Here's how I'd explain a Smart Grid to someone like me: you know how the Internet is ad hoc and messy? Well, Many of the same problems apply to the power grid. The Smart Grid is the fix.
Most people, however, are not me, so maybe the analogy isn't that too helpful.
The power grid is ad hoc and messy. To get an understanding of the magnitude of this, consider the fact that we use an AC grid, having made the decision to go with AC rather than DC back in the late 1800s, and yet we didn't get around to turning off the last of Thomas Edison's DC grid until November of 20072--something like a 125 years after it became obsolete.
Our grid was designed according to plans by Nikola Tesla in the late 1800s, before computers, before computer networks, and before we had the option to put a solar array on our roofs. As a result, the grid doesn't use very intelligent routers as we now have with computers, doesn't communicate to end-users well, and doesn't understand me when I say 'my solar array is producing more electricity than I need--let me sell it to you so you don't have to produce as much yourself.'
The Smart Grid does. It's all this and more, partly because the term's not really defined--it just refers to a bunch of different smart things we want the power grid to do. Let's look at some problems and how the Smart Grid solves them.
We don't just need power plants that can supply enough power to keep up with average demand. When a really hot day strikes, everyone turns their air conditioners to the max and power demand spikes through the roof. Storing power is difficult, and we can't just stop delivering power to customers, so we need to make sure we have enough power plants to handle peak usage. When usage isn't at its peak, we can turn off the dirtiest/most expensive plants, but they need to exist.
Having them sitting idle is wasteful, of course, but additionally, since we turn off the least efficient, the marginal cost of power increases as we use more. So reducing peak means we don't need to built so many plants and means what we do produce is cheaper/cleaner. Right now, though, consumers don't know when we're at peak (though you can guess--hot summer afternoons tend to be the worst, at least in warm climates). Also, there's no incentive for us to reduce peak, as customers. (Well, there is, but it's a tragedy of the commons-type incentive.) Besides, when it's hot, you might not want to turn off your air conditioner. But suppose we charge more for electricity during peak hours (and less during off hours), and show the cost on your meter (or perhaps a website, for easy access). You might wait to run your clothes washing machine when it's cheaper. This reduces peak usage, resulting in fewer power plants needed, and meaning we get to leave off the more expensive or more polluting ones more often.
With a dumb grid, if I break the line because I'm a clumsy bulldozer operator or a knowledgeable terrorist, it's a bit of a crapshoot whether the grid has redundancy hacked on at that spot or whether the power goes off for all of New York City. The relatively-intelligently-designed Internet was designed to be redundant, but even so we get choke-points that have, in the past, caused splits making large portions inaccessible to some people. A really smart power grid controlled or regulated by our kind, benevolent government could achieve really good reliability. The ability to automatically route-around problems is good.
We have numerous micro-generation technologies--solar, wind, hydro, &c.--which are (or are nearing) cost-parity with our centralized power plants. If I can put a solar panel on my roof, that's great. If I can also feed the electricity it produces back into the grid (should it be producing more than I need at the moment) in exchange for some sort of compensation (money!!!!) I'll do that and everyone is better off.
This also helps deal with breakage. Maybe you broke the line from the power plant to my neighbour's house, but excess electricity from my solar array can help him out. Even without breakage, this is a good thing, as the farther the electricity travels along the power line, the less of it makes it to the end point. (Superconductors are expensive.) Less wasted electricity saves money.
This will cost a lot of money to build. Some cities are working on some of this smart technology, and the Federal government has ponied up budgeted a hundred million or so, but if we want a national Smart Grid, we'll need a lot more money--it's anyone's guess just how much.
Still, some claim blackouts cost a hundred billion USD per year3, so improved reliability alone could make this worthwhile. Add on the benefits of cheaper, cleaner energy and you've got yourself a winning idea.
For Wintergreen: An Earth Quest.