Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric

[kristopher]

This paper has spawned a great deal of discussion so I thought some people might like to access the original instead of just reading the derivative articles.

Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business

Prepared by:
Peter Kind Energy Infrastructure Advocates

Prepared for:
Edison Electric Institute

January 2013


Table of Contents
Executive Summary ........................................................ 1
Background.....................................................................3
Disruptive Threats—Strategic Considerations ........................6
Finance 101 - Introduction to Corporate Finance....................7
Finance 201 - Financial Market Realities................................8
Finance 501 - Financial Implications of Disruptive Forces........11
Telephone Industry Parallels.............................................14
Strategic Implications of Distribution 2020 Disruptive Forces...17
Summary......................................................................19


Executive Summary
Recent technological and economic changes are expected to challenge and transform the electric utility industry. These changes (or “disruptive challenges”) arise due to a convergence of factors, including:
falling costs of distributed generation and other distributed energy resources (DER);
an enhanced focus on development of new DER technologies;
increasing customer, regulatory, and political interest in demand- side management technologies (DSM);
government programs to incentivize selected technologies;
the declining price of natural gas;
slowing economic growth trends;
and rising electricity prices in certain areas of the country.
Taken together, these factors are potential “game changers” to the U.S. electric utility industry, and are likely to dramatically impact customers, employees, investors, and the availability of capital to fund future investment. The timing of such transformative changes is unclear, but with the potential for technological innovation (e.g., solar photovoltaic or PV) becoming economically viable due to this confluence of forces, the industry and its stakeholders must proactively assess the impacts and alternatives available to address disruptive challenges in a timely manner.

This paper considers the financial risks and investor implications related to disruptive challenges, the potential strategic responses to these challenges, and the likely investor expectations to utility plans going forward. There are valuable lessons to be learned from other industries, as well as prior utility sector paradigm shifts, that can assist us in exploring risks and potential strategic responses.

The financial risks created by disruptive challenges include declining utility revenues, increasing costs, and lower profitability potential, particularly over the long-term. As DER and DSM programs continue to capture “market share,” for example, utility revenues will be reduced. Adding the higher costs to integrate DER, increasing subsidies for DSM and direct metering of DER will result in the potential for a squeeze on profitability and, thus, credit metrics. While the regulatory process is expected to allow for recovery of lost revenues in future rate cases, tariff structures in most states call for non-DER customers to pay for (or absorb) lost revenues. As DER penetration increases, this is a cost-recovery structure that will lead to political pressure to undo these cross subsidies and may result in utility stranded cost exposure.

While the various disruptive challenges facing the electric utility industry may have different implications, they all create adverse impacts on revenues, as well as on investor returns, and require individual solutions as part of a comprehensive program to address these disruptive trends. Left unaddressed, these financial pressures could have a major impact on realized equity returns, required investor returns, and credit quality. As a result, the future cost and availability of capital for the electric utility industry would be adversely impacted. This would lead to increasing customer rate pressures.

The regulatory paradigm that has supported recovery of utility investment has been in place since the electric utility industry reached a mature state in the first half of the 20th century...

http://www.eei.org/ourissues/finance/Documents/disruptivechallenges.pdf


See also: Solar Energy: This Is What a Disruptive Technology Looks Like
https://medium.com/armchair-economics/cbc9fdd91209

[djean111]

1. If I am initially skimming this correctly.......?????

solar energy will impact how much profit electric suppliers make, and they want to ensure that their profits will not be negatively affected. They will seek legislation to ensure their profits, and seek to either get rid of subsidies for solar and wind power, or increase subsidies for the current methods of creating electricity - coal, nuclear, whatever.

They will seek to raise rates to ensure their profits do not fall, so that even though people are using cheaper solar energy, they will pay much much more for access to the grid, and for what electricity they do need to buy, thus ensuring that the actual customer does not see any savings.

Or perhaps they can pay Congress to somehow be able to license access to the sun, or make using solar panels require sizable fees or something. Sounds funny, but didn't some western state actually sell access to rainwater and fine people for having rain barrels or something like that.

Funny how jobs lost and revenue (income) lost don't matter when jobs are sent overseas, but guaranteed profits via a regulated service are threatened? OMG!!!!!!!!

They wanted the regulatory paradigm to ensure that cheaper solar and wind power does not change their profit structure.
I imagine that if our government was as whored out many years ago as it it is now, we would all still be required to purchase buggy whips. And/or buggy whip makers would be receiving subsidies.

[kristopher]

2. (Without the editorializing) I'd say that captures the gist

But there is something to consider - much of the investment made by utilities is backed by ratepayers. While the problem doesn't significantly impact their bottom line yet, when it does start to become a force we are going to have to figure out a way to protect ratepayers from getting screwed. There are ways to do this that will not impede investment in renewables - be sure you have that point clearly in mind.
The reason I say that is because there are a lot of utilities that are already making the claim that their ratepayers are suffering a significant burden because of what the paper describes. That is absolute crappola; as is the proposed solutions they offer that are nothing more than very deliberate attacks on renewables.

Google /CPS solar/ and read what has been happening there.

[djean111]

3. Thank you!

I do tend to go immediately to the bottom line.
As a Floridian, I am watching what Duke Power does now, as they can start charging customers for planning to build nuclear power plants that may probably never get built - and can keep quite a bit of the money anyway.
So it worries me that all the power companies will start charging for nuclear plants even though solar and wind is becoming more useful.
The power companies are worried that THEY may suffer a significant burden.
And I have no sympathy for stockholders who make money by depriving others of jobs or affordable currently-produced electricity. None.
Invest in something else.

[kristopher]

5. It's a problem similar to road taxes and EVs

We maintain our roads with taxes on gasoline. As EV penetration increases and gasoline sales decline so does the tax base for highway construction and mx.
EVs use the roads, so how will we structure funding around that technology?

From the policy standpoint both areas are something that must be dealt with. Your view on renewables is on one end of the spectrum, and the stakeholders in what are potentially prematurely stranded assets are at the other end. The trick is how do you meet the needs of both ends and all in between.

It sometimes can't be done, but in this case I believe it can. The claims being made now by utilities like CPS deserve all of your scorn and then some.

[JDPriestly]

4. I skipped to the article on solar energy and recc'd this post.

Very interesting. Energy costs will decline due to solar energy.

In California, that is good news.

Our electric company in LA is municipal --- government-owned.

We don't want it any other way. In the Enron crisis, other for-profit companies didn't have enough electricity. Our municipal electric company was able to sell some of its surplus.

Energy costs declining could mean good things for our economy. And solar energy is relatively clean.

So skip to the article in medium.com. I don't think it is finished yet, but it is interesting.