The Edison Electric Institute (EEI) recently published a report titled “Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business”. Peter Kind, Executive Director of Energy Infrastructure Advocates (an investor lead initiative to educate and advocate public policy that is supportive of infrastructure development) and Senior Advisor to Macquarie Capital’s U.S. Utilities and Power industry group authored the report. In it, Mr. Kind predicts dire consequences for retail utilities and their investors from “distributed energy resources” (DER) and demand-side management (DSM).
Mr. Kind sounds the alarm from, predominantly, the utility’s point of view, drawing on investor behavior. His analysis of the likely outcomes matches what I have been writing, as do many of his recommendations. Perhaps his focus on the financial aspect will light a fire under utility CFOs to do something.
His short-term recommendations are spot on, as is his urgency. Many of his longer term recommendations, however, are from the investor perspective and do not jibe with the political realities regulatory commissions face. Finally, once a utility believes what he says and decides to act, it will need help making its case in a way that is credible with regulators and customers.
Here is the outline of the argument in the report:
- Disruption is coming through DER, DSM, and current regulatory policies.
- Current price structures have non-DER and non-DSM customers subsidizing DER and DSM customers. It is acceptable today because the subsidies are small. Once they become large, the customers providing the subsidy will not put up with the cross-subsidies and utility cost-recovery and investor capital will be a risk.
- Investors are not factoring the disruption into their current valuations since they only look out 12-24 months.
- Current security analysts of the utility industry are not taking into account disruption. They use a bottom up approach that starts with the assumption of cost recovery, while “the basis for analysis of non-utility industries is competitive position, sales prospects, and sales margins.”
- Industry credit quality has declined for five decades; further credit quality erosion will lead to below investment grade ratings and dramatically increased revenue requirements just as utilities need low-cost capital to enhance their systems.
- New capital investment is twice the rate of depreciation while sales are falling, which will cause rates to increase and DER and DSM to be more competitive.
- Although investors are supposed to be forward-looking, it takes revenue declines to make them realize the viability of the business is in question; then they flee for the exits. By the time utility investors focus on the new risks and witness customer and earnings erosion, it likely will be too late to save the current utility business model.
The recommendations are a little fuzzy in that they call for consideration rather than action, but Mr. Kind does avow that “it is not the objective of this paper to outline new business model alternatives to address disruptive challenges”. I think he has four key recommendations:
- Immediate Actions:
- A customer service charge to recover fixed costs. This will eliminate the cross-subsidy biases created by DER, net metering, energy efficiency, and DSM. [Agreed]
- Revise net metering programs so that self-generated DER sales to utilities are treated as supply-side purchases at a market-derived price [Agreed, but recognize this is tantamount to eliminating net metering].
- Longer-term Actions:
- Base depreciation recovery lives based on the economic useful life of the investment, factoring the potential for disruptive loss of customers [I think this will be a tough sell];
- Stranded cost charge paid by both DER and fully departing customers (exit fee) [This will not fly].
Idaho Power has tried the short-term actions, but has done so in a way that makes it very hard for regulators and customers to accept (see Solar energy companies upset over Idaho Power proposal). The necessary changes will take time and will need to be done gradually. That is what makes it so critical to start now.