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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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The Beginning Of The End For U.S. Utilities?

Powerlines

Capital expenditure projections for the electricity industry in the U.S. were just released by the Edison Electric Institute (EEI). The data show a utility industry with plans for continued healthy levels of spending. Interestingly, planned capex is even above projections made last year despite long term kilowatt hour sales trends that can best be described as flat-to-down. (See Figure 1 for projections.).

Of this projected capital spending, roughly one third is expected to be devoted to new power generation, a quarter for electric distribution and less than one fifth each for transmission and gas distribution. The numbers will, no doubt, change somewhat but given their size they do send a message about industry management's intent and priorities.

Table 1. Capital spending in $ billions

(Click to enlarge)

Based on these projections, net plant will grow roughly 6-7 percent per year. However, as has been the case for more than a decade, that projected increase once again far exceeds the anemic growth in sales. Lacking the revenue enhancing sales growth that would typically be enjoyed by a growing industry, the utility industry instead can only attempt to recover its costs for this new plant investment, barring an extraordinary (and unlikely) increase in productivity, by continuing to raise electricity prices.

Much of the electric utility business in the U.S. remains a regulated monopoly. If utility managers can convince mostly state (and some federal) regulators that price increases are warranted (regardless of near zero interest rates and low fuel costs) then this policy of heavily investing in a zero-growth industry will continue to bear financial fruit--at least for a while.

But like many of life's economic squabbles, sometimes it really is just about the money. New technologies are almost always cheaper. Wind and solar power, all thoughts of intermittency aside for the moment, have zero fuel costs. So regardless of capital costs, when the sun shines or the winds blow, renewable energy will displace traditional energy from fossil fired coal and gas power generating stations.

Adding attractively priced battery storage to renewables will give consumers even more of an incentive or opportunity to move off the grid. Related: Energy Breakthrough? China Has Successfully Mined ‘Fire Ice’ From The Sea

We believe the electric utility industry in the U.S. is getting closer to that tipping point (of customer and revenue loss). But that is not the main focus of this report. The question is what does this spending program indicate for the price of electricity and gas in the coming years?

Assume for the moment that fuel and natural gas prices for power generation remain unchanged. Also, that sales rise 1 percent per year; that industry productivity gains are also 1 percent per year (in line with long term trends); and returns granted on investment remain stable. Under those circumstances, the real price of electricity and gas sold by U.S. utilities would have to rise about 4 percent annually--or about double the current inflation rate. (Natural gas is a small part of the sales package so we are talking essentially about the electric bill.)

With over one fifth of utility expenses fixed by contract or accounting convention, inflation's impact on utility bills should be rather benign provided fuel costs remain well behaved. So assuming a 2 percent inflation rate probably would add no more than 1.5 percent to consumer's electricity bills. That is, the consumer will see 5-6 percent electricity price increases in current terms.

The iconic management consultant, Peter Drucker, exhorted his followers against trying to predict the future. But as a rigorous empiricist he did urge them to draw conclusions about the future from already existing evidence. That is what we are doing.

Based on projected business-as-usual hefty utility capital expenditure programs, it is not difficult to conclude that central station electricity costs in the U.S. will continue to rise faster than the rate of inflation (fuel costs aside). Given not just the introduction, but more importantly the acceptance of new distributed power generation technologies with declining cost structures, these price increases will make the franchise owning, incumbent utilities that continue to offer a commodity product at an ever increasing price less competitive in the future.

By Leonard Hyman and Bill Tilles for Oilprice.com

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  • Convenient Lies (and profitable, too!) on May 18 2017 said:
    Subsidies have always produced higher prices and higher energy prices has always been the goal of the renewables agenda, carbon trading, and AGW.

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