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Building a business case for smart meters

Utility regulators tend to put investments in newer technologies such as smart meters (or advanced metering infrastructure) under a microscope — even though they pay relatively little attention to ongoing investments such as substations and transformers. Fortunately, policymakers in over 30 states and countries have already found that the benefits of smart meters have exceeded the costs.

Here’s what you need to know about building a business case for smart meters.

For context, these analyses go back at least to the first comprehensive AMI analysis I did in 1990. However, the concepts are straightforward and still hold true today.

There are two basic types of smart meter costs:

  • Up-front (capital) costsinclude meters, communications, software, installation of field equipment, and implementation and integration of software — as well as the project management needed to make it all come together.
  • Ongoing costs include operating the communications network and software, managing the data, and maintaining equipment in the field as well as other elements in the system.

How much money are we talking about? We found in an earlier survey that the capital costs run about $250 per meter, with ongoing costs roughly $10-20 per meter per year.

Smart meter benefits are more fun. They include:

  • Reduced utility customer service costs.Meter reading, connect/disconnect, field visits, fewer estimated bills, shorter customer phone calls, better cash flow, and more savings.
  • Additional utility efficiencies.Better outage management, lower system losses, reduced energy theft, more targeted transmission and distribution system investment, avoided equipment overloads, etc.
  • Customer benefits. Enhanced energy efficiency, lower peak demand, more convenience through automation and online interaction with utilities, and intangible benefits such as improved customer satisfaction.

What do these benefits add up to? On average, for our over 30 examples (see our table below), estimated benefits total about $450 per meter. (To get this, we multiplied the average cost of $250 by 1.8 — the benefit-to-cost ratio from the table.)

As the table shows, sometimes utility benefits completely offset the costs — though in most cases some customer benefits are needed to make the overall business case positive.

Doing the math for your smart meter business case

Typically, utility regulators and other government officials and policymakers rely on utilities to provide this type of analysis before deciding whether to approve smart meter rollouts. The details of these calculations can get quite complex, so it’s important to focus on a couple of basic points.

  1. Present your numbers as the “present value” of smart meter costs and benefits.This is the sum of the costs and of the benefits over project life (typically 15 years). Calculate the present value by looking at the cost or benefit for each year, then “discounting” back to today using an interest rate for the estimated cost of capital. This allows the costs and benefits to be compared apples-to-apples. When you subtract the present value of the costs from that of the benefits, you obtain an impressive-sounding “net present value” — one of the most common summary values on which policymakers rely.
  2. Benefit to cost ratio. This is the benefits divided by the costs. For a project to proceed, this value should exceed 1.0. (That is, the benefits should be larger.) Typically this ratio also uses present value amounts, but it can be calculated using total lifetime costs.

Beyond these simple principles, the devil is in the details. For example, many states and countries argue for months or years over how to calculate the value of reducing peak demand by one kilowatt. For this reason, most smart meter business cases include a sensitivity analysis as well as estimates for low, medium, and high cases, or their equivalent. (Our table uses “medium” projections.)

Politics. Remember that both utilities and regulators have an incentive to be conservative on both costs and benefits. Utilities want to achieve their spending targets, and regulators want to achieve the expectations they set for customers. Few will complain if the targets are met; many will complain if they are not.

Tips for decision makers:

Use a credible expert to do this analysis — someone who has done it before and understands the economics. A neutral third party consultant may be helpful, but utility experts also are good.

Also, provide the opportunity for stakeholder input to benefit from “the wisdom of the crowd.” This is usually done via a formal ratemaking proceeding or a government consultation. It’s helpful to include sensitivity analyses.

And of course, use common sense. Are your results similar to those of others’ analyses? Are the differences explainable? Do the estimates seem realistic?

A good example is consumer energy savings: a recent study of over 100 smart meter pilot programs showed that smart energy feedback yields an average 8.7% drop in consumption. Yet the business cases we summarized in our table assume far more conservative reductions of 2-3%.

The best news about all this? These analyses have been done in many places, many times. We don’t need a brand new approach to smart meter or smart grid benefit-cost analysis; we just need to make good use of what other smart people have already done.

E-mail me if you would like the details for any of the analyses in this table.

View or download this spreadsheet from Google Docs.