Increased business and regulatory challenges have utilities lagging in investments to meet energy demand a decade from now.
A primary rationale behind the restructuring of the electric utility industry 10 years ago was that competitive markets manage supply and demand, incent innovation, and allocate investment more effectively than centrally regulated monopolies. While fundamentally sound in principle, the policy implementation of this rationale has not adequately reflected either the unique physics or the public entitlement characteristics of electricity. The consequence has been a breakdown in the traditional public/private partnership built around the obligation to reliably serve, and upon which the electricity sector's value and reputation was built.
In short, the electricity enterprise has tended through restructuring to become a victim of its historic success in maintaining universal service reliability at ever-lower cost. The essential foundation for restoring enterprise vitality in the coming decade is rebuilding this fundamental public/private partnership, based on technology innovations that can increase the value of electricity service, including providing higher levels of reliability and security. This transformation of the traditional electricity supply network into tailored, multi-functional service networks should result in significant new business growth opportunities, reinforced by greater consumer satisfaction.
Impediments to Progress
The impediments that must be overcome in the next decade revolve around four themes:
1. Lack of Appropriate Public Policies. The electricity enterprise must deal with numerous conflicts among various federal and state policies and regulatory bodies that undermine the achievement of a confidently stable regulatory regime. Short of a crisis, resolution of these conflicts within the current sector leadership structure could take a very long time. In the meantime, the enterprise is trapped in a continuing period of turmoil in which its shared vision of the future has fragmented, its stakeholders have become polarized, and its commitment to long-term development has eroded. The expectation that competition would somehow fix this "broken wheel" has thus far failed because it lacks the essential foundation on which successful markets depend-that is, adequate infrastructure and consistent, enforceable rules.
2. Insufficient Investment Incentives. Adequate investments in infrastructure continue to be deferred due to the financial risks of policy uncertainty and inadequate compensating return for investors. Until these risks and rewards are confidently rebalanced, neither existing entities, nor new players, are likely to make the system investments needed. As a result, the U.S. power-supply system remains dependent on aging, analog electromechanical technology, developed in the 1950s or before. This technology legacy can neither keep pace with the steady growth in the quantity and quality of electricity demand, nor effectively support an open access competitive electricity market structure.
3. Difficulty Communicating the Rationale for Improvement. Participants in public policy debates face severe competition from advocates of many other causes. In such an environment, it is difficult to hear and understand even the most compelling public policy arguments. Effectively communicating the rationale for a modernized electricity system will require the electricity sector to rally around a consistent and compelling message, and to proactively inform its constituency accordingly.
4. Increasing Business Challenges. The electricity sector also is experiencing a number of business challenges that compound its difficulties. These are, in many cases, derivative of the impediments outlined above, and include:
Growing cost pressures on fuel, labor, and construction, as well as inflation and the cost of capital. Limited and uncertain ability to pass these cost increases on to the consumer. Reliability and security of energy supply, which increasingly are threatened by under-investment. The general inability to gain either confident longer-term purchase contracts at prices commensurate with supply costs, and/or shorter write-off periods, further discourages both innovation and capital expansion. Capital expansion, which at the same time will be critical to earnings growth. This may involve contentious rate cases within the current service-value structure, thus causing distress for utilities, regulators, and consumers alike who generally have enjoyed an extended period of rate stability. Mergers and acquisitions, which can only, at best, temporarily compensate for limited electricity sales and earnings growth potential within the current electricity business model and value proposition.
Over the past decade, the restructuring of the electricity sector has served to accentuate these underlying business and infrastructure impediments. The following offering provides a pathway to resolving these impediments.
Business as Usual vs. A Transformed Sector
A modernized electricity sector would provide widespread benefits for the economy and society. The following table summarizes the payoff from deploying the technology needed for an electricity sector capable of meeting the growing demands of the 21st century. In this enhanced scenario for 2015, productivity growth rates are higher and the economy expands more rapidly, while electricity consumption, intensity (kilowatt-hours per dollar GDP), and carbon emissions are reduced relative to business as usual.
A technically transformed infrastructure would, for example, enable up to a 2.5 percent/year worker productivity growth rate, substantially above the 2.0 percent rate projected for business as usual. Higher productivity rates can be sustained because a more reliable digital power delivery infrastructure would enable workers to perform existing and new functions more accurately and efficiently. This accelerated productivity growth has been demonstrated and established selectively in the economy, but its potential could be expanded dramatically through a smart power supply system. In effect, improved power reliability and quality would enable the digital economy to expand at a broader and faster rate-an essential factor for successful U.S. competition in a global economy.
The digital revolution is the third major economic transformation in the last 100 years, and each increasingly has depended on electricity. Each also has created substantial new levels of wealth, as well as winners and losers at the scale of individuals, corporations, and nations-all depending on the effectiveness with which the innovative technology underpinning the economic transformation is exploited. In this new electricity business environment, it is the quality of customer connectivity and responsiveness that increasingly will differentiate the winners from the losers. The most precious business asset becomes the customer access portal. In every electricity supply function preceding it will be under relentless cost pressure, only moderated by the value that each consumer receives.
This transformed electricity infrastructure and business model also will catalyze entirely new capabilities for consumer participation in the electricity marketplace, while significantly reducing the parasitic costs of power disturbances characteristic of today's system. Technological innovation finally will break open the commodity box currently constraining both the electricity enterprise and consumers, and will usher in an era of ever-higher-value energy/information services even beyond our imaginations. The payoff from this economic progress easily could exceed $1 trillion per year in additional GDP by 2015. This accelerated economic expansion is essential to meeting the nation's growing debt, security, and aging population costs.
How to Deal With Cost Pressure
Above all, this modernized electricity system would provide greater functionality and service value for consumers. This additional value is increasingly necessary to compensate for the expected rise in the cost of electricity. A number of upward cost trends are likely to increase electricity cost by at least 30 percent during the coming decade (). Alternatively, there are no significant supply side silver bullets available or on the horizon that can compensate for these upward cost pressures. There is also no evidence that "competitive" markets have been able to deliver on their promise of cost reduction in the absence of innovation.
These upward cost pressures largely occur because of forces beyond the control of the electricity sector, including fuel price, environmental protection, and protection of the physical and cyber infrastructures against potential incursions. The prices of fuels-natural gas, coal and uranium-are rising, and are likely to remain significantly elevated. As a result, fuel costs are expected to account for at least half of the net increase in the price of electricity over this period.
Similarly, the cost of compliance with steadily tightening environmental regulations also continues to increase. In addition, there is a growing possibility that mandatory carbon control requirements will be instituted, possibly in the coming decade. This would have significant additional impact on electricity costs, including the need for major, strategic investment in replacement generation facilities using gas and nuclear, Integrated Gasification Combined Cycle (IGCC) for coal, and renewables.
Security improvements, both to discourage terrorist attacks and to recover from them, may further add to the cost of electricity. A fully functional security program would, for example, combine enhanced physical security systems with self-healing grid capabilities and cyber tech security advances. Cyber security would focus on increasing the security of communications, data monitoring, and automated system control functions, plus provide vulnerability assessments supporting the self-correcting grid and related adaptive islanding capabilities. Rising fears of terrorist attacks also may fuel political pressure to further escalate infrastructure security measures, irrespective of their value-added. On the other hand, a modern digitally monitored and controlled power supply system comprehensively and automatically would address these concerns.
The need to improve the reliability and quality of power is another important reason the cost of electricity likely will increase through 2015. Mandatory reliability standards have been endorsed widely and were moving through Congress until stalled with the rest of the 2003 Energy Policy Act legislation. However, to be relevant to the needs of the new century, these standards will need to move beyond the traditional "keep the lights on" level of reliability to reflect the more stringent requirements of the digital economy. Today, the inability of the nation's power system to keep pace with the escalating reliability requirements of a digital economy is already costing businesses and consumers at least $100 billion each year (about a 50 cent surcharge on every dollar of electricity purchased).
The cost of capital also is likely to remain elevated. For years, the financial community was willing to provide relatively leveraged investor-owned utilities with funding on favorable terms (compared to industrial companies with the same debt ratings) because of investor confidence in the predictable regulatory treatment of these costs. As regulatory treatment becomes more uncertain, credit ratings slip, and the financing costs for the industry have risen proportionally. In addition, replacing institutional knowledge as worker retirements escalate may particularly increase the cost of utility operations and maintenance. Moreover, integrating new technology into the electricity sector workplace will require a more highly trained workforce, which, in turn, entails higher wages for more skilled personnel and higher costs for recurring training.
A New Proposition
There are two general solution alternatives to resolving the electricity sector's growing financial gap. The first is reliance on public subsidies, but this is politically unattractive, runs counter to the business incentive goals of restructuring, and, based on experience, is likely to do little more than maintain the performance -thus requiring ever higher subsidies.
The second alternative is to steadily raise the consumer value of electricity. The most important asset in resolving the growing electricity cost/value dilemma, and its negative implications, is technology-based innovation that disrupts the and changes the rules of the game. This disruption begins by marketing the greater value of smart electricity services, rather than continuing to sell bulk energy below cost. The innovative technology opportunities for this value enhancement begin at the consumer interface. These include:
Transforming the consumer interface itself from a one-way energy "iron curtain" meter into a real-time, transparent, service portal that truly empowers consumers; Increasing fundamentally the controllability, functionality, and resilience of the electricity distribution system through digital automation with power electronic controls (, FACTS); Incorporating very high-power quality microgrids as capillaries within the electricity supply system. These could, for example, effectively utilize DC power to minimize digital disturbances, and to incorporate distributed/ renewable power sources. These microgrids would have the capability to expand based upon growing consumer demand; while Enabling the true convergence of electricity and telecommunications into a smart, "Intelligrid" system powering the digital society.
In effect, the electricity supply network no longer will be artificially interrupted by an arbitrary meter, but will extend seamlessly to every consumer's end-use devices and appliances. The result, for the first time, would engage consumers directly in assuring the continued commercial success of the electricity enterprise in the most efficient manner, while also enabling integration of cleaner distributed generation technology as a power supply system asset.
It is quite clear from extensive stakeholder discussions that consumers at all levels increasingly expect, and are hungry for, higher value and more flexible levels of electric service that they can control. They also are generally willing to pay accordingly if they can be assured of realizing this result. In the end, consumers want to better control their monthly electricity bill based on the value they receive. When electrons and information are merged, consumers can create customized services that are tailored to best meet their individual needs. An arbitrary, opaque, rate structure is not an acceptable surrogate in today's reality.
As a first step toward offsetting the impact of higher electricity prices, the electricity enterprise needs to design innovative offerings that meet the needs of diverse consumer segments. Differentiated offerings will, however, require improvements to the electric power delivery system that enhance the functionality of various utility services. For example, real-time connectivity between the utilities and the consumers will facilitate automated meter reading, theft detection, outage management, and a variety of new offerings and consumer benefits such as:
Consumer-managed demand-response and real-time pricing; Energy management services, including power quality; Communications and data services; and Personally customized home automation.
These transformed networks will place new levels of comfort, convenience, speed, efficiency and adaptive intelligence at each consumer's finger tips.
Growing emphasis by a variety of major technology based firms, indicates that home automation will emerge as a major consumer market during the next 10 years, as "ubiquitous computing" becomes a technological reality. Home-based "gateways" will enable providers (including utilities) to offer bundled, whole-house energy/communications systems connecting HVAC, security, lighting, consumer electronics, PCs, and other appliances, accessible through any Internet connection. This is a significant new market opportunity for electricity distribution utilities that invest in technologically advanced distribution systems.
In summary, this smart infrastructure system modernization can comprehensively resolve the combined vulnerabilities of today's power system-reliability, power quality, and system security, as well as declining consumer value. Simultaneously, this system modernization will raise efficiency and thus reduce both fuel and capital costs.
Policy Initiatives: The States and Feds Must Take Action
Various state and federal policies, other than tax-based subsidies, are needed to incent electricity sector investment. There are numerous precedents for publicly supported mechanisms that, if applied to the electricity sector, would boost investment.
Three such policy initiatives broadly are recommended by stakeholders to fundamentally increase investment confidence in the electricity sector. The first is the establishment of mandatory federal electricity reliability standards. As noted earlier, such standards should anticipate the need for reliability enhancements appropriate to the digital economy and to greater infrastructure security. There clearly will be greater consumer confidence in the electricity sector after it establishes, and adheres to, up-to-date reliability standards.
The second measure to reward investment in the electricity enterprise is the establishment of federal electricity efficiency standards. The need to use energy more efficiently grows in importance as the prices of oil, natural gas, coal, and even uranium are reaching historic highs. Certainly, a variety of more energy-efficient technological innovations are available to support such standards. At the same time, regulators need to protect supplier profitability in the face of declining unit sales through measures that reward efficiency improvements, rather than simply the number of kilowatt-hours sold. Annual trueing-up of rates is suggested as a promising way of solving this problem.
The third recommended policy initiative is directed primarily at state regulatory practices, specifically, greater reliance on performance-based regulation. This will, of course, place greater responsibilities on each public utility commission to benchmark utility performance, set standards, and reward performance accordingly. Certainly, the knowledge and mechanisms to apply these regulatory leadership principles wisely are widely available. Until this transformation in regulatory practice is thoroughly applied, the nation's power system will remain incented to maintain the past, rather than to create a higher value future for consumers.
In sum, the clear lesson of the past decade has been that neither regulated nor deregulated electricity markets are conditioned or incented to pay today's true cost of just "keeping the lights on." Efforts to maintain an artificially low electricity cost structure at the expense of the necessary infrastructure development and investment are simply not sustainable. A new course must be taken in the coming decade that accepts this reality.
Implicit in the ability of the electricity sector to better control its destiny will be the re-establishment of the regulatory compact around a mutual, public/private obligation to serve more valuably and reliably through innovation. Uncertain regulatory treatment of costs, plus rising fuel, labor, interest, and equipment costs make it more difficult to modernize and expand the electricity supply system and raise its value proposition.
The cost/benefit of modernization is profoundly positive. For example, the cost to the average household would be less than $5 per month, taking no credit for the considerable energy savings opportunities that each consumer would be empowered to achieve through a modernized, more functional power system. In return, each consumer would save hundreds of dollars a year in the price of purchased goods and services as power reliability and quality improve.
Even more financially significant would be the income potential added to each household as the nation's productivity, security, and competitiveness increase. Over the next 10 years, the over-arching priority of the electricity sector will be to define and pursue a combination of policies and initiatives that will lead to substantial growth in sector value and investment. In support, a proactive technology-development program will be necessary. This should emphasize power system reliability and functionality, management of greenhouse gases, and the development of higher value, more efficient smart electricity services. Technological innovation will be, as it has been throughout the history of commercial electricity service, the essential asset determining the destiny of the electricity sector and its value to society.
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