New Name – Old Idea

Micro-grids connecting distributed energy resources with the utility power grid are new forms of an old solution: decentralized power generation that, through advances in controls and power electronics, are now able to interact efficiently with the utility grid and "island" from it when necessary.

Early in the development of the electric industry, generating energy locally was not unusual. In fact, it was common for large campuses – like universities, hospitals and resorts – to have their own power systems. The July 16, 1909 edition of The Ostego Farmer, reporting on the opening in Cooperstown (NY) of the "palatial [Otesaga] Summer Hotel," describes a power house located 300 feet from the main building, with boilers, a 100 kW and a 50 kW generator directly connected to the hotel to furnish light for the building and all the electric motors for elevators and pumps, to maintain a temperature of 70 degrees year round. Columbia University for many years operated its own power house in the middle of its Manhattan campus.

But often these distributed power facilities were abandoned over time, as economies of scale and scope favored connection with centralized power generation and the capital cost to replace the old stand-alone plants became prohibitive.1 Now, micro-grids – a modern take on the small power systems that were common in factories, hospitals and university campuses at the inception of the electric industry in the 1870s – may be poised for a renaissance.

The renewed interest in micro-grids is due in part to the frequent occurrence of extreme weather events, like the widespread flooding and downed power lines following Hurricane Sandy, or a series of early snowstorms that weighed down tree limbs in the Northeast resulting in widespread power outages. These events highlighted the fragile nature of our aboveground electric transmission and distribution infrastructure and focused attention on micro-grids and back-up power systems for the sake of resilience. In addition, building codes increasingly require buildings of public assembly, hospitals, police stations and other government buildings to install expensive back-up power systems that go unused most of the time.

Potential Benefits of Distributed Energy Resources in a Micro-grid

Targeted use of distributed energy resources, or planned development that incorporates distributed energy resources in new projects, could improve the resilience of electricity supplied to essential services and can produce economic benefits for both the customer-generator as well as utilities and their customers – purchasing from the grid or selling to the grid when it is economic. The micro-grid concept is an extension of traditional distributed energy applications that, in some contexts, may be capable of yielding lower energy costs for the customer-generator than energy available from the centralized grid.

Distributed energy resources in a micro-grid may also offer the grid, and its remaining customers, relief from high peaking power costs – shedding internal load and selling excess power to the grid in response to appropriate price signals. Advances in controls and power electronics can allow a micro-grid to interact with or "island" from the larger power grid in response to a grid interruption. When the grid is interrupted during a storm the micro-grid may be able to disconnect from the grid and "island" to continue operating and serve critical needs customers like hospitals, police stations and other government buildings. When electricity is in short supply on the larger power grid, the micro-grid may also find it economic to adjust its internal load and sell excess power to grid.

Integrating Distributed Resources with Complementary Technologies

Generally, the economic and environmental quality benefits associated with distributed energy resources will involve the use of cogeneration applications that recover waste heat to displace natural gas combustion for space heating and cooling and water heating. A cogeneration facility, sometimes called a combined heat and power plant, is a generating facility that sequentially produces electricity and another form of useful thermal energy (such as heat or steam) in a way that is more efficient than the separate production of both forms of energy.2

The local provision of high reliability power will depend on the integration of the distributed energy resource with energy management systems and complementary technologies such as uninterruptible power supplies and automated controls. A typical micro-grid uses cogeneration to efficiently provide electricity, heat and/or cooling to multiple customers, with complimentary power, heating and cooling loads, and is connected to a local utility network from which it purchases supplemental and back-up energy or to which it provides wholesale power when the price on the grid, or power interruptions, provide an appropriate price signal. Micro-grid applications may also incorporate renewable energy resources, such as wind or solar generation.

The cost-effectiveness of a proposed micro-grid will depend on the size and type of the installation. Economies of scale of distributed energy resources are dependent on a number of factors: reduction in installed equipment costs, increased operating efficiency of generating equipment, the load factor of the end-use customers, energy storage opportunities and improved asset utilization from predictable load-demand profiles. Yet, despite the potential economic benefits of a micro-grid, the development of new distributed energy resources and integration of micro-grids with the traditional utility grid face an uncertain regulatory environment that impedes investment.

Overlapping Regulation of Micro-grid Applications

Capturing the full range of benefits that a micro-grid can provide will depend on its design and implementation – and on regulatory considerations. A careful review of project economics and legal structure is necessary.

The generation, transmission and distribution of electricity are subject to a comprehensive scheme of federal and state regulation. The generation, sale and transmission of electricity in interstate commerce is subject to the exclusive jurisdiction of the Federal Energy Regulatory Commission ("FERC") pursuant to the Federal Power Act. States, not FERC, have jurisdiction over retail electric service. Micro-grids may be subject to potentially overlapping federal and state jurisdiction. If the micro-grid intends to sell electricity in the wholesale power market it would be subject to FERC's jurisdiction. Serving the electricity requirements of consuming facilities ("end-users") could also create exposure to state regulation as an electric utility.

Federal Regulation

At the federal level, independent power producers may be organized as exempt wholesale generators ("EWGs") or as a qualifying cogeneration or small power producing facility ("QFs"). EWGs are restricted to wholesale sales. They cannot take advantage of retail sales opportunities in state jurisdictions where direct retail sales to end-users may be permitted. While FERC may not authorize a QF to make any electricity sales for purposes other than resale, QFs are not restricted to wholesale sales. QFs may make retail sales to the extent that such sales are allowed under state law. QFs are also exempt from most federal and state utility-type regulation of their rates and terms and conditions for service.

Whether a firm or group of customers has the legal right to build and operate a micro-grid for distribution to end-use customers depends primarily on one issue: whether the particular micro-grid application would be characterized as a public utility under state law subject to the jurisdiction of the state public utility commission. If a micro-grid is regulated as a public utility, it faces barriers to being permitted to operate, especially within the service territory of a hostile incumbent public utility. The administrative and financial burden of being treated as a public utility are likely to be prohibitive and a barrier to investment and financing as they impede the freedom and certainty to allocate risks among the owners and customers (some or all of which may be inter-related) by contract. However, if a proposed micro-grid can avoid public utility status, there are areas of the country where it has the right to operate.

State Regulation

Not all micro-grid applications are created alike. Nor will they be viewed the same by state regulators under state law. Whether a particular micro-grid application is potentially subject to regulation will often turn on whether the producing or consuming elements are held by the same or separate ownership, or the extent to which they are located contiguous to or adjacent to each other.

Most states recognize the right of a commercial property owner to provide its own utility service within its own property or for a landlord to provide such services to its tenants. The potential for regulation emerges when a single micro-grid plant would serve the electricity and thermal requirements of customers owned by different entities or located on adjoining or adjacent properties. Here, differences in state statutes, or the decisions of a state's courts or state regulatory commission interpreting those statutes, will govern whether the micro-grid or its owners are characterized as, and would be regulated as, a public utility. The statutory framework needs to be carefully reviewed and often it will be necessary to obtain a declaratory ruling regarding jurisdiction from the state public utility commission to establish sufficient certainty for parties to obtain or advance financing.

Key Factors for Regulators

The differences among micro-grids that matter most to regulators are defined by statute. They are not necessarily related to the technical details that may make the micro-grid installation an attractive proposition from a business sense, but rather in the details concerning ownership of the various elements making up the micro-grid installation – who owns the plant that produces electricity and thermal energy, who owns the real estate and the distribution lines that connect end-users to the plant.

For example, New York statutes permit a landlord to provide electricity to its tenants. They permit the owner of small cogeneration facilities, with a power production capacity of less than 80 MW, to distribute electricity and steam to unrelated end-use customers free from regulation so long as those customers are "at or near" the plant site. Despite more than 20 years of experience with this statute, there is only limited clarity regarding what proximity qualifies as "at or near" and what is not. And, a customer of the cogeneration facility may find itself subject to regulation if it owns the facilities for redistributing the electricity to any of its tenants or unaffiliated customers.

In New Jersey, an "on-site generator" would not be considered a public utility if it is located on the property or contiguous to the property of its end-use customer. It is unclear whether the "on-site generation facility" may distribute electricity to more than one customer and the extent to which the facility and its customer(s) are contiguous even if geographically located next to each other but may be otherwise separated from each other by easements, public roads or other rights-of-way.

The risks, real or perceived, that different types of micro-grid systems may pose to legacy utilities and their customers will often govern the regulators perception of what is and what is not subject to their jurisdiction. More favorable outcomes may be expected where the micro-grid may serve only a limited number of customers, is on or contiguous to the site where power is generated and the micro-grid owner/operator is the primary consumer of the electricity.

The potential for an adverse decision increases as any of these factors diverge, as may be necessary or economically beneficial to create a micro-grid that connects adjacent and complimentary loads, or as may be required for the separate financing of the adjacent consuming business entities.

Conclusion

Micro-grids are complex undertakings that face myriad challenges. Understanding those challenges allow developers and customers the opportunity to reap economic, environmental or reliability benefits. Early analysis of a proposed project's technical goals, economics and the appropriate legal structure are required for successful implementation.

Jon R. Mostel is a Partner in Stroock's Energy and Project Finance Practice. Mr. Mostel represents a wide range of clients in natural gas and electricity transactional and regulatory matters, including the formation, mergers, acquisitions, dispositions and regulation of energy sector companies; power generation project development; project and transmission line site selection; interconnection procedures and agreements; permitting; and environmental review.

Footnotes

1 Some small power systems grids have been successfully maintained for many years. Cornell University has operated an electric/steam system at its rural Ithaca, New York campus for over 100 years. Cornell recently upgraded a 40 MW micro-grid system that serves its campus load and is interconnected with and makes sales to the New York State power grid.

2 A plant that produces electricity, heat and cooling is called a trigeneration plant.

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