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Navigating in the Age of Uncertainty

Business models are evolving to suit a shifting industry landscape.

Fortnightly Magazine - September 2011

home area networks, non-AMI dependent home automation technologies and electric vehicles, will lead to two key risks:

* Disintermediation of the customer from the utility as new entrants, including non-utility retailers, technology companies, and manufacturers, seek to sell energy and energy based products to end users. Despite the pullback from Microsoft and Google in the energy efficiency space recently, we believe this trend will continue and new entrants will eventually succeed.

* Disruption of the distribution grid as more intermittent, variable and unpredictable sources of generation come online, many of which bypass the grid altogether.

Not surprisingly, utilities are now being asked by regulators to develop plans to deal with all of these variables and to integrate these new technologies. The traditional integrated resource plan (IRP) framework is obsolete and can’t effectively deal with all these variables. Furthermore, most utilities currently employ grid designs—with limited visualization and automation—that aren’t suited to supporting such complexities, including wide-area coordination of distributed generation assets and two-way power flow. New capabilities are needed and it’s critical for utilities to start developing a deep understanding of these technologies, their market potential, emerging business models, and the strategies that will be needed to effectively leverage or accommodate new technologies as they are adopted and achieve scale over the coming decades (see Figure 1) .

The final force is related to the ability of utilities to earn a return and recover their capital investments. The cost to upgrade the grid and support new technologies is estimated to be between $250 and $350 billion 4 over the next 20 years. An additional $700 to $800 billion 5 investment in generation will be needed to replace and increase the capacity required to serve the projected load. Customers will ultimately have to foot a bill that can easily exceed $1 trillion over the next two decades.

Not surprisingly, customer advocacy groups aren’t thrilled about this prospect. They’re demanding that utilities accept a lower rate of return on their invested capital or reduce their capital spending and O&M levels so that inflation adjusted rates will remain flat. This pressure is intensified by persistent economic weakness and high unemployment rates, which will take years to improve as the economy de-leverages itself. Another complicating factor is that utilities will continue to face rising construction costs as well as pension and benefit costs. While construction costs have historically tracked inflation, from 2000 onwards total costs have increased roughly 42 percent 6 versus inflation of approximately 17 percent. 7 A major driver for increased costs is the rise in raw material commodity costs—cement, steel, copper, etc.—which has been accentuated by the depreciation of the U.S. dollar. Utilities will have to be even more diligent with their capital efficiency, supported as always by a solid regulatory foundation.

The New Business Models

In order to survive and thrive through this period of intense turbulence, the winning utilities will need to focus on two key dimensions: a focus on operational excellence, and an ability to embrace new and disruptive technologies (see Figure 2) .

Operational excellence can be defined as