AI Demand Strains US Electricity Grid Infrastructure and Regulation

Key Quotes

"if you're going to pinpoint the dominant factor behind higher electricity prices right now is it the wholesale price or the actual cost of transmission yeah it's kind of the scope of time that you choose to evaluate but you know just to give you kind of a benchmarking you know if you looked at say the new england power market over the last 20 years which sort of is the beginning point of the the restructuring of the industry and the introduction of competition in a place like new england the actual commodity cost would have fallen by about 50 on an inflation adjusted basis whereas on the same basis transmission costs have sort of increased something like 900 now from a very low level to a much more substantial level"

Travis Kavula explains that the dominant factor in higher electricity prices depends on the timeframe considered. Kavula highlights that over a 20-year period in New England, commodity costs decreased significantly, while transmission costs increased dramatically. This suggests that the infrastructure costs, rather than the energy itself, have become a larger driver of overall electricity expenses.

"the problem it was meant to address is that regulated utilities which used to own this whole chain of links on a consolidated vertically integrated basis bet wrong very badly on the amount of demand growth in the sector and they put themselves out there building power plants that were intended to be included in what's called their rate base on which they earn a return and are able to charge off those costs to a captive set of customers"

Travis Kavula identifies a core historical problem that led to market restructuring: regulated utilities overestimated demand growth and invested heavily in power plants. Kavula notes that these investments were intended to be recouped from customers, but when demand did not materialize as expected, utilities faced financial strain. This situation created an incentive for utilities to overbuild, leading to escalating costs for consumers.

"the companies earn a return that is sort of announced in advance by their state or federal economic regulators based on the amount of capital they've invested in the system so spend more make more has some paradoxical effects where the most amount of profit a utility will ever make is in the first year that it owns a particular asset and then when they own it free and clear they actually earn zero profits"

Travis Kavula describes a fundamental incentive structure within regulated utility economics. Kavula explains that utilities earn a return based on their invested capital, creating a "spend more, make more" dynamic. This system paradoxically incentivizes utilities to profit most when an asset is new and depreciates over time, leading to zero profit once the asset is fully paid off.

"ordinarily electricity demand growth would be a composite of growing demand from many different end use applications that would kind of diversify the risk of betting on growth here it's like a one or a zero you know if you take out the data centers the sector is actually you know pretty stable in terms of electricity demand if you add the data centers the sector is really poised to grow a heck of a lot"

Travis Kavula points out the unique nature of current electricity demand growth, driven primarily by data centers. Kavula contrasts this with typical demand growth, which is usually a mix of various end-use applications, thus diversifying risk. Kavula highlights that without data centers, the electricity sector shows stable demand, but with their inclusion, the sector is poised for significant, concentrated growth.

"the problem here is that in a kind of an inflationary environment for all the materials the transformers the cabling everything that goes into the poles and wires if you're adding demand and you're not just using headroom that already exists on the system if you're not increasing that capacity factor on the system if you're tripping into a lot of new capital expenditures then even if you're adding demand that's paying regulated rates it may not be enough to offset the total amount of expenditures incrementally you're making on the system"

Travis Kavula explains the challenge of rising costs for grid infrastructure in an inflationary environment. Kavula notes that even with increased demand paying regulated rates, these revenues may not cover the significant new capital expenditures required for transformers, cabling, and other grid components. This suggests that the cost of maintaining and expanding the grid can outpace the revenue generated from new demand.

"the nodal pricing formulation is intended to reflect a market that unlike the stock exchange isn't just trading bits of data to represent kind of paper securities it in a very real way is meant to simulate a kind of flow of electrons on a system constrained basis and then it provides valuable information too because if you continue to see locational marginal prices you know in one place that are very high and 20 miles away they're very low that's a signal to the people who plan the transmission grid that hey you know we should probably build a transmission line here because the addition of the transmission line will be the thing that flattens out that price differential"

Travis Kavula defends the concept of nodal pricing in electricity markets. Kavula explains that nodal pricing, unlike stock trading, simulates the physical flow of electrons on a constrained grid and establishes location-specific prices. Kavula argues that this system provides crucial price signals, indicating where transmission infrastructure investments are needed to balance supply and demand more effectively.