A plead for utility leadership on climate change
What I want most for 2008 is serious action on climate change — not just in terms of policy, but in terms of action. Mathematically, this mandates serious and constructive engagement from the electric sector, which has thus far been not only absent, but hostile to any serious discussion of GHG reduction.
Given their relevance (42% of US GHG emissions) and tremendous inefficiency, they are a source of much of my personal quixotic quest. But ultimately, they must engage — and so far, they have not even come close. So in case we have any utility executives in the Gristiverse, here is the speech I’d like to hear from one of you in 2008:
I come to you today seeking to be part of the solution. My industry is responsible for almost half of all our greenhouse-gas emissions, and yet we have no economic incentive to conserve. The 100-year old regulatory model under which we operate our business must change. I am almost certainly risking my job and the value of my shares by making this speech today. But that is a risk I’m willing to take on economic and environmental grounds. I don’t want my kids to grow up in a world without glaciers, but I also don’t want them to grow up in a country where they can’t afford electricity. Giving my kids the kind of future I owe them mandates that we stop driving up electric rates so that we can warm the planet.
To understand the scale of this problem, let me first share a few statistics with you. In 2006, the nation’s investor owned utilities — my industry — had total revenues of about $330 billion, generating $30 billion in net operating income. We’re doing OK. But our profits are highly dependent on our ability to pay off our capital. Indeed, only $38 billion of our operating costs was from fuel. A big number to be sure, but relative to revenues, we spend more money servicing debt. This is, in part, because we are in a capital-intensive business. But we shouldn’t lose sight of the fact that the way we make money is by deploying capital. And this gives me a strong incentive to deploy lots of capital. Most businesses make money by selling a better product at a better price. I make it by convincing utility commissions that my capital is prudent. Don’t get me wrong: I am economically rational, and I respond rationally to this incentive. But it is not a rational incentive.
After all, if it made sense, I’d convert all my salaried employees over to a formula where I just pay them 120% of all their submitted expense reports. I don’t kid myself about what would happen to expense reports if I actually did this — but we shouldn’t kid ourselves about how my industry responds to the same formulation.
So we spend a lot of time trying to convince utility regulators that our latest big capital project is prudent — and we’re pretty good at that. We get capital built into the rate base, we make money, and shareholders are happy. We also spend a lot of time trying to convince regulators that other people’s capital is not prudent — and we’re pretty good at that too. So we get special rates designed to block competitive power, or impose exorbitant interconnection costs on customers who seek to install capital we cannot build into our rate base.
And the system has worked, in the sense that it has electrified our country, given us all cheap electricity, and generated stable and predictable dividends to my shareholders. But that’s also unleashed a lot of nasty chickens, all of whom are coming home to roost. If I paid my employees based on expense reports, I would rapidly lose control of expenses, and spend lots of time managing fights between employees trying to figure out who got to put the rental-car receipt on their credit card. It might work for a while, but the system would rot from within — and that’s what we now face in the electric industry. From rising fuel costs to power-plant siting challenges, I simply don’t have any cost-effective ways to serve future load growth other than efficiency and renewables. But I can’t make any money off those. We need to change the paradigm.
I will confess that you would never know this to be true from reading our industry press releases, and for that thank our PR efforts. Thank you also to the ratepayers who fund our PR efforts. But I assure you that even those things that we have reason to trumpet are largely irrelevant.
Consider: we spend $3.7 billion as an industry every year on demand-side management to help our customers install more efficient light bulbs, motors, and other load sited measures. These programs have helped a lot of technologies get into market, and helped a lot of customers to save money. $3.7 billion is a big number — but relative to the $38 billion we spent on fuel, it’s peanuts! Worse still, even as we spent those billions helping our customers to become more efficient, we didn’t spend a dime to improve our own efficiency — or at least not a dime any of us are going to admit to, lest we draw uncomfortable attention to the fact that the fuel efficiency of our industry hasn’t improved since 1957.
Our efficiency failures haven’t come about because we’re stupid. I’m proud to tell you that I employ some of the smartest people I know. But my shareholders won’t let me keep my job if I don’t focus on their dividends. And the rules say that I can’t profit from efficiency — and so I make sure that my smart employees focus their considerable efforts elsewhere: namely, on maximizing the amount of capital I can deploy.
But efficiency is only one of the many opportunities to lower energy costs that we squander. Burning less fuel to make a kWh lowers power costs — and therefore, we don’t focus on it. But focusing on lower-cost fuels also lowers costs, and we don’t focus on that either. Here are some more telling statistics:
Try as we might to prevent it, many of our customers have elected to self-generate their own power, and since 1978’s PURPA law, we have seen the slow creation of a competitive power-supply industry. Whether deployed by our customers or by unregulated third parties, those capital projects only get built if they can save money. And the differences between those projects and ours are striking.
The most obvious difference is in cogen, which is typically twice as efficient or higher than our fleet — and so we ignore it from our mix, even as we fight to block it elsewhere. Of the 3,200 cogeneration facilities in the country, just 72 are owned by utilities. To put that in perspective, 75 are owned by laundromats. In other words, we’re about as focused on that particular efficiency play as we are on making sure that our customers get low-starch shirts. But look further:
Of all the hydroelectric generation in the country, 90% is run by traditional utilities. (Not surprising, since most of the big facilities were built prior to the advent of a competitive power market, but this is a stagnant business, since we don’t have any more opportunities for big dams.) We’re responsible for 74% of all the coal-fired generation in this country, and we’d like to have more. After all, it’s expensive, and we love expensive capital. Speaking of expensive capital, we also like nuke: we’re responsible for 54% of all the kWh from nuclear in the country, and we’d own more but for the fact that we divested so much in those states that went through restructuring.
We like the sex appeal of renewables, but we don’t much like to own them — remember, we don’t have any financial incentive to prefer low-cost generation. Not surprisingly, then, we are only responsible for 7% of all the renewable electricity generated every year. There’s a lot more renewable out there — it’s just that it got built in spite of my industry. That said, renewables are at least expensive — and their sex appeal makes for great PR. The stuff we really don’t like is opportunity fuels where you can recover waste energy in low-tech power plants. We’re responsible for just 0.2% of that mix – we are essentially blind to this 40,000 MW opportunity.
So what fuels do we dominate? Coal (74%), big hydro (90%), nuclear (54%) and oil (63%). What fuels do we ignore? Natural gas (34%), non-hydro renewables (7%), opportunity fuels (5%) and process wastes (0.2%). Oddly enough, the cleaner the fuel stream, the less likely we are to have a “dog in the hunt.” The idea that you can’t have an electricity grid without coal and nuclear is a canard, belied by the data. What’s not clear is whether we can support traditional utility shareholders with a grid that isn’t dominated by coal and nuclear, under the current paradigm. We need to change that paradigm.
As you might imagine, I did not come here simply to point out the faults of my industry. Our world needs clean, low-cost electricity, and I believe that the electric industry ought to be up to the challenge to provide. But as the data shows, we simply are not meeting that challenge under the current rules. I will not direct my company towards a path that will cause it to lose value. But that narrow focus on shareholder responsibility has been used to justify too much inaction and outright hostility to good ideas by my colleagues. It is time for us to focus on embracing and encouraging the types of regulatory reform that are necessary to align the interests of my shareholders and my customers. So here is my request:
- Let me keep a portion of the savings I can create through more efficient conversion of fossil fuel into electric power. Current rules that compel me to pass all savings to my customers ensure that I do not try to save money. Give me the financial incentive to conserve.
- Incentivize me to increase the overall efficiency of my entire service territory. Energy conservation ought not be the exclusive province of my competitors, but it also ought not be the exclusive province of my company. The pressure to keep big customers has driven all level of anti-efficiency behaviors by my employees, from overly expensive interconnections to special rates for those who promise never to cogenerate. This will continue so long as my profits are so heavily exposed to shifts in kWh sales. Give me an incentive to help my customers lower their energy costs, regardless of how kWh of conservation is achieved.
- Give me a way to buy clean power at a competitive price. Many of my customers could generate on-site power from opportunity fuels in excess of their needs, but do not do so because the pittance I have agreed to pay them under PURPA rates provides no incentive to do so. Give me a rate structure where I can buy that power at location-specific prices that are low enough to leave profit for my shareholders, but not so low to keep power from coming on line. All my other options for new power are much more expensive, and I’m going to need all the tools at my disposal to serve our growing load.
Joe Utility Executive