Realizing the benefits of a modernized system requires an integrated strategy.
Todd Filsinger is global head of PA Consulting Group’s energy integrated sector team. He acknowledges the contributions of Keturah Nelson, Charles Tooman and Ethan Paterno.
The U.S. power market consistently has displayed cyclical characteristics of boom and bust over the last two decades. Today’s market environment has been directly and significantly impacted by the recent economic recession. Decreases in load growth, declining commodity prices, and lack of accessible financing have caused challenges for the industry.
Despite these challenges, policy makers have put an emphasis on three objectives for the energy industry: reduce carbon dioxide (CO2) emissions; expand and enhance the transmission and distribution (T&D) infrastructure; and develop higher levels of renewable generation. Although pursuit of these objectives represents a significant challenge to policymakers, regulators and executives alike, success in these three areas has the potential to fundamentally change the course of the electric power industry.
However, to realize the benefits from the above priorities, it’s critical to pursue each within a closely integrated program of work, focused on the interrelated objectives of facilitating environmental stewardship, building a significantly more modern electricity network, and implementing the technologies to help producers and consumers make optimal choices about the production and use of power. Furthermore, innovative methods of financing these costly programs are necessary, given the continued tight credit markets and challenges related to financing large scale capital investments.
State of the Market
Understanding today’s power market environment requires an understanding of both general macroeconomic conditions, as well as the state of the power markets leading up to the deepest troughs of the economic downturn. Entering the summer of 2008, the power markets appeared to be positioned for growth. In general terms, markets across the United States were beginning to stabilize from years of overbuild, commodity prices were at near-record highs, and there was an increase in new generation development—in particular, renewable generation. However, the economic crisis that deepened by the third quarter of 2008 fundamentally changed the outlook on the power markets. Decreases in load growth projections (see Figure 1) caused a significant and systematic delay in recovery expectations across the U.S. power markets. Markets currently aren’t expected to reach equilibrium levels until the 2014 and 2015 timeframe, on average (see Figure 2). In addition, steep commodity price declines put downward pressure on margins for many types of generation assets. In the context of renewable generation, declines in natural gas prices—and subsequently power prices—can cause significant compression of margins (see Figure 3).
The combination of depressed power market conditions and restricted financing due to tight credit markets has led to a challenging environment—particularly when considering the goals and objectives of both federal and state policy makers. Specifically, there has been an increased focus on CO2 emission reductions and renewable generation supported by T&D infrastructure upgrades at both federal and state levels. At the federal level, the Waxman-Markey bill was passed in the House of Representatives in June 2009 and intends to create a CO2 cap-and-trade regime aimed at reducing CO2 emissions to 17 percent below 2005 levels by 2020 and 83 percent below 2005 levels by 2050. It also contains a provision for 20 percent of U.S electricity to be supplied by renewable generation by 2020.1 The Senate is currently working on the Kerry-Boxer bill, which in its current form2 proposes to reduce CO2 emissions to 20 percent below 2005 levels by 2020 and 83 percent by 2050. Meanwhile, at the state level, there have been a variety of regional CO2 initiatives, such as the Regional Greenhouse Gas Initiative (RGGI) and the Western Climate Initiative (WCI) (see Figure 4). Additionally, state renewable portfolio standard (RPS) or renewable energy standard (RES) programs require that varying percentages of total electricity production come from forms of renewable generation. Currently, 28 states plus the District of Columbia have RPS targets in place.
Policy makers also have recognized that T&D upgrades will be necessary to meet these challenges. President Obama has called for the construction of 3,000 miles of new transmission lines3 and in October 2009 unveiled $3.4 billion in stimulus funds for specific electricity infrastructure projects, including smart-grid systems and supporting infrastructure and modernization of transmission lines.
Looking forward, it’s clear that renewable generation will play an important role in the future of the power markets. However, ensuring both the installation of significant levels of renewable generation to meet CO2 abatement and other regulatory objectives, as well as the ability to deliver the generation from the new renewable plants to load centers, is a large undertaking, exacerbated by the continued challenging financial market environment. To create a modernized electricity production and delivery network that supports environmental sustainability, delivers energy in a reliable manner to changing load centers, and facilitates the evolution of customer demand characteristics, it’s important to integrate a solution that not only addresses the character of installed megawatts, but also the need for significant T&D infrastructure and that balances generation.
One of the biggest challenges associated with the development of substantially greater sources of renewable generation is the need for a new and enhanced T&D infrastructure to accompany the new assets. Stated simply, while the United States has vast amounts of renewable resources, a majority of these resources are located away from load centers, requiring major investment in new T&D infrastructure.
Perhaps the best example of this is the Electric Reliability Council of Texas (ERCOT), which has added more than 8,500 MW of wind capacity to date.4 Over 90 percent of ERCOT’s wind capacity is located in the sparsely populated West, while the major demand, or load centers (eg., Dallas, Houston etc.), are located in the East. Due to limited transmission capability from the West to the South and East zones, much of the wind capacity is stranded, and therefore ERCOT is unable to realize the full benefits of wind power, in terms of both energy pricing and CO2 emissions reduction. These stranded megawatts have resulted in large price variations across the ERCOT zones (see Figure 5). In fact it’s not uncommon for the West to experience negative energy prices as a result of excess wind generation.
In an effort to realize the full benefits of ERCOT’s wind capacity, the Public Utility Commission of Texas (PUCT) approved the Competitive Renewable Energy Zone 2 (CREZ 2) in 2008. Projected to cost approximately $5 billion, CREZ 2 is designed to increase the transmission capability from West to East by more than tenfold. When completed in 2013, CREZ 2 will provide transmission for a total of approximately 18,500 MW of wind capacity in ERCOT.
Smart-grid technologies also will be an important element of the overall T&D modernization effort. Smart grids should allow for two-way communication and response between utilities and consumers through the use of a dynamic network utilizing smart meters, device and appliance controls, data management tools and neural networks. This will enable consumers to respond to real-time prices and select the most cost-effective energy usage pattern. Fully implemented smart grids aim to create an integrated distribution system between utilities and consumers that also incorporates such aspects as distributed generation sources including house solar panels, and electric cars.
Another critical component to the integrated solution is balancing generation. Many types of renewable generation aren’t dispatchable and have much smaller capacity factors in comparison to base-load generation such as coal plants. Renewable generation is subject to generating only when renewable resources are available. Therefore, some types of renewable-generated energy, such as wind, often is produced in large volumes during low demand periods, and subject to substantial volatility. Given this, it’s important to have balancing generation to supplement renewables.
One specific example of the importance of balancing generation also involves ERCOT, when in July 2008 wind generation spiked 1,500 MW in 30 minutes. This forced the system to remove several non-wind generators from operation. The wind generation then proceeded to drop 2,500 MW, which forced the system to try to bring those same non-wind generators back on-line, in addition to others. Over a four-hour period, real-time energy prices fluctuated from nearly $100/MWh to over $170/MWh (see Figure 6). In this case it’s important that quick-start resources, such as peaking plants, are available. Without such resources, markets like ERCOT—made up of a large proportion of wind capacity—will be subject to grid instability and consequently subject to spikes in real-time energy prices.
Smart grid and storage technologies also can help balance supply and demand. On the supply side, storage facilities will be able to store excess generation in hours that it isn’t needed, such as wind generated in off-peak hours. Smart-grid technologies have the capability to also have storage elements, through electric car batteries, for example. On the demand side, smart-grid technologies will send appropriate signals to the consumer so that demand can be shifted to hours when renewable generation is available.
Financing the Solution
Realizing the potential benefits from energy initiatives aimed at modernizing the country’s generation fleet and T&D network will require development and execution of a closely integrated set of programs. Successfully implementing these solutions will require significant capital, and the appropriate set of incentives. While the cash grants provided by the American Recovery and Reinvestment Act of 2009 (ARRA) have produced some of the right incentives, these generally represent near-term solutions to a longer-term requirement; to encourage sustainable renewable generation growth—and in general, the sustained reinvestment in the energy infrastructure—a long-term solution is needed.
The Department of Energy (DOE) loan guarantee program,5 also established under ARRA, is a step in the right direction, albeit also more focused on the near-term.6 For commercially-proven technologies, the program guarantees 80 percent of a project’s debt, so long as the debt is less than 80 percent of the project’s total cost. In addition, the program is designed to expedite the loan-approval process by partnering renewable developers with lending institutions prior to filing the loan application. According to DOE, the $750 million in funding available under the program could support $4 billion to $8 billion in renewable generation. Depending on the borrowing rate, others have suggested the level of support could be closer to $15 billion.
A complementary and longer-term solution is the proposed federal green bank, or Clean Energy Deployment Administration (CEDA). CEDA is currently part of the Waxman-Markey Bill and has been approved by the Senate Energy and Natural Resources Committee.7 As currently proposed, CEDA would operate as an independent, government-owned, non-profit investment bank, with an initial charter of 20 years and $7.5 to $10 billion in funding.8 CEDA would provide access to capital and offer lower financing rates through loans and loan guarantees. With $10 billion in funding, CEDA is estimated to be able to support more than $100 billion in debt to finance elements of the integrated solution, including the renewable generation and associated T&D and other technologies that can reduce CO2 emissions.
The recent significant economic recession has presented a challenging environment for all aspects of the U.S. economy, and the power industry is no exception. Despite the lingering effects of the downturn and continued economic uncertainty, a unique opportunity exists to fundamentally change the future of the U.S. power industry through the successful execution of an integrated reinvestment plan that explicitly recognizes the interrelated nature of renewable generation development, CO2 emissions abatement, modernized T&D, and more flexible energy production capability. Importantly, the levels of innovation in creating the right incentives for sustained financing and investment must match the levels of innovation around renewable energy production and delivery, development of smart-grid technologies, and efforts to significantly reduce emissions.
1. For utilities with sales greater than 4 million MWh with adjustments allowed for existing hydro generation, new nuclear generation, and new carbon sequestration units. Additionally, 25-40 percent of the targets will be allowed to be met by energy efficiency measures.
2. Chairman’s Mark of the Clean Energy Jobs and American Power Act (S. 1733) Oct. 23, 2009.
3. President Obama’s Weekly Address, Jan. 24th, 2009.
4. Source: PA Consulting Group’s merchant capacity database.
5. Section 1705.
5. Projects funded through this program will need to show that it is likely they will be able to start construction by September 2011.
7. American Clean Energy and Leadership Act 2009.
8. In the Waxman Markey bill, CEDA is funded with $7.5B and in the Senate version it is funded with $10B.