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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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Why Utilities Won’t Be Upended By Renewables

Solar installation

Experts, especially in finance, often have a deservedly bad reputation. Their predictions, especially about things like the direction of interest rates or stock prices, are often more than somewhat off the mark. Analysts on the "sell-side" (brokerage analysts) tend to run optimistic while hedge fund short sellers may take the under. In both cases, investors often act on these predictions.

Even if experts are only right about half the time, same as a coin toss, it is far better for investment managers and fiduciaries of all stripes to tell the board or investment committee that you considered a range of expert opinions rather than simply "gambling". But expert opinion affects how people behave and invest. Humans as investors are inherently crowd followers. And true financial research is beyond the capability of many investors. It's difficult, time consuming and requires some specialized knowledge, mostly accounting, and some finance.

As a result, experts' predictions are important whether right or wrong--at least for a while until the paradigm clearly shifts. So, when Public Utilities Fortnightly, a leading trade journal, corrals a bunch of experts and asked them about the future of the electricity business, investors should take note of their views.

Let’s start with distributed energy resources, a rather fancy name for small-scale solar and other renewables. Even diesel-fueled emergency generators at hospitals or other commercial buildings could be deemed "distributed" if the regulatory tariffs were written to allow it.

For electric utilities, the potential widespread customer adoption of distributed, on-premises generation is an existential threat. Customer self-generation by its nature reduces reliance on all segments of an electric utility's assets, especially generation. Or for that matter, what's the value of transmission and distribution systems when customers are generating their own power and trading it amongst themselves over your network? How do you price this new type of "go-between" or integration services? Are the margins comparable to matching vacationers with available lodgings like AirBnB? And roles could suddenly reverse, with the local utility limited to providing back-up power, a commodity provider only of last resort. In effect, it becomes a battery, albeit one with an extremely valuable commodity in times of scarcity. No one who can afford it wants to be without air conditioning in a heat wave, for example. Related: Exxon Misses Estimates By A Mile, Plunges To Two-Month Lows

But all this implies a bi-directionality of electricity flows at the retail level. Wholesale power markets and trading among major power generators has existed in various forms for decades.

In a way, electric utilities are experiencing the opposite of what happened with the breakup of the old telecommunications wireline monopoly. It was the lucrative inter-city market that early competitors like MCI were permitted by the courts to enter. For the electrics, unlike tele-communications, their product can be both produced and consumed in the same location. Hence, the new competitive threat is at the retail level.

We certainly believe that franchise owning electric utilities can be successful in renewables installation, financing, and distributed systems integration. But do they want to pursue this type of business strategy? The historical, hierarchical relationship of utility corporation and retail customer may need to change. Up till now, the electrics have retained almost complete discretion over how power is produced. All customer choice was in the realm of pricing. The more you bought the lower the price.

But these issues aren't a question of either/or. Renewables and power storage options are here to stay at least to some degree. The issue is rather how quickly upstart technologies will make genuine inroads in earnings and profitability? And the answer, according to the experts, is – you guessed it – it depends. If the industry receives "supportive regulation", another fancy way of saying if utilities can earn an adequate return on their investments, then the pace of change may quicken.

But there in essence is the rub. With distributed generation plus storage and networking, a large percentage of electric utility assets are rendered either irrelevant or obsolete by this relatively new type of customer. Some states, like Nevada, charge large commercial customers like casinos a hefty exit fee, presumably to offset the utility's costs of plant and equipment built in part to serve that particular customer. But once gone these large commercial and industrial customers who install their own solar arrays are not likely to return. At least not as power buyers.

Given emerging technologies like distributed generation plus storage and networking, will regulated utilities play a greater or smaller role in the electricity business by 2025? The expert consensus: about the same. With a combination of low fuel costs, low interest rates and a fiscally conservative approach to building new generating plant, electricity prices could remain fairly stable. This would support a status-quo-for-longer view.

Apart from new retail level power generation, behind-the-meter services are or will be on offer: "smart" thermostats connected to one's phone or Ipad, appliances controlled remotely or even a refrigerator that might say you're low on eggs. Underpinning all this may be time-of-use rates. If we combine this with bi-directional metering, customers who produce at least some electricity could decide to be buyers or sellers of power throughout the day. The likely impact of this will be to lower price spikes during peak periods somewhat dampening profits in the power generation business. Related: Libya Now Back In The Oil Business – For How Long Though

Will a significant number of homeowners continue to resist intelligent energy management in 2025? In all likelihood, yes. If we can roughly extrapolate from the numbers of people in the U.S. today without internet then perhaps as many as 25 percent. These legacy customers may not want or appreciate new services on offer but they will remain.

Renewables today come in basically two 'flavors", smaller scale and utility or grid scale. Now rooftop solar may have received the lion's share of the public attention, but will this type of distributed energy resources catch up with utility scale renewables by 2025? No way, say the experts, but they could reach 25 percent of utility scale renewable generation by then. In other words, the threat to utility scale generation is expected to emerge slowly.

What do customers want from the utility of the future? By a wide margin, experts said customers mostly wanted reliable power. That is, customers will stick with the tried and true, the reliable utility. It is almost as if utility engineers had written the answer.

We have no problem with their answers. We're not clairvoyant. We don't know whether the experts are right or not. Our problem is with the suggested strategy--wait for approval from regulatory authorities rather than develop products customers want. This discourages utilities from looking at distributed energy resources as a new business opportunity and in making intelligent energy management something easy for customers, something they might want. If consumers are mainly concerned with obtaining a reliable source of electricity, is there a way to turn that desire into a real business, not merely an excuse to add to rate base?

The Public Utilities Fortnightly survey uncovered a plethora of obstacles and opportunities for electric utilities. To some extent, the experts advised managements and investors, "Don’t worry, change will come slowly.” We believe better advice might have been “Hope for gradual change in your business model but plan as if it might come sooner than expected. Don’t wait for the regulator. Take advantage of opportunities now and don’t defend the indefensible.”

By Leonard Hyman and William Tilles

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