Oracle Corp. Chief Executive Officer Larry Ellison plans to build one to power the Hawaiian island he bought last year. EBay Inc. has one to run a data center. The University of California at San Diego and the federal government have invested tens of millions of dollars in the technology.

Microgrids are emerging as a credible threat to the dominance of America’s 100-year-old-plus utility monopoly. The small-scale versions of centralized power systems, once just used against blackouts, are now gaining thousands of customers as homeowners in states with high power costs turn to them as a way to manage rooftop solar systems, cut electricity bills and, in some cases, say goodbye to their power companies.

The systems use computer software and remote measuring devices to control energy sources such as rooftop solar panels and natural gas-fueled power generators. They allow a home or business owner, a college systems engineer or a farmer on a mountainside to generate, distribute and regulate their locally produced power with an ease and sophistication that only utilities had a few years ago.

Not much of a factor a decade ago, microgrids are expected to explode into a $40 billion-a-year global business by 2020, according to Navigant Research, a clean-technology data and consulting company. In the U.S., about 6 gigawatts of electricity -- enough to power as many as 4.8 million homes -- will flow through microgrids by 2020, Navigant said.

Utility Leapfrog

“Microgrids are going from evolutionary to revolutionary,” said Jon Creyts, a program director at the Rocky Mountain Institute, a nonprofit energy and environmental think tank. While microgrids control a sliver of generation in relation to the overall grid, they are being built with a speed and projected scale that is cause for utilities to worry, according to Creyts.

In the developing world, they may leapfrog the need for conventional utilities -- the same way mobile phones leapfrogged the need for landlines -- and bring power almost half of the 1.3 billion people on Earth who don’t have it.

While the earliest microgrids controlled simple generator backup systems, they have evolved into sophisticated smart grids. Operators can remain tethered to the larger grid and switch seamlessly between the electricity they generate and utility power, whichever is cheaper. They can even sell surplus electricity back to the utilities through a process known as net metering.

If the main grid goes down, a flip of a switch or automated computer program deploys their mix of green energy, backup generators and storage batteries to keep the lights on.

Eating Revenue

Microgrids have the potential to radically change the U.S. electricity paradigm as they proliferate and begin to eat into the utility revenue stream. For example, U.C. San Diego saves an estimated $850,000 a month on its electricity bill by self-generating and using its microgrid to fine-tune campus power consumption.

The 3,200 U.S. utilities are already facing what NRG Energy Inc. CEO David Crane calls a “mortal threat” to the industry. Forces including deregulation, green politics and an explosion of rooftop solar and other homemade energy -- known as distributed generation -- mean a reduction in the fossil-fuel electricity utilities sell.

Microgrids may be the mechanism through which this revolution in clean distributed generation will be carried out - - a portal for leaving the traditional power grid.

Mixed Reaction

For utilities, which sell $400 billion worth of electricity a year delivered by 2.7 million miles (4.3 million kilometers) of power lines, the reaction is mixed.

In California, epicenter of the rooftop solar revolution, utility executives have begun to complain to regulators that microgrid operators who remain tied to power lines should shoulder some of the costs of keeping the grid stable, perhaps through connection fees. Sempra Energy and American Electric Power Co. are considering microgrid investments as a way to hedge the threat.

While only about 30 commercial-scale systems like those used by EBay and the U.S. Food and Drug Administration exist now, that number is projected to climb to 300 in just two years, said Steve Pullins, chief strategic officer for Green Energy Corp., a Tennessee-based builder of commercial-scale microgrids.

His company estimates that 24,000 U.S. commercial and industrial sites are ripe for large-scale microgrid conversions. Globally, about 400 additional big microgrid projects are under way. Lockheed Martin Corp. completed in May the U.S. Army’s first domestic microgrid at Fort Bliss in Texas. The military is already using them at sites in other countries to reduce fuel consumption.

Requests Increase

“We are seeing requests for proposals going up significantly, 30 to 40 percent higher than last year,” said Paul Orzeske, president of the Honeywell International Inc. unit that designs and builds commercial-scale microgrids. Honeywell built a $71 million microgrid for an FDA research center in Maryland and the agency is in the midst of a $213 million addition that will be online early next year.

On the consumer level, San Francisco-based Gen110, which installs leased microgrid systems with no out-of-pocket costs to homeowners, is attracting utility customers put off by tiered pricing that penalizes them when their use exceeds a certain level.

Gen110, which was acquired in September by franchiser Solar Universe Inc., harvests rooftop solar for its microgrids, then sells power back to its 6,000 customers at rates 10 percent to 30 percent below grid prices. Gen110’s users remain tethered to the grid, from which they draw about 10 percent of their power.

‘Plug and Play’

Other consumers, like Drew Barber of Petrolia, California, have deployed microgrids to cut ties to their power companies altogether. While cost is still a factor, the technology isn’t.

More than a decade ago “it required an electrical engineer to get you off the grid,” said Barber, who decided on a microgrid when he factored in the relative cost of bringing electrical lines to his remote Northern California neighborhood. These days, “it’s plug and play.”

Meanwhile, some developers are putting microgrids into new construction. In Sacramento, California, a 34-unit residential complex is being purpose-built with an integrated microgrid designed by Sunverge Energy Inc. The system will automatically switch residents to the cheapest power source, whether solar or conventional, while storing backup power for use if the grid goes down.

Recent power failures that have affected millions of customers help fuel demand for microgrids. Hurricane Sandy knocked out electricity for 8.5 million customers, showing just how vulnerable utility infrastructure is to storms. A 2006 heat wave across the U.S. caused 36 major power failures, including a blackout that left tens of thousands of Queens, New York, residents without power for a week.

Modernizing Grid

A 2012 report by the American Society of Civil Engineers estimated that utilities need to raise cumulative spending by $763 billion by 2040 if the grid is to be properly modernized and hardened against natural disasters.

Indeed, Sandy proved a powerful endorsement of microgrids. While millions languished in the dark, microgrids at the FDA’s research center and Co-Op City, a 45,000-resident housing cooperative in Bronx, New York, kept the power flowing by disconnecting from the stricken grid and running in what’s called “island mode.”

“There is no question that microgrids breaking the grid down into smaller sections can prevent millions of people being knocked out of power by a major circuit going down,” said Honeywell’s Orzeske.

Rising Prices

Besides blackout protection, Honeywell’s corporate and institutional customers are looking to offset rising conventional electricity rates -- retail power prices have climbed 34 percent since 2003, according to the Energy Information Administration.

The annual U.S. electric bill for businesses is around $200 billion. Lost business continuity from outages and power quality issues adds another $80 billion to $150 billion to the tab, according to data from the Lawrence Berkeley National Laboratory.

In response, U.S. commercial and industrial customers spend about $5 billion to $6 billion a year on self-generation and energy efficiency programs, increasingly employing microgrids to manage them.

“Our clients start out seeking maximum savings,” said Pullins. “But the difference between achieving maximum savings and grid independence is not that big of a leap in terms of capital costs.”

Power Reliability

The U.C. San Diego microgrid, which has evolved into a mix of green and conventional energy from an early generator-backup system, provides a picture of the rationale.

“Our campus does $1 billion a year in research,” said Byron Washom, the university’s director of strategic energy initiatives. “We have an electron microscope that every time we have a supply disruption, it takes six weeks to recalibrate. We can’t let that happen.”

The conventional grid simply can’t provide that reliability, and all manner of institutions and companies that have “a high-reliability requirement” now understand that, he said. “Look at credit-card processors -- for every hour they can’t process it costs them money. That’s where the high-end, energy-intensive market for microgrids is going.”

And then there’s that $850,000 a month in cost savings, achieved because the campus is able to generate 92 percent of its own power. The microgrid manages a peak load demand of 42 megawatts with power produced from 1.5 megawatts of solar, a 2.8-megawatt fuel-cell generator powered by methane from a wastewater treatment plant, two 13.5-megawatt gas turbines and a 3-megawatt steam turbine. Any additional power needs are met through a contract with the local utility.

‘Economic Incentives’

All this is managed by a cutting-edge microgrid controller made by San Diego-based Power Analytics Corp.

These savings aren’t an anomaly. The FDA estimates it’s already cutting about $11 million a year off its electric bill through both self-generation and the ability to sell power back to the grid -- savings that will rise to $25 million a year when an addition is completed in 2014.

“When you start layering in the ability to do that, there’s even better economic incentives to build a microgrid,” said Orzeske.

Powering Villages

Microgrids also may be a solution for thousands of the world’s remote villages that subsist without electricity. The Washington-based nonprofit EarthSpark International has built a microgrid that runs off a diesel generator, bringing power for the first time to 54 inhabitants of the village of Les Anglais. It will soon add solar and backup storage to serve others in the village center.

Similar groups are at work in Africa, India and Latin America, deploying microgrids that mix fossil-fuel generators with solar and wind power. In most cases they’re replacing sooty kerosene or wood stoves, bringing cheaper and cleaner energy to the poor.

“It’s fairly evident that a central station utility model is not really viable in many less developed countries” where the low-income customer predominates, said Daniel Schnitzer, founder and executive director of EarthSpark.

Hawaiian Grids

Remote microgrids aren’t just proliferating for the poor. Northern Power Systems, a Barre, Vermont-based maker of wind turbines, in April crafted a microgrid for a group of farmers in the North Kohala region of Hawaii’s Big Island, using wind and solar power to help irrigate 400 acres of land.

Ellison, the billionaire Oracle CEO who bought 98 percent of the Hawaiian island of Lanai from Castle & Cooke Inc. last year for an undisclosed price, has hired U.C. San Diego’s Washom to design a microgrid that will be powered by multiple renewable energy technologies. Lori Teranishi, a spokeswoman for Pulama Lanai LLC, the island operator, said project costs haven’t been determined yet.

Some utilities have responded to microgrids the same way they reacted to the rapid growth of solar and other forms of distributed generation: denial that the threat is serious, push back that the technology is still too unreliable and calls for regulators to clamp down on expansion until the industry can sort out economic and technical issues.

Grid Charge

Tony Earley, chairman and CEO of San Francisco-based PG&E Corp., makes the same argument that he makes about the surge of solar users on PG&E’s grid.

“To make microgrids work, you also have to upgrade the existing grid,” he said in an interview. “It was designed to push power one way, not to take power back in, and not to have variable flows of power.” Builders of microgrids “need to pay for that through some sort of charge.”

Self-generating microgrids are taking some of the load off the conventional grid, aggregating power that’s sold back to utilities and potentially sparing them from having to build costly new plants and transmission lines down the road.

“When you think about the overall grid, it’s sized for the worst-case scenario,” said Orzeske. “If you can pull down or slow down the rate of growth, then you don’t have to be adding peaking plants into the mix.”

Some utility executives don’t see microgrids becoming a big deal.

No Proliferation

“You might have a microgrid but you still need good infrastructure supporting it,” said Michael Montoya, director of grid advancement at Edison International’s Southern California Edison.

Michael Niggli, chief operating officer of Sempra’s San Diego Gas & Electric, agrees. Military bases, universities and a smattering of remote customers will adopt them “but I don’t think they will proliferate.”

Orzeske and most microgrid builders aren’t lobbying for an end to the grid. They simply think it won’t play as prominent a role as it does now in a microgrid-saturated future.

Utilities by necessity are likely to switch from being entities that primarily generate power to companies that help manage the surge in distributed generation that will be flowing their way via microgrids, perhaps finding a way to collect revenue for keeping the grid stable.

What’s changed is the concept that goes to Earley’s point - - power is already flowing both ways whether utilities like it or not.

‘Hard Pill’

“It’s a hard pill to swallow,” said Pullins, likening utility resistance to microgrids to that of U.S. car companies in the 1970s when the federal government first imposed mileage standards. “When those rules came out, Toyota went out and hired 1,000 engineers to figure out how to meet them. GM went out and hired 1,000 lobbyists to figure out how to beat them. There is some of that going on. With a few exceptions, the utility industry hasn’t embraced microgrids.”

Some utilities are hedging their bets. With the help of $10 million in U.S. Energy Department and state grants, SDG&E has set up a microgrid in the remote desert town of Borrego Springs, about 90 miles northwest of San Diego. When a severe rainstorm knocked out utility power to the town last month, the microgrid’s collection of rooftop solar panels, micro-turbines and batteries was able to keep electricity flowing to nearly half the town’s customers, including buildings sheltering the elderly and ill from the desert heat.

Next 106 Years

Nick Akins, the CEO of American Electric, said some of his customers, including the U.S. military, have expressed interest in setting up microgrids. American Electric is amenable.

“I think you have to embrace what’s going on,” he said in an interview. “It’s a different way of doing business but it’s still part of the energy infrastructure business.”

The company, based in Columbus, Ohio, has existed for 106 years, he said. “We’ve got to think about what we have to do to stick around another 106 years.”

The wild card is the prospect of millions of homeowners building microgrids and kissing their power companies goodbye. Cost is still a barrier for most ordinary consumers, particularly in states with low power prices.

A typical 10 kilowatt rooftop solar system serving a three-bedroom house still costs about $15,000 to $20,000 after subsidies and state incentives, according to a survey of various solar groups and installers. That works out to about 15 cents to 20 cents a kilowatt-hour. Adding battery storage and a generator to complete a microgrid can bring that cost to about 25 cents a kilowatt-hour.

In a state like Arkansas, where electricity sells for 10 cents a kilowatt-hour, microgrids aren’t likely to be much of a factor except among ardent environmentalists or people needing to power remote cabins far from the grid.

Gen110’s model works because its lease structure lets homeowners get in with no money down and the company takes care of maintenance. Efficiencies of scale allow it to price microgrid-produced power at about 17 cents a kilowatt-hour, targeting high-usage California consumers who pay 19 to 35 cents because of a state rate structure that climbs as usage goes up.

Battery Costs

That 17-cent pricing is not far from 11 other states that have electricity rates above 15 cents a kilowatt-hour, topped out by Hawaii at 37 cents. As those rates continue to rise, solar costs continue to plummet -- panels are 60 percent cheaper today than they were in 2011 and installed costs are dropping by about 10 percent to 15 percent a year, according to solar industry data.

One holdup in wider adoption is the high cost of battery storage for home microgrids that makes the final step to grid independence unattractive if not unaffordable to most consumers.

Research may change that. The Joint Center for Energy Storage Research, a project within Chicago-based Argonne National Laboratory, is using a $120 million federal grant for a five-year plan to improve battery efficiency by an order of five. Such a breakthrough would dramatically improve the economics of both electric cars and microgrids.

Gen110 CEO Jason Brown thinks the picture is clear. “Ten years down the road, I think a substantial portion of consumers who can opt for low-cost onsite power will have already made the switch,” he said.

To contact the reporters on this story: Ken Wells in New York at kwells8@bloomberg.net; Mark Chediak in San Francisco at mchediak@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net