The debate about the future…
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In our fractious domestic politics, squabbles over infrastructure spending are as old the republic. But here we propose an infrastructure project of considerable scope that the country needs and which would not require governmental assistance. The US electricity industry (utilities and other providers), we calculate, will have to spend $7-8 trillion in order to modernize (the average plant is about 35 years old) and to eliminate its greenhouse gas (GHG) emissions.
The sectors most likely to continue to decarbonize, moving away from extensive fossil fuel use, are electricity production and vehicular transportation and freight movement. In theory, electric vehicles could be powered by electricity produced from coal-fired power stations which are still relatively prevalent across much of the nation, although there is no rationale to do so since running vehicles on coal-fired electricity would not reduce GHG emissions - just transfer them from the tailpipe to the smokestack at the power plant. Coal-fired electricity, however, will not get that market. And coal’s principal “enemy” in this struggle for market share is not environmentalism. It is natural gas which has become cheaper and cleaner to use as boiler fuel.
In this struggle, coal has already lost for a simple economic reason. In a commodity business like electricity, price is the only thing that matters. Now natural gas fired power generation faces price competition from renewables, mostly wind, that produce electricity with zero fuel costs—the principal cost input for gas fired generation apart from capital. The only thing we can safely say here is that if present cost trends persist the penetration of renewables is likely to increase. And since the electricity fuel mix is something of a zero-sum game in a low growth environment ,that means that coal usage will trend to zero (as it did in the UK) and natural gas generators will have to struggle with ever cheapening renewables.
But switching gears for a moment, the reason electricity production is singled out for regulation is one of policy practicality. If mitigating pollution is the goal, it is easier for the government to regulate a few thousand large power plants than a few hundred million motor vehicles. And in doing so we could reduce the nation’s output of greenhouse gases by about 25 percent.
And this brings us to our favorite part of the discussion, namely, what will all this cost and how do we propose to pay for it? Up front electric utility industry capital spending would more than double – to $350–400 billion per year if this clean energy transition occurs over a period of 20 years. Current annual industry capital spending is about $150 billion per year.
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But there are two components to this forward-looking capital expenditure plan. First, much of our present electricity infrastructure is simply aging out and must be replaced, and the cost of a new utility plant far exceeds the cost of the original. Therefore, about two-thirds of the large so-called “green” capital replacement program would be devoted simply to modernizing aging assets in all aspects of the present power business - generation, transmission, and distribution. The bottom line? U.S. electricity industry capital spending will increase (assuming we wish to maintain present levels of service) even without a strong environmental push towards decarbonization.
If U.S. utilities committed to a refurbishment and decarbonization program this would elevate their prospective annual capital expenditures by at least $200 billion. This would significantly boost the U.S.’s non-financial corporate capital spending which totaled $2 trillion last year. This number for obvious pandemic related reasons is headed lower this year. And unlike the plethora of recently announced federal economic stimulus programs, this level of electricity capital expenditures once committed to would not evaporate once the present emergency recedes or political interest fades.
The next question is “Who would pay for this effort?” In the U.S. electricity business as presently structured, the answer is the customer. Costs of a new plant (like a thirty-year home mortgage) are spread out over the often very long lives of equipment. We calculate that in real terms the average electric bill would increase roughly 2 percent per year simply to modernize our present electricity industry and 4 percent annually to modernize and fully decarbonize.
These rough “ballpark” estimates may, in fact, overstate the total cost of decarbonization. Green power projects tend to be smaller than conventional baseload generation. And given present economics, smaller facilities tend to experience far fewer cost overruns than big, old-style power plants. This, in turn, lowers their investment risk and ultimately lowers their cost of capital as well.
Technological improvements have been coming in faster for renewables than for conventional facilities, too. In addition, a growing body of investors are seeking to fund specifically green projects and that demand also reduces industry capital costs. Furthermore, there is some indication that if the industry adopted a “half a loaf” strategy with respect to the elimination of greenhouse gas emissions, keeping a residuum of fossil-fired plants online to ensure reliability, it could further minimize planned cost increases.
Let’s stick to the 2 percent annual electricity price increase attributable to decarbonization for the sake of conservatism. This would cause average household electric bills in the U.S. to rise by about $25 per year. But here is the really startling statistic. As vital as electricity is to residential and industrial users alike, the revenues from this key industry equates to only 2 percent of U.S. gross domestic product. Stated differently, the typical residential electric bill totals only 2 percent of household income. If our estimates are even remotely accurate then paying for a clean, modern electricity system would barely impact most household budgets.
But the present Republican administration in Washington takes a rather lax view on pollution and potential polluters in general. What would encourage U.S. electricity producers, many of whom at least until recently were ardent climate change deniers to begin with, to move forward on a capital program of this size? A carbon tax? Sure, but not with the present leadership in Washington.
The states, however, under our bifurcated regulatory regime (states and the Feds both have authority) do have the power to influence both the price and the means of producing electricity. Long term capital plans, as well as authorized returns on shareholder equity, must be approved by state public utility commissions. Many have set renewable energy standards to encourage action, but these tend to remove carbon at a high cost.
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But the state regulatory apparatus already exists to hasten this process and even make it more efficient. States can, for instance, offer accelerated asset retirements to encourage more rapid closure of existing fossil-fired power generating plants or grant companies a higher return on equity for those who produce or distribute low carbon electricity.
In our present age of minimal interest rates, even a small incremental boost leads to a big uptick in profits. A 1 percent bonus on sales of low carbon electricity, for instance, would raise pretax net income by a full 10 percent if fully implemented - a number that would undoubtedly enhance utility industry enthusiasm for decarbonization.
An accelerated capital investment program along the line suggested here would transform U.S. electric utility companies (and other electricity producers and suppliers) into the growth stocks they were in the 1950s and 1960s. In those halcyon days of yesteryear, the U.S.’s electric utilities offered investors both growth and income. Hard as it may be to believe there were electric companies included in the “Nifty Fifty”, an ancient precursor of today’s FANGs. Back then, the industry spent lavishly both to modernize and meet accelerating post-war demand - all while increasing margins due to increasing economies of scale.
There is an ongoing need in the investment community for companies that offer the unusual combination of growth and income. But apart from the needs of Wall Street, a capital program along the lines contemplated here should easily attract capital for this capital replacement/decarbonization spending marathon as well as boost the economy with years of steady investment. Collaterally this would stimulate demand for new technologies and workers locally to construct new plants. This would also reduce the nation’s greenhouse gas emissions by one fifth, directly, and enable electric vehicle users to run on green electricity, thereby reducing emissions perhaps by another fifth. Finally, this would modernize an aging electricity grid to meet the challenges of an energy-hungry digital economy in an increasingly challenging operating environment.
By the time our present pandemic related difficulties are over, the U.S. federal government alone will probably spend in excess of five or six trillion dollars supporting the economy. For roughly the same amount, we could rebuild the entire electricity infrastructure cleanly and with a price tag that most Americans would barely notice. And for the most part, it’s “shovel ready.”
By Leonard S. Hyman and William I. Tilles
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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…