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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Handling Renewable Growth: What Should Utilities Do?

solar revolution

First headline (on page one). New green energy capacity exceeds new coal capacity. Average generating costs of onshore wind declined 30 percent and grid scale solar electricity prices 60 percent in 2010-2015. (That's a bigger drop than our local electricity prices, for sure.) At their present rate of expansion renewables will provide 28 percent of world electricity by 2021 according to the International Energy Agency.

Second headline (on page 17). South Korean chemical firm, LG Chem, one of the world’s largest lithium battery manufacturers, announces partnership with an American home solar installation firm to offer a package of rooftop solar and battery storage. The new venture claims that their solar plus storage offering will be "competitive" with grid supplied power in California by 2017. They add that “given the right pricing” their combined product would be "only slightly more expensive” than grid power in the rest of the U.S. These claims may be bold but they're not unthinkable.

Taken together we get a picture of global growth in renewables and power prices in the residential solar plus storage market approaching grid parity. There are three ways to think about the implications of these stories.

First, one could argue the picture is misleading. Renewables are not price competitive with grid supplied electricity after subtracting state, federal and net metering subsidies. As a result, optimistic estimates of low priced energy don’t always add up--barring of course meaningful strides in technological evolution.

But subsidies are like popular music groups. They develop a loyal following. We know subsidies can distort the market. But once initiated they typically prove difficult to eliminate. And from a public policy perspective, many goals of the environmental movement enjoy widespread, bipartisan public support.

In recent polling data, self-identified conservatives who were climate skeptics, still wholeheartedly supported adoption of renewables. These issues now transcend mere economics. "Decarbonization" has become public policy on a global scale and there is probably no turning back.

Our second alternative is acceptance. Acknowledge the transformation and embrace change. In this approach the goal is new ways to profit, minimize financial harm and maximize cash flow from existing operations. We're not certain if this presages an asset light strategy, but capital allocation decisions may receive increasing scrutiny. (If write-downs may be in your future why make them worse?)

The third alternative is to act as if the new environment will have only a glancing impact on your business in the immediate future, even though modest changes in long term assumptions can adversely affect earnings, cash flow and other key financial metrics. For example, if power plants have to cycle more to accommodate an increase in intermittent renewables, this more stressful operating environment might require higher depreciation rates. But higher depreciation typically reduces earnings or raises electric bills and annoys regulators. As the saying goes, denial is not just a river in Egypt.

In choosing this "slow walk" in the face of new technological threats, managers hope these new technologies will emerge in a way that gives them time to respond. Senior managers at Kodak, an oft cited case study, clearly saw the emergence of digital imagery. They assumed, though, that conventional film sales would continue as their "cash cow" while they managed their transformation into a new, digital format company. But in the face competition, film sales evaporated as did their entire business.

There is another aspect here that may be relevant to the electricity business apart from the speed with which Kodak's legacy business imploded. It was known that the picture quality of digital imagery was inferior to that of conventional film. Executives in the film industry believed that consumers would prefer a clearly superior product at a higher price. Consumers, however, preferred convenience over image quality. Maybe we're reading into this too much but we hear faint echoes of the current complaint about the limits of renewables and the significant problem of intermittency.

One sees a similar phenomenon in today's newspaper business. Again, the threat is digital but this time in the realms of print as well as imagery. Management's goal, again taken from the "slow walk" playbook, is to build up on line or digital businesses fast enough so as to replace print sales and lost advertising revenues. They can't. A trickle of lost business quickly turns into an avalanche of customer defections to the internet.

Does our carbon-emitting power generation fleet, aging coal and natural gas plants, still have a financially viable future? Or will it soon be displaced by renewables with zero fuel costs? As in the Kodak example, we think it depends on the utility's customers. If a significant percentage of them decide intermittent electricity service, like that still experienced throughout much of the world, is acceptable at a sufficiently low price, then it's light out for much of our aging power generation. But this is not our base case.

Until consumers are offered meaningful choices about power quality, akin to a choice of internet speeds, we see most generation businesses lumbering along more or less economically. At least until electricity storage technologies change the shape of peak loads. Power plant owners can still sign contracts and collect cash. So the managerial "slow walk", milk the cash cow analogy may still work for a while. The obvious operating challenge is learning to cycle base load units designed and engineered for a different, non-intermittent operating environment.

Who wins and who loses? As a caution to commodities producers, we note that one of London’s biggest art galleries used to be a power plant. Riverfront real estate has value.

Related: OPEC Remains Positive On Output Cut As Oil Crashes To $44

Those who buy wholesale to and sell retail might have to become service firms like oil distributors, providing product, equipment and service.

As for the supposedly low risk wires business, customers (typically the larger ones) already can bypass the entire network and become electrically self-sufficient at a price. Other consumers, for example those with rooftop solar panels need less from the utility, making it like a storage battery that augments the customer's own on-premises generation. But a viable transmission network also affords consumers access to large scale, low cost renewable energy produced at some remove. Will consumers prefer decentralized or grid-supplied renewables? We depart this discussion at the crossroad where policy meets technology.

In the early part of the last century, trolley cars crisscrossed the urban landscape. Pressure from politically powerful automobile and tire companies, among others, helped deliver the "coup de grace". The trollies went the way of the dodo and municipalities paved over or pulled up unused tracks.

Fast forward to the present day where urban planners work feverishly to enhance public transport in the crowded metropolis. Their "new" solution? Bring back the trollies. With the benefit of hindsight, they regret the loss of pre-existing urban infrastructure.

The electric utility business model reminds us of restaurants offering prix fixe and a la carte menus. Since the dawn of universal service power companies sold electricity on a prix fixe basis. All the components, generation, transmission and distribution were bundled into the price.

With the advent of deregulation, an unbundling of these services has occurred. They are now offered "a la carte" if you will. What is most evident is the internal subsidy of the power generation business under a fully rate regulated regime. Without regulatory guarantees or firm contracts, new generation, apart from gas and wind, is becoming increasingly difficult to build. And if customers continue to gravitate towards self-generation, transmission and distribution assets are likely to devalue as well--even before we add in worries about a future rise in interest rates.

Current neo-liberal public policy coupled with various technological infatuations diminish the importance of central station power and perhaps the grid itself. Our parting question is this. Before we rip up and pave over the "tracks" is there any part of this system we should save for posterity or should we simply submit to the harsh judgement of "creative destruction"?

By Leonard Hyman and William Tilles for Oilprice.com

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  • Jeffery Surratt on November 06 2016 said:
    Very interesting article. I believe the move to solar and wind is very good. But the average consumer with a $60 power bill. My average in MT where there is plenty of hydroelectric power generation. Also, plenty of cheap NG for heat, water heating, cooking, clothes drying, that keeps the electric bill low, does not really carewhere the power comes from. Also, there is no reason to spend thousands of dollars to save $60 per month. My son who lives in OK just installed a NG clothes dryer, when he purchased a new washer / dryer combo. His NG supplier paid for the gas line install ($500) for the new dryer. He is now saving $60 per month on his electric bill. The savings will pay for the new W /D combo in 15 months. I was hoping to see more new home construction adding Solar Systems into the build, this would add very little to the monthly payments. Maybe in the near future this will start happening. Cheap NG is slowing Solar System adaption, I am sure.
  • David Hrivnak on November 13 2016 said:
    There is another big benefit of solar. It opens the door to electric vehicles. We now not only power the house but our two cars as well. So in my case we are saving $250/month. That starts to become significant at least for us.

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