be mitigated?
  • What are the next steps required to realize the REV vision?

What and Who is a DSP

The straw proposal describes a DSP as a flexible, competitive platform on which multiple technologies and services can flourish, which will “foster broad market activity that monetizes system and social values, by enabling active customer and third-party engagement.” Together, DSPs and New York utilities will be required to coordinate responsibilities for market operations, grid operations, and integrated system planning that achieves REV policy aims.

Because DSP functions are so interdependent with distribution utilities’ traditional responsibilities, the straw proposal recommends that the incumbent utilities serve as the DSP in each of their service territories. DPS staff argue that it would be redundant to create an independent entity to serve as the DSP, when DSP functions will need to be seamlessly coordinated with utility grid operations and will rely on utility knowledge of the network. Further, relying on an existing entity to serve as the DSP means that the transition towards the REV vision can occur faster. While DPS staff have recommended that incumbent utilities serve as the DSP in the near-term, the straw proposal holds out the possibility that regulated utilities could compete to serve as the DSP in other service territories or that the DSP could be transferred to a different entity in the future—a means for regulatory recourse that should, in theory, encourage utilities to get the market “right.”

Building the Market

To create a competitive retail market and therefore stimulate new DER services and innovation, the market opportunity needs to be sufficiently large and barriers to entry sufficiently low. However, one practical implication of making utilities the DSP is that there will be six different local markets in the state, corresponding to each of the investor-owned utility service territories. This raises a concern for interoperability between territories and the ability of third-party DER providers to easily enter different markets without significantly altering their service offerings and business model.

At its worst, this could result in a balkanized retail market in which market participation is dampened by barriers to enter smaller DSP territories (e.g., upstate NY, which is geographically large but proportionally small in its electric load compared to the high demand of downstate population centers), effectively shrinking the size of the total market and stunting opportunities for competition and innovation. To address this concern, the straw proposal suggests standardization and interoperability between DSPs to the extent practicable, and recommends that stakeholder processes be launched to investigate design parameters and standardization for both the technical platform and market design.

Information Exchange and Transparency

For any market to function properly, there needs to be a degree of transparency and open data sharing that allows market participants to compete on a level playing field. To this end, the straw proposal recommends that transparency be a central principle of all future market design and operations, and provides a few examples of the types of data that will need to be available to market participants, including detailed customer data based on which service providers can assess the market and system-level data to identify where network constraints occur and therefore where DER solutions are most valuable.

Achieving Policy Goals Through Markets

Notable in the REV vision is the attention to addressing major policy objectives through retail electricity markets, including goals for decarbonizing the electricity supply, grid resilience, and overall system efficiency. To achieve those, DSP markets will need to send strong price signals for benefits and costs that currently are not monetized. The straw proposal recommends that a full accounting of benefits and costs be applied for major grid investments and utility programs and, where appropriate, in day-to-day operating decisions and price signals. Notably, the straw proposal identifies a set of benefits and costs, including a number of externalities such as carbon emissions that should be assessed. Here again, the proposal recommends an ongoing process to create a standardized benefit-cost framework that is both meaningful and administratively feasible.

Market Power Mitigation and Utility Ownership of DERs

The competitive retail market envisioned under REV introduces new and different market power concerns that have not previously been addressed in electricity markets. Among those, there may be opportunities for the utility acting as DSP to exercise market power by virtue of its privileged access to network data and future investment plans, control of interconnection rules, dispatch and control of DER assets that could benefit from or influence electricity prices, and knowledge of its customer base that other market participants do not possess. These market power concerns are heightened if, in addition to serving as the DSP, utilities are allowed to own DER assets.

At the same time, DPS staff argue that utility ownership of DERs has its advantages. In some cases, where a market does not yet exist for a technology such as energy storage, the utility can build an asset base and accelerate achievement of policy goals that would otherwise take many more years. Utility-owned DERs could also provide revenue opportunities that will fill a void left by avoided grid investments, on which utilities have traditionally relied for earning a return.

To balance these various concerns, the straw proposal recommends that utilities be allowed to invest in and own DERs in specific circumstances, such as in cases where a public benefit from their ownership is identified, but those investments should be subject to competitive procurement processes and regulatory oversight. To further reduce utilities’ potential market advantages, the straw proposal recommends that DSP functions be financially, administratively, and operationally separated from other utility functions, including network maintenance and traditional customer relationship management. Strong rules for data sharing and overall transparency in the markets will be critical for mitigating these market power concerns. In the end, DPS staff have also recognized that new forms of regulatory oversight and DSP governance will need to be developed to ensure fair and competitive markets.

What’s Next in REV

The straw proposal is not the last word on REV—in fact, it is only the first. Next up come party comments, due later this month. After that, DPS staff will develop a final proposal on Track One policy matters for the New York Public Service Commission’s consideration in January. Meanwhile, Track Two of REV is now under way, which will investigate specific details of regulation and rate design to achieve REV policy goals and modernize the electricity system.

As important as the ongoing procedural activities are, a lot of work and market experience is needed to bring this market into being. On that count, the straw proposal recommends a set of near-term actions. As mentioned above, DPS staff recommend the launch of stakeholder processes to investigate critical issues and offer recommendations to the Commission, including technology options to enable the market platform, rules for market design, and a benefit-cost framework. Those will take time, however, so staff recommend that utilities pursue immediate opportunities that will help all parties gain experience with new DER solutions, as well as build the distributed asset base to support further market development. These near-term actions include competitive solicitations of DER solutions to defer anticipated capital investments on the distribution system, creation of demand response tariffs by each utility, and measures to enable energy service companies (ESCOs) in New York to offer new customer-oriented services beyond basic commodity service.

New York is a Leader, But Not Alone

The Track One Staff Straw Proposal does not provide any silver bullets to what are some of the most fundamental questions of how to modernize the electricity system. Rather, it reflects the sober reality that these are complex issues that will take time to resolve. Importantly, however, with this straw proposal the DPS staff have taken the necessary but daunting first steps in recommending what that future system will look like, while acknowledging that the end-state market will take time to develop.

In doing so, New York has put itself at the leading edge of creating the distributed, clean energy grid of the future. But New York is not alone in this pursuit. European countries created the first DSO markets a few years ago and continue to learn from and refine their approach, while California recently launched a California Public Utility Commission proceeding that will require investor-owned utilities to develop “distribution system plans.” This is good company to have, because in the case of new regulatory structures, all players involved will benefit from a community of peers among which to test ideas and advance the best market designs.

Disclosure: RMI serves as a strategic advisor to the NY Department of Public Service on the REV proceeding.

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