A handful of U.S. utilities have discovered they can save money by encouraging small rooftop solar projects—the same projects utility industry leaders have insisted were too expensive and unreliable to be practical.

The Long Island Power Authority (LIPA) in New York, for instance, is paying developers to build solar panels on top of buildings in tiny towns that are experiencing population booms but don't have enough electric grid infrastructure to bring in the electricity they need. The pilot initiative will allow the utility to avoid spending more than $80 million to build new transmission lines and grid equipment.

"It's actually cost-effective to add renewables" this way, said Michael Deering, LIPA's vice president of environmental affairs.

The program reflects some utilities' changing relationship with distributed generation, or DG, the name for small-scale energy generators like solar systems and micro wind turbines that produce electricity close to where the power is used.

Many of the nation's 3,200 utilities have resisted distributed generation, partly because they believe the small projects would cut into their profits. Private utilities make their money by investing in infrastructure—mainly massive centralized power plants and high-voltage transmission lines—and then charging customers enough to earn that money back with a guaranteed return. Distributed generation shakes up this century-old model by shifting control of electricity from utilities to smaller developers, communities or individuals, who produce power onsite and rely less on traditional grid infrastructure to keep the lights on. This, in turn, reduces the returns that utilities collect.

In Germany, distributed generation has been the backbone of a national clean energy overhaul that has turned that nation into the world's largest solar market. Nearly half of Germany's renewable power is owned by private individuals or farmers, while in the United States customer-owned generation is still less than 5 percent of the clean energy market.

The Edison Electric Institute, the U.S. utility sector's main trade group, wrote in a recent report that locally produced clean energy is a "disruptive challenge" to utilities that is likely here to stay.

Long Island Power's embrace of distributed generation may not be surprising, given its progressive policies on renewables. Last year, LIPA enacted one of the country's few feed-in tariffs, a policy to attract renewable energy investors in decentralized projects. It is also a non-profit municipal utility and a state-owned enterprise. Meaning, compared to private utilities that are held liable to investors, it's somewhat easier for LIPA to take risks with clean energy and unconventional programs.

Other major U.S. municipal utilities, including the Los Angeles Department of Water and Power and Austin Energy in Texas, are also betting on distributed generation to improve grid operations.

Clean energy advocates believe it's just the beginning.

"I would be really surprised if there aren't quite a few more utilities who pick up on this," said John Farrell, a champion of distributed solar and a senior researcher at the Institute for Local Self-Reliance, a nonprofit advocacy group. If the programs work as promised, "it's going to undermine those utilities that have been resistant to solar and said that it’s too costly for them to add," he said.

One Utility's Savings: $84 Million by 2020

LIPA launched the small-town distributed solar initiative in July, folding it into its feed-in tariff and offering contracts for up to 40 megawatts in non-residential solar projects, enough to power the equivalent of 5,200 homes.

Deering explained that for a year utility officials had been grappling with how to deliver more power to Long Island's far-flung communities where electricity demand was rising and grid infrastructure constrained. They decided to try solar panels instead of spending an estimated $84 million by 2020 on new power lines and on purchasing more electricity, mainly from natural gas power plants.

The utility will target six areas on the east end of Long Island's South Fork—a narrow stretch of scattered hamlets that includes the Hamptons and Montauk. To encourage solar installations, developers will receive a special rate for every kilowatt-hour their panels produce over 20 years—7 cents more than what LIPA will offer elsewhere on the island for other feed-in tariff projects.

Deering described it as a three-birds-with-one-stone strategy. Distributed solar would help the utility contribute to the state's goal of getting 30 percent of electricity supplies from renewables by 2015. It would also encourage solar job creation and defer hefty capital investment in the grid, he said. LIPA expects to begin accepting applications from developers in October.  

Farrell of the Institute for Local Self-Reliance called the plan "pioneering."

"It's certainly the first program I've heard of run by a utility" that offers higher incentives for distributed solar projects based on geography, he said.

While unique, LIPA's move is in line with a shift among progressive utilities to pay more for distributed solar when it can benefit the grid.