Can regulators protect small customers from rising transmission costs for big data centers?

Can regulators protect small customers from rising transmission costs for big data centers?

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Abraham Silverman is a research scholar at Johns Hopkins University and principal of Silvergreen Energy Consulting. Suzanne Glatz is principal consultant at Glatz Energy Consulting and was previously a director with PJM’s System Planning Division. Mahala Lahvis is a student at Johns Hopkins University.

Grid operators in the United States are on a building spree. Billions are being invested in electrical infrastructure, in part, driven by an unprecedented expansion of hyperscale data centers and the return of manufacturing to the United States.

Regulators are asking increasingly urgent questions: should federal and state policymakers seek to insulate mom and pop retail customers from the impacts of data center expansion, and if so, how can regulators ensure fair and equitable treatment of all customers? These issues were front and center at the Federal Energy Regulatory Commission’s Nov. 1 meeting on data centers and co-location of data centers at existing generating facilities.

The concept of creating a protective moat to ring-fence retail customers from risk has been around for generations. Federal and state regulators should unite around a modern-day data center ring fencing movement to protect small retail customers from footing the bill for transmission upgrades needed to serve big data centers and ensure that data centers contribute their fair share to the fixed costs of operating the transmission grid.

The risk of under-investment in the transmission grid & stranded costs

In the United States, the dominant method for allocating the cost of new transmission facilities necessary to serve new load customers is to spread the costs across all retail customers — a practice known as socializing or peanut-buttering costs. New factories and other large users of electricity make substantial commitments to the local community and operate for long periods of time, paying enough in transmission charges to pay off the utility’s investment in new transmission facilities. Adding new customers to the system reduces transmission rates for all users of the system — since the total cost of operating the transmission grid (the numerator) is spread over more sales (the denominator), resulting in a lower $/kilowatt-hour charge. 

Data centers, however, challenge this conventional wisdom in several ways. First, there are concerns over whether data centers will contribute sufficient revenues to pay for the transmission facilities that are being built on their behalf. The investment necessary to serve these new mega-loads is large and the payback period is long — that is, a new data center customer must pay for transmission service over many years to justify the large upfront investment. Data center customers, however, can evaporate as quickly as they’ve appeared. If the anticipated data center load does not materialize, or if they close shop prematurely, the transmission expansion costs can be stranded. Instead of payments from the data center going to pay off the transmission investment and funding a portion of the costs of running the grid, remaining customers would be left paying for a more expensive grid without offsetting revenues.

Second, data centers, in their quest to come online as quickly as possible, are increasingly seeking to co-locate with already existing generators. Colocation has the potential to shatter the existing grid funding paradigm because, as a number of commenters noted at the FERC technical conference and in comments filed on Dec. 9, generators pay the actual costs of connecting to the grid but are exempted from purchasing additional transmission service and thus make significantly smaller contributions to the fixed costs of operating the grid. 

Notably, these dynamics can play out in a variety of ways in addition to colocation — including if the data centers end up not using the amount of electricity that they predict or end up leaving the grid after only a few years or significantly reducing their consumption, whether because of evolving business needs, overbuild of data center capacity, an unexpected downturn in data needs, or simply increased energy efficiency as technology evolves and each server rack consumes less energy. 

Neither state nor federal regulators can do it alone

While the Federal Power Act of 1935, in theory, established a bright line between federal and state regulation of the electric power grid, the line often gets smudged in practice. When they are at their most effective, federal and state regulators often work together to protect retail customers, a philosophy amorphously referred to as cooperative federalism. Given the ability of data centers to shift costs across multiple states, a cooperative approach is desperately needed. Neither regulator can do it alone; state regulators have jurisdiction over retail sales of electricity, while federal regulators oversee transmission spending. 

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