Managing the Utility Enterprise – Winter 2015

The ScottMadden Energy Industry Update | February 2015

Differing regulatory constructs are driving utilities to adjust their business models. In this section we look at examples of these options. We also examine trends in levelized cost of energy from various resources and what those drivers are.

Key highlights include:

  • Evolving Utility Business Models: Differing regulatory and incentive constructs matter
  • Levelized Cost of Energy: The trends, the debate, and the outcome

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EVOLVING UTILITY BUSINESS MODELS

DIFFERING REGULATORY AND INCENTIVE CONSTRUCTS MATTER

UTILITY BUSINESS MODEL EVOLUTIONS WILL BE GOVERNED BY REGULATORY AND MARKET ENVIRONMENTS—AND IT IS STRIKING HOW DIFFERENT THESE ENVIRONMENTS ARE BECOMING

Central Planning

Regulators establish comprehensive regulatory framework and compact that defnes utility roles, responsibilities, and fnancial incentives and penalties

  • Utilities as platforms for technology (NY)
  • Demonstration projects (NY)
  • Fundamental redesign of ratemaking process (NY)
  • Distribution-level demand response programs (NY)
  • Community choice aggregation (NY)

Technology- Rich

Legal or regulatory requirements are established that put a “fnger on the scale” for certain technologies

  • Aggressive renewable portfolio standards (CA)
  • Solar carve-out in RPS (MN, NJ)
  • Smart grid requirement (CA)
  • Storage requirement (CA)

Incentive Subsidies

Special tariff or other subsidies (including tax credits) are established to encourage certain types of resources or utility behaviors

  • Value of solar tariff (MN, TN)
  • Tariff for customer-sited generation (CA)
  • Applicable retail rates for solar gardens (MN)
  • Federal subsidies (tax and other)/loan guarantees
  • Net metering (various)
  • Voluntary RPS cost recovery, increased rate of return (VA)

Infrastructure Incentives

Programs and mechanisms to promote development of certain kinds of energy infrastructure are established

  • Energy-tech venture fund (IL, NY)
  • Performance-based formula rates (IL)
  • Special (IL) or accelerated (MA) infrastructure cost recovery programs
  • Grants for projects to increase resiliency (MD)
  • Electric vehicles (CA, WA, et al.)

Market- Based

Market and competitive forces are relied upon to allocate resources, select technologies, and compensate market participants

  • Highly market-driven environment (TX, GA)
  • Few permitting requirements (TX)
  • Minimal subsidies and mandates (TX, GA)
  • Direct access/retail choice for industrial customers (TX)
  • Time-varying rates (MA)

LEVELIZED COST OF ENERGY:

THE TRENDS, THE DEBATE, AND THE OUTCOME

THE ELECTRIC INDUSTRY CONTINUES TO LOOK AT HOW VARIOUS GENERATION TECHNOLOGIES STACK UP ON AN UNSUBSIDIZED COST BASIS


Solar Photovoltaic (PV)

Decline in the cost of components (e.g., PV panels, inverters, etc.) and improvements in effciency

Solar Thermal with Storage

Newer, cheaper technology: 2012 assumed 3 hours of storage vs. 10-18 hours of storage in 2014

Fuel Cell

Decline in cost of components at the high end

Biomass Direct

Unchanged; capital cost and O&M expense have remained steady, and fuel costs have stayed low

Geothermal

Unchanged; capital cost and O&M expense have remained steady

Wind

Decline in the cost of components (e.g., turbines) and improvements in effciency, especially for lower wind power class sites

Energy Efficiency

Unchanged; continues to be highly variable depending on the specifc initiative and application

Gas Peaking

Decline in fuel cost

Integrated Gasification CC*

Increase in next generation technology costs as more becomes known with the latest wave of new build

Nuclear

Increase in emerging technology costs as more becomes known with the frst few projects in the U.S.

Coal

Increase in fxed O&M related to new environmental controls and a slight increase in fuel cost

Natural Gas CC*

Decline in fuel cost

A BROOKINGS INSTITUTION WHITE PAPER HAS LED TO A SPIRITED DISCUSSION OF WHETHER LEVELIZED COSTS CAPTURE “TRUE” ENERGY COSTS AND CAPACITY AND OTHER BENEFITS PROVIDED WHEN INTERMITTENCY IS FACTORED IN.

Levelized Cost Analysis is Flawed

Point: Intermittency Matters (Frank)

  • Levelized cost analysis does not account for the time- varying benefts and varying capacity factors
  • Resources should be evaluated by the net benefts they provide and resources they displace, especially baseload
  • Nuclear and gas NGCC* benefts are undervalued for CO2 reductions

Counterpoint: Intermittency Effects Are Overstated (Lovins)

  • Counting time-of-day value and grid-integration costs yields the same result as levelized cost: grid integration costs are small, and solar is cheap enough to beat gas- fred plants
  • Renewables’ intermittency effects will be manageable even with increased penetration: variability ≠ unpredictability

Storage is Essential for Renewable Integration

Point: Intermittency Matters (Frank)

  • Solar PV and wind cannot contribute reliable supply without bulk electricity storage and impose balancing and cycling costs on the system

Counterpoint: Intermittency Effects Are Overstated (Lovins)

  • Load can be made smaller and less “peaky” with increased asset effciency
  • Bulk electricity storage and fossil-fuel backup are the costliest sources of grid fexibility

New Natural Gas-Fired CCs (NGCCs) Can Replace Baseload Coal Generation

Point: Intermittency Matters (Frank)

  • New, highly effcient units would rank higher in the merit order vs. existing NGCCs: do not use historical capacity factors
  • NGCC benefts are highest due to low capacity and energy costs
  • A CO2 emissions price would result in NGCCs swapping places with coal in the stack

Counterpoint: Intermittency Effects Are Overstated (Lovins)

  • 92% capacity factor for NGCCs is unreasonable: historical capacity factors have been 45%-50%
  • NGCC dispatch is less economical where gas prices are higher, displaceable coal generation is overstated, and improvements in effciency are driving down overall demand

Wind and Solar Are Costly and Unreliable

Point: Intermittency Matters (Frank)

  • Wind and solar, even with zero fuel costs and more recent cost improvements, have lowest avoided energy and capacity costs due to high capital costs and low capacity factors

Counterpoint: Intermittency Effects Are Overstated (Lovins)

  • Cost and performance of wind and solar, including balance of system solar costs, have improved dramatically in recent years
  • Operating lives for wind and solar are longer than assumed

Nuclear Generation is Undervalued

Point: Intermittency Matters (Frank)

  • Nuclear net benefts are among highest: high capital costs offset by avoided carbon, energy, and capacity costs, low energy costs, and high capacity factors

Counterpoint: Intermittency Effects Are Overstated (Lovins)

  • Nuclear costs, including capital, fxed O&M, and decommissioning costs, are dramatically understated
  • Avoided capacity cost is moot – the U.S. is long on generation

UNSUBSIDIZED LEVELIZED COST OF ENERGY FOR SOLAR AND WIND HAS FALLEN SIGNIFICANTLY AND NOW RIVALS THAT OF NATURAL GAS COMBINED CYCLE UNITS.

RENEWABLES SHOW COST IMPROVEMENT

  • Historically, economics (i.e., least cost) was the primary point of debate regarding renewables; integration (i.e., reliability effects) has largely been in the background as penetration levels remained small
  • Declining costs (see above) are expected to continue to encourage more renewable resource expansion
  • Going forward, one might expect the economics debate to move from the cost of energy to the full cost including integration costs
  • The point/counterpoint on intermittency (see previous page) offers a preview of the industry dialogue we expect to see in the future

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