US utilities urged not to bet the trillion-dollar farm on natural gas

Natural gas prices are predicted to remain low over the next two decades, albeit not as low as today's price just under $2MMBtu, while the only way is up for electricity retail prices. 

You'd think that gas-fired power plants would be a no-brainer for investors looking to put long-term dollars to work in the power generation sector - even if the US introduces a price on carbon by the 12th of never, natural gas is far cleaner and less of a risk than coal.

But betting on natural gas as a non-volatile commodity is a high-risk strategy, according to a new report published this week by Ceres, which did a lot of work last year to lobby for even more stringent CAFE standards for vehicle fuel economy.

Practicing risk-aware electricity generation: what every state regulator needs to know sets out the challenges facing the energy industry in the US. Unlike other sectors, it is regulated to balance the needs of investors who want returns, utilities who want to make money for their shareholders and consumers who need to be protected from price shocks in electricity prices.

 These interests compete with each other in a context where the US has huge imbalances in the power sector: the country already has a legacy of overcapacity in gas-fired power generation in some regions thanks to a build-out campaign in the last decade (see figure above); coal-fired power plants in the rustbelt east are already likely to be phased out in favour of more gas generation thanks to EPA regulations; nuclear power plants around the country are approaching the end of their licence periods; and renewables are becoming disproportionately expensive compared with cheap natural gas-generated electricity.

"These challenges call for new utility business models and new regulatory paradigms. Both regulators and utilities need to evolve beyond historical practice," says the report. "About 70 percent of US electric generating capacity is at least 30 years old," says the report. "Much of this older capacity is coal-based generation subject to significant pressure from the Clean Air Act (CAA) because of its emissions of traditional pollutants such as nitrous oxides, sulfur dioxides, mercury and particulates."

Investment in transmission has also failed to keep pace with demand and technology, with some U.S. transmission facilities approaching 100 years old, it says.

Utility investment in transmission facilities slowed significantly from 1975 to 1998. In recent years, especially after the creation of deregulated generation markets in about half of the U.S., it has become clear that the transmission deficit will have to be filled.

One of the questions posed by Ceres in this report is: does the US want to bet the farm on yet more gas-fired generation? Clearly the answer is no.

Ron Binz, report co-author, president of Public Policy Consulting and former Chairman of the Colorado Public Utilities Commission, said: "Utilities, regulators and customers are entering what's going to be the most uncertain, complex and risky period in the history of the electric power industry.

"We have relatively flat load growth and that's predicted to continue for quite a while that makes capital to the utility system a lot more important to rates there's going to be a lot of upward pressure on rates and all of the intended effects that that creates in the economy and the politics around regulation."

The report estimates that the net asset value of the plant in service for all U.S. electric utilities in 2010 was about $1.1 trillion, broken down as $765 billion for IOUs, about $200 billion for municipal (publicly-owned) utilities (or “munis”), and $112 billion for rural electric cooperatives (or “co-ops”).

It cites the Brattle Group report in 2009 which predicted that total industry-wide capital expenditures from 2010 to 2030 would amount to between $1.5 trillion and $2.0 trillion.

"If the U.S. utility industry adds $100 billion each year between 2010 and 2030, the net value of utility plant in service will grow from today’s $1.1 trillion to more than $2.0 trillion— a doubling of net invested capital," the report says.

But utilities will struggle to raise large volumes of capital required as their balance sheets droop because of flat demand and the erosion of their creditworthiness since the 1970s and 1980s - there are now no triple A rated utilities in the USA.

"The financial metrics of the utilities going into this build cycle are much weaker than they were when the last build cycle occurred," said Binz. "We had some triple A rated utilities and a lot of double A and single A utilities back in the 70s and 80s the average rating was in the range of a this time around it's around the B triple B range, two or three clicks lower than it was before. That puts the utilities much closer to the boundary of non-investment grade ratings."

Denise Furey, report co-author, and principal of Regent Square Advisors, said that a diversified fuel mix is a credit positive for a utility.

"A sizeable negative event will have an impact on the utilities credit ratings and the market appetite for its bonds which will result in turn in an increase in the cost of capital.

"The problem with natural gas and anything that is commodity based like this is that the price of it is a short-term price and we can't hedge very far out.

"A portfolio with diversified fuel mix reduces risk the sector is looking to build new generation assets currently the price of natural gas makes gas-fired generation look optimal. However, gas power plants have long lives and conversely the price of natural gas used constantly relying on current natural gas prices as predicted in long-term trends is pure folly. A mix of asset types including renewables is really optimal.

But beyond the regulators attempts to rein in rates for consumers, the social contract in the energy industry extends much further. Some 65% of utility equities and fixed income securities are owned by institutional investors such as insurance companies, mutual funds and pension plans while most retail investors own utility stock and bonds indirectly through mutual funds and 401k plans.

More than any other industrial sector, if utilities do well, everyone is a winner from the investment fund managers to the pensioners who have the potential to win twice on regulated rates and a comfortable retirement.

The utility industry is not yet being dismantled one residential rooftop solar panel at a time, but managers, utilities and regulators know that business models cannot stay the same over the next 20 years.

Regulators will play an essential role in playing referee in the long game to come in the energy sector.

Sue Tierney, managing principal at the Analysis Group and former Massachusetts Public Utilities Commissioner, said:

"What signals do regulators and policy makers send to private decision makers about what matters? Regulators often inject other measures of what matters in utility investment decisions.

"As we look across the US there are parts of the country that are in competitive markets where investors in new power generation technology are merging or competitive players and they are not making decisions based on guidance from regulators about what they may or may not invest in. In those markets we're highly likely to see gas generation dominate.

But west of the Rocky Mountains the regulated energy markets could look very different, she said: "Those are the parts of the country that are being addressed in this report where regulators can put a different non-market orientation onto the decisions at utilities managers where to invest."

"There is likely to be a different role for diversification, hedging for fuel risk … so those decisions are being made by shareholders and managers of merchant companies."

Californian utilities are having a FIT over good clean energy policy

When I first came to California to report on the clean energy industry a few months ago, I was surprised to find the absence of feed in tariffs, in particular for domestic users. 

I have since puzzled why the US was so resistant to such a simple system, which has created massively successful solar PV markets in Europe, particularly in Germany. Craig Lewis of the Clean Coalition has even had to resort to call FITs something else - clean programmes - to break through the mental block in the US.

I have not been able to find a good reason why European-style FITs don't fit in the US - until now. I don't so much have a definitive answer, but at least I have a plausible theory.

Nowhere on this earth could the reasons behind resistance in the US to FITs have been more obvious than at the Intersolar conference earlier this month. Armadas of European companies, analysts, academics and politicians flooded the halls of the Moscone Centre in San Francisco to win business and report from their own frontline on policies that create value for society, rather than just profits for investors.

The California Public Utilities Commission does some valuable work in shielding ratepayers from excessive price hikes from utilities. If only the UK’s Ofgem had similar powers. But Californian ratepayers pay the CPUC to act in their interest through a tariff on their monthly energy bills.

But I am increasingly uncertain that the CPUC is always acting in the interests of ratepayers, instead favouring close relationships with utilities, which is why it launches half-way house schemes such as reverse metering instead of hitting FITs with both barrels.

When people ask me about my experience of the US so far, I wonder whether Winston Churchill was thinking about the US (he was proudly half American, after all) when he described Russia as a riddle inside of an enigma.

My experience of California and the San Francisco Bay Area has been one of contradictions – bright sparks of first-world innovation that set the world alight start in Silicon Valley. It is exhilarating and a privilege to witness this clean energy evolution at the fringes as a journalist.

Yet it is difficult to stomach the desperate poverty of the street homeless. I would guess a disproportionately higher percentage of the city of San Francisco’s official population of 800,000 would classify as homeless or insecurely housed than other “world-class” cities.

But this rot that undermines social cohesion doesn’t stop at those who sleep next to their shopping carts on the pavements during rush hour. The multiplier effect of allowing these desperate souls to sleep rough resonates way beyond the blocks have turned into no-go zones such as the Tenderloin. For every drug addict, there are probably at least 3 dealers. For every dealer, there are probably three suppliers no doubt connected only by a few degrees of separation from the ugly and extreme violence that curses Mexico.

This is where I abandon liberal values and romantic notions of people choosing to live like this. I’m sure even Republican politicians would advocate zero tolerance of such visible social decay… as long as they don’t have to pay taxes to support it.

What has this got to do with utilities and their resistance to FITs? Put simply, it is just one example where commerce trumps common sense. 

The chasm between the elite of Silicon Valley and the homeless on the streets of San Francisco should be filled by good public policy. But problems over funding for the basic requirements of a healthy economy, such as mass transit, expose the failures of public policy to bridge the gap. The valley of death means something quite different for San Francisco’s homeless…

Policies are meant be designed to create value to society, not just individual companies. But in the US, there is an emphasis on policy and regulation that encourages commerce, rather than restricting it.

For the most part, the CPUC balances its regulations with the need for utilities to make money. But some critics have argued that the CPUC has gone too far.

The San Bruno disaster has already cost the "retirement" of PG&E’s chief executive Peter Darbee. And it might not end well either for Michael Peevey, the chief commissioner of the CPUC.

The investigation is ongoing. But has already thrown up some fairly awkward moments for Peevey’s CPUC regarding its oversight of utilities and why the commission hadn’t followed up when it granted PG&E $5m to fix the faulty stretch of pipeline that then blew up. The CPUC had previously not followed through with enforcement of fines after PG&E  was found at fault when a gas pipeline explosion killed one person in Rancho Cordera in 2008.

A few months ago the Bay Area Guardian ran an excellent piece of investigative work into the CPUC’s junkets overseas. I disagree that poachers never make good gamekeepers – who wants a regulatory authority run by someone who doesn’t understand the industry after all?

It is also of tangible benefit to send CPUC and utility executives to see how other jurisdictions in Spain and Germany for example structure their energy industry. God forbid they should never look beyond the walls of the Californian or US energy industry for examples of best practice. I don’t care how big the hotel pool is – but I do care about what they take away from meeting energy industry executives in Europe.

It also describes the California Clean Energy Fund as “obscure” which it transparently is not…

But I agree with the well-researched article that, given his background at Southern California Edison, that Peevey will have taken a generously sympathetic attitude towards utilities into his role at the PUC.

Light winds of change are blowing, however, after Governor Jerry Brown made his first CPUC appointment in March. Mark Ferron, has a background in financing so badly needed in the energy industry. And a fresh pair of eyes without direct experience of working in the energy industry may be an advantage.

Perhaps Brown is playing a shrewder strategy here. By keeping Peevey in post, he keeps him accountable for the San Bruno disaster.

Until there is fresh blood at the top of the CPUC, the state is unlikely to see any significant movement on FITs.

As Dan Adler, CalCEF president, said in the article:

"Utilities are effectively monopoly, or oligopoly, controllers of the energy industry," he said. "And they don't like outside innovation coming and disrupting their work process or their relationship with their customers."

Adler’s comments are a common refrain in the energy innovation sector in California and go a long way to explain why the CPUC has resisted at least domestic FITs on behalf of utilities … because they will sell less electricity and lose money.

Proponents of clean energy have told me that they still see themselves as electricity retailers and the electric vehicle is the best thing to happen to them since air conditioning. All electricity retailers want to sell their commodity regardless of how it's generated and a shift to renewables is a shrewd move to avoid the risk of the inevitable rising cost of carbon.

Utilities are fearful that their revenues will dwindle as US investors wake up to energy efficiency. And making money in a market where energy is cheaper than it is in most other rich nations is going to be a problem when more homes and businesses start producing their own electricity.

But utilities need to stand aside on FITs and allow the policy stimulus to do its work and prove that not all regulations are bad for business. More than that, good regulations should create businesses that bring benefits greater than the sum of their dividends to shareholders. 

More on FITs and the view from Europe tomorrow…

California's energy regulators make UK counterparts seem powerless

Energy prices in the UK, and the rest of Europe, are much higher than those in the US.

Residential rates from my energy supplier PG&E average $0.18549 per kWh. Business rates are equally low - I've even heard businessmen report that they tell factory owners in China to start manufacturing in the US because the price of energy is so cheap. But in the UK, my electricity tariff would be according to this comparison site between 8.7675p per kWh (Npower) and 23.6355p per kWh (British Gas).

In the US, these kinds of prices would spark a revolution.

The UK government is currently struggling with utilities to keep prices in check. But it appears to be failing.

Britain's energy secretary, Chris Huhne, recently tried aggressive tactics in urging customers to exercise their right to vote with their wallets in the "free market" energy sector by changing supplier.

Huhne is as free-thinking a politician as you'll see in the current British government. Last week he attacked his Conservative colleagues for placing environmental regulations on a list of red tape to be considered for scrapping. Regulation he argued, isn't always bad and often creates vigorous markets, citing the difference between the boom in European mobile telecomms that far exceeded the industry in the US:

"At one point the USA had no less than 16 separate and incompatible networks. In contrast, the EU adopted a single standard, GSM, which established global roaming. This was so effective that today, of the world's largest 20 mobile networks, six are European and only two are American – and they're in 19th and 20th places."

But Huhne's complaints against the UK's electric utilities suggests that the regulations aren't quite set right yet.

The Guardian reported earlier this month that Scottish Power announced it would raise gas prices by 19% and electricity tariffs by 10% from August this year, adding 48p a day, or £175 a year, to the average daily combined gas and electricity bill of its 2.4 million customers.

It is all very well for Huhne to publicly attack the "Big Six" - Scottish Power, nPower, EDF, Scottish and Southern, E.ON and British Gas - and urge consumers to go elsewhere. But where do energy customers go? The electric utilities in the UK appear to act like a cartel and all raise their tariffs after the first power company has broken ranks. Profits may have "slumped" last year at Scottish Power, but profits at its Spanish owner Iberdrola were a bouyant €2.87bn last year.

It is unthinkable that California's utilities would be able to act in this way without reference to the state's Public Utilities Commission, or its consumer watchdog, the DRA. Consumers in the UK by comparison appear remarkably unprotected and the country's defences against price hikes seem toothless - its energy minister and regulator Ofgem expose weaknesses in the system.

Michael Peevey and other commissioners at the CPUC would be able to put the brakes on …

But the UK energy industry's regulatory issues do not end there. Despite having the world's only legally binding targets on reductions in CO2 emissions and reasonably aggressive targets on renewable energy something really is amiss in the integration of policy and regulation across the energy industry when the National Grid has got itself into a power purchase agreement that means it had to pay wind farm operators £2.4m to switch off its turbines during a low period of demand thanks to an unusually warm May.

Perhaps coal-burning power stations are also compensated in this way, but I doubt it since they carry the UK's baseload. And I am still searching for an example in the US of a utility being compensated in this way.

But it raises serious questions about the UK government's strategy when it comes to integrating renewables into the grid. Premiums for renewable energy is an acceptable part of trying to bring the market to maturity and will eventually lead to price parity with fossil fuel energy.

But when Scottish Power receives £720,000 for not producing electricity and raises prices without reasonable explanation, then the UK consumer has every right to ask questions about the effectiveness of the government and the regulators to protect them - whether from oil shocks in the Middle East or unseasonally warm springs.

These snags in the UK's renewables sector really need fixing if it is serious about clean energy. Perhaps it's time Peevey shared some tips with his UK counterparts…