By Mahesh P. Bhave
As a businessman exploring investments, I need simple answers, however complicated the problem. I wish to know: Are microgrids economical? How much investment is needed and for what? What are the factors that principally affect profitability, within the system and in the environment? If microgrids are not profitable at the present, when will they be? I recognize that understanding microgrids as a system requires complicated mathematics and modeling. I’m sympathetic to and respect those who do that.
For many months, I’ve struggled to model the economics of microgrids. For a set of paying customers of a homeowners’ association with 120 homes, for instance – a “load” – with daily and seasonal variations in demand, we can anticipate revenues easily enough.
Understanding microgrid costs, however, involves at least two complex optimizations followed by pro forma cash flow analysis. As best I can tell, this has not been done.
A microgrid typically has multiple generation sources and a battery. Some people call such systems “hybrid,” but that states the obvious, physical truth. They ought instead be described as integrated systems, since their working combination should be more than additive, and follow a well-articulated logic toward solving an objective function, for instance, production at the lowest cost; with the lowest emissions; continuous operation with quality electricity; or predictable demand with low peaks.
Consider a 100,000 DWT container ship, a sizeable floating microgrid. Its propulsion requires ~ 70 MW engine power generated by burning heavy fuel oil. In addition, it has sizeable power systems for cargo refrigeration; air-conditioning for the crew’s living spaces; critical communications systems; and other loads much like any community, likely about 15 MW. Ships do not emphasize renewable generation, yet like any terrestrial microgrid, they have batteries, diesel generators, and waste heat recovery systems, optimized for cost savings and reliability. Do ships offer lessons for microgrid design? Shipbuilders might design optimized microgrids.
Two Optimizations and a Discounted Cash Flow
Capacity Planning: The first challenge of microgrid design is: For the given demand, in what combination should we deploy, say, solar, wind, diesel or gas generator, and batteries? How many kW of each? This sizing is a thorny challenge. Every location, having different resource endowments, needs customization. Homer Software claims to address this important issue, thereby permitting us to budget for capital costs. How many solar panels are needed for the sunlight available in the proposed location? What are the wind turbine sizes, and their number, for the given topography? How much battery storage, and the size of generators needed, to meet the given load?
When the capital needed for the various generation sources is represented as payments spread over a number of years, it sets the first constraint on aggregate economics. The revenue estimated has to cover that, plus operating costs.
Operations Modeling: The second constraint is efficient operations. How should we utilize the deployed resources in an optimum manner to reduce overall operating costs? How should we maximize solar use, reduce diesel or gas use, store electricity generated in batteries, and use the stored energy after sundown? This is an integer-programming problem; a number of recent research papers have made admirable contributions toward addressing it.
To manage this optimization well, however, we need a good control network interfacing with the resources, a non-trivial engineering and design challenge, for the resources must satisfy a dynamic demand. This likely requires experimental prototypes working simultaneously with associated analytics.
Financial Modeling: Beyond capacity planning or sizing, and optimized operations, we need to make assumptions about the differing life of solar panels and batteries; the cost of money – the weighted average cost of capital (WACC) – for the business undertaking the project; factor in risk through a discount rate; and assume a terminal multiplier at the end of, say, ten years in the cash flow statement. We need to anticipate operating costs as in any business plan – for people, offices, sales, maintenance, fuel consumption, and the like.
The goal is to assess the economic feasibility of microgrids at a high level, and understand the relative role of the various economic drivers. For simplicity, we assume mature technologies, a standalone microgrid and no subsidies in our estimates. These factors may be included in future iterations of the model.
At this stage, we are ready to calculate the Net Present Value of the project, and conduct breakeven analysis for the system. Is the project worth doing? Now? If not now, when? What are the sensitivities?
Environmental Barriers To Realizing Microgrids
Mind you, these issues are merely the technical challenges of establishing a business case. Regulatory and public policy issues need to be addressed too. For instance, in the U.S., does the microgrid service territory cross public rights of way? If it does, do microgrid operators violate the franchise rights of incumbent utilities?
If the microgrid expects to connect with the macrogrid, there are the additional equipment costs, and operating challenges of islanding. Let us assume that they are addressed satisfactorily in the IEEE 1547 standard, and through global manufacturers.
We next need to bridge historic academic boundaries, and their reflection in any organization or team. Electrical engineering, operations research, and public policy, among other disciplines, are distinct competencies with well-defined boundaries that are not easily breached. Cross-disciplinary research can be career limiting in that it belongs neither here nor there, and requires the burden of new learning.
Finally, business schools are notably absent in utility matters. For instance, there are few case studies about the challenges of utilities; and neither marketing nor conventional business strategy meaningfully applies to regulated utilities.
For the multinationals that develop products, inertial momentum has existed for a hundred years. Manufacturers may believe microgrids represent a peripheral product, mostly for the emerging markets, a fraction of the total. Therefore, why bother?
Microgrids as a competitive alternative to incumbent utilities may be good theory, yet how likely would this be? From a manufacturer’s perspective, should some investor owned utility, or five, made a commitment to microgrids, only then would they be worthy of development.
The Department of Energy or the Department of Defense sponsored microgrid projects, or the recent interest in microgrids by East Coast states following Hurricane Sandy, are either experiments carried out for testing technological possibilities, or for military purposes, and are either too early, or too few or small – money no object and little business orientation.
Federation Of Microgrids: Innovation Possibilities Or A Can Of Worms
Let us assume that the optimization problems above will be solved, that the demand exists in emerging markets and in developed markets, and that the financial models suggest promising results. Microgrids may then start popping up on campuses, jails, high-rise buildings, factories, new homeowner associations, colleges, schools, and the like.
And when they do, a host of new possibilities arise. Can microgrids connect and coordinate with each other? Can they share resources, for example, storage? Can they offer each other reliability guarantees? Will we have inter-microgrid PPAs? While research has been done on linking microgrids to macrogrids, there is little research about possible inter-microgrid coordination. This represents a whole new area for innovation.
In such an inter-microgrid world, what is the role of regulators and regulations? They may not even be necessary, except for direction-setting, as microgrid operators can create a market among themselves, and as prices are set by market mechanisms rather than by rate of return regulations.
Perhaps the grid of the future will be a honeycomb, much like the cellular telephone network, consisting of cells of different sizes and attributes – a federation of microgrids. Very likely, the economics of microgrids, and their clean generation benefits, will surpass the value provided by the conventional grid. Will that incremental value be large enough to help us overcome the inertia of the present system? Today, we have working, historically reliable macrogrids in most parts of the world. The system isn’t broken. Does it need to be “fixed” using microgrids?
In contemplating microgrids comparatively with telecommunications, we note that the smartphone equivalent is missing in the emerging electricity industry – a new product with a new revenue stream, compelling, affordable, addictive, and multi-functional. It is unclear what the market drivers for a new topology of the grid, re-organized as a federation of microgrids, might be.
My hypothesis: The valuation of a utility owning and operating a cluster of microgrids likely surpasses the valuation of today’s hierarchical grid, burdened by legacy infrastructure, undifferentiated products, and regulatory overheads. Releasing this hidden value in today’s grid might well be the market driver for re-structuring it as a federation of microgrids. (Courtesy of renewableenergyworld.com)
Mahesh Bhave is a Visiting Professor of Strategy at the Indian Institute of Management, india.