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IOUs Under Pressure

Policy and technology changes are re-shaping the utility business model.

Fortnightly Magazine - June 2009

and will continue to experience, upward cost pressures due to the imposition of external environmental costs—namely carbon controls or purchased credits—as well as construction commodity cost increases, and the deployment of new, technologically advanced facilities. Nuclear plants seem particularly susceptible: FPL concluded in late 2007 that two new 1,100 MW units could cost between $5,500 and $8,100 per installed kilowatt. 6 And partially lost in the noise of discussion on renewable energy sources is the impact of carbon pricing on the operating costs of existing fossil-fueled facilities. Naturally, the impact depends on the price of carbon and the facility type, but with approximately 50 percent of U.S. generation supplied by coal-fired units, the impact could be significant. Moody’s recently estimated that carbon regulations could cause power prices to increase between 15 percent and 30 percent, assuming a CO 2 cost of $20/ton. 7 And the impact is likely to be disproportionate depending on geography and fuel mix. So while the cost gap between renewable and conventional technologies may be narrowing, supply costs will be rising along with delivery charges.

The investor-owned utility business model has its roots in the creation and management of a scale-based monopolistic industry, which fueled the 20th century conversion to electric power. To date, the underlying major technologies—coal-fired, gas-fired and nuclear facilities—have supported this model. However, this could change rapidly as new technologies, operational characteristics and economics are introduced. Many of the new energy technologies do not conform easily to a scale-based business model. Optimal capacity is smaller and the economics are dramatically different, as are the grid requirements. In fact, the industry search for utility-scale new generation technology deployment might be little more than a costly attempt to jam a square peg into a pre-conceived (or institutionally comfortable) round hole. A common sense example: Wind and photovoltaic facilities in good locations have a 20 percent to 30 percent utilization factor. Increasing the size of such a facility to say, 200 MW ( i.e., utility scale) dramatically increases the size of a variable and non-dispatchable asset. On the other hand, a portfolio of smaller facilities, diversified across fuel sources and operationally integrated (through a smart grid) can provide reliable and consistent generation. The investor-owned utility, as currently configured, might not be well-equipped to deploy such a model. Market forces could choose to bypass them and create a network of self-generating entities, wherein the utility is increasingly needed for stand-by and system reliability capabilities, creating very different challenges and opportunities.

Change is Accelerating

Utilities are not renowned as incubators of change. Generally they’re managed as conservative, low risk businesses. Utilities don’t lead the way in the development or deployment of new technologies. R&D functions, if extant in a utility, are primarily geared around monitoring, supporting and underwriting industry organizations that undertake research for groups of companies. Given the critical nature of electricity, new technologies are introduced only after careful testing and usually in limited applications. There’s no reward provided for being first to market with any development; in fact, there is more downside risk to any new technology