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Facing the Climate Challenge

Climate risks are entering the calculus for utility investment strategies.

Fortnightly Magazine - August 2006

being developed in the United States, and most of them are pulverized-coal (PC) units.

While it’s true that PC plants pose risks and costs for complying with future carbon constraints, many utilities see little choice but to invest in boilers now, and wait to see what happens with carbon constraints.

“When carbon sequestration becomes a requirement, the cost will be filtered through to the market,” says Stephen A. Stolze, a managing director with Black & Veatch’s enterprise management solutions division in Long Island. “It will have different impacts on different technologies, but it’s naïve to think coal will become a less-important fuel in the near term, given the limitations of the alternatives.

Thus, the next wave of power-plant construction seems certain to be dominated by PC plants—a trend that nevertheless seems counterintuitive in the long-term context of ever-tighter environmental constraints.

“From a sustainability perspective, increasing reliance on coal is a risky strategy,” says Michael Zimmer, a partner with Thompson Hine in Washington, D.C. In addition to carbon constraints, he notes growing transportation costs and uncertainties. Coal shipments have been interrupted multiple times in recent years, due to line congestion and other factors.

In an effort to catch up with demand growth, rail companies are investing in new lines, such as a $100 million project by Union Pacific and BNSF to build 40 miles of expanded line capacity to carry Powder River Basin coal from Wyoming. These investments will help, but adding 150 new coal-fired units all over the country, along with retrofits that extend the operating lives of existing plants, could stress an already strained rail system.

“More utilities need to be developing portfolio approaches on generation, to use a blend of supplies that will keep delivered prices stable,” Zimmer says. “Utility credit quality is hinging on the issue of diversity—the rising cost of fuel and what you are doing to manage it.”

Climate Stability

The risk for power generators is that they will be caught relying too heavily on a fuel or power-generation technology that becomes impaired in the market, whether because of supply problems or climate concerns. Such risks are difficult to manage, because competitive markets and regulators alike reward low-cost producers in the immediate term and punish high-cost ones, even if their investment decisions are the most prudent and beneficial for ratepayers in the long run.

For their part, ratepayers don’t seem to care much about climate change, but then neither do they care about the effects of criteria pollutants until they are directly affected by asthma or smog. In each case, ratepayers accept the fact that protecting the environment bears a cost, and they expect utilities to pass that cost along to them. “The reason ratepayers aren’t in the debate is because energy is a minimum-price play,” says Michael Valocchi, a senior managing director with FTI Consulting in Philadelphia. “But they expect American corporations, including utilities, to be good environmental citizens.”

Utilities might find greater support from ratepayers if they actively promoted a forward-thinking vision. Ratepayers readily understand the value of research and development, especially if it is