Utility to Drive Smart Grid Advances

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Drive a car with one foot on the gas and the other on the brake, and you'll get some idea of how we're driving our energy sector today.

We're asking Duke Energy (NYSE: DUK) and Exelon (NYSE: EXC) to promote Smart Grid initiatives to cut our electricity consumption, but it's a solution that's ultimately gouging their own profits. Since utilities make money from selling us more electricity, not by encouraging us to use less, the rules of the road are going to have to change if we want them to drive the car. Smart Grid development needs to push utilities from simply billing for the electricity we use to becoming partners in this efficiency road trip.

Mighty morphin' power rangers
One step being taken is decoupling, which separates a utility's profits from its revenues and instead calculates rates on savings achieved. If say, Sempra Energy (NYSE: SRE) reduces electricity consumption by helping customers install more energy-efficient appliances, it would earn a reward for the savings.

A dozen states have implemented these kinds of changes, and 26 more are considering them, with California and Idaho having perhaps the most advanced decoupling programs today. Since it is cheaper to create additional energy through efficiency than by building new plants, Duke Energy is calling efficiency "the fifth fuel" -- plus, the cleanest source of energy is the power plant that's never built.

While it sounds like a neat idea, decoupling could have the unintended consequence of divorcing pricing from reality. By keeping revenues constant as sales decline, either the government (i.e., the taxpayer) subsidizes the savings, sort of like paying farmers not to grow crops, or the utility company may pass a rate increase to their customers to keep margins stable. At least decoupling represents some different thinking that may lead to better, market-based reforms.

An electrifying opportunity
With $3.3 billion of stimulus funding available from the Energy Department for smart grid projects, utilities are lining up to fund the automation of their electric transmission and distribution infrastructure. Here are just a few of the initiatives some top utilities are looking to finance:

• Exelon. Through its subsidiary PECO, Exelon is installing more than 1.6 million residential and commercial smart meters with a potential cost savings of $1.5 billion. It's also building out its infrastructure to support the meters, using "smart switches" and distribution automation.
• Southern (NYSE: SO). In addition to installing advanced metering capabilities, Southern is developing "smart substations" to remotely monitor lines, isolate trouble spots, and protect against failure.
• Xcel Energy (NYSE: XEL). Taking all of these initiatives one step further, Xcel Energy is creating what it calls the nation's first SmartGridCity, turning Boulder, Colo., into a fully integrated smart grid community.

Other proposals call for intelligently integrating the Internet with the utility through a "home area network," or HAN.

Plugging into the grid
The HAN would manage home appliances, entertainment systems, and even your plug-in hybrid electric vehicle. You'll see wireless service providers seeking greater cooperation with utilities to provide advanced telecommunications products and data services supporting a wide range of automation initiatives, from advanced metering to demand response.

Via wired and wireless applications, we'll be tying together devices and appliances in the home for smarter energy decisions. Several competing technologies are vying for mindshare, including the Z-Wave Alliance, which backs a wireless in-home network technology based on open wireless control standards, attracting more than 160 manufacturers who've created products based on the protocols. Also, the Zigbee Alliance and the HomePlug Powerline Alliance team that's developing a common application layer, offered on both wired and wireless technology, is backed by a group of major power companies including Sempra Energy and American Electric Power (NYSE: AEP).

No need for shock therapy
Implemented smartly, the smart grid infrastructure improvements will result in a heckuva lot more than just a new generation of smart meters. It will become a disruptive force that will enable greater efficiencies while allowing utilities to diversify and enter new markets, perhaps some unrelated to electricity generation. For investors wanting to capitalize on the trend, it might mean doing little more than plugging into your local power company. Better yet, utilities typically pay handsome dividends that today yield more than 4% on average.

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