If the U.S. is faced with a $2tn tab for utility construction over the next two decades, regulatory and financial models employed a generation ago aren’t up to the task.
That’s the conclusion of a new report issued by Ceres, a Boston-based coalition of investors and public interest groups working to address climate change and other sustainability issues.
Its report, “Practicing Risk-Aware Electricity Regulation: What Every State Regulator Needs to Know,” was released April 19. Capital investment of $100bn a year, twice the level of recent times, is expected over the next 20 years.
“We know that there’s not a lot of slack in the U.S. economy to absorb the kind of cost overruns we saw in the power sector in the 1970s and 1980s,” said Mindy Lubber, Ceres president, during a conference call for the report’s release.
Highlights of the report include an emphasis on fuel diversity, greater reliance on energy efficiency and renewable energy, and a revamping of the regulatory construct to include more broadly based practices to minimize risk.
“A lot of what we say has to do wither the regulators incentivizing certain policies. There is a lot of potential in energy efficiency,” Lubber said.
“This is probably the most risky, complex and uncertain period in the history of the U.S. power sector,” said Ron Binz, a report co-author and president of Public Policy Consulting and former Chairman of the Colorado Public Utilities Commission.
“There’s a focus now on environmental values that is bigger than it was in those previous years,” he said.
Distributed generation, whether it’s residential solar or industrial sites adding on-site gas generation, complicate matters even more.
With flat load growth in the background, the demands for investment capital will put pressure on rates.
“The financial metrics going into this build cycle are much weaker than they were when the last build cycle occurred,” Binz said, citing average bond ratings that put utilities at a lower level of investment grade.
Denise Furey, another report co-author and principal of Regent Square Advisors, said fuel diversity is incumbent on utilities, despite the current gas craze caused by record-low prices.
“Generation plants have long lives, and since the price of natural gas moves constantly, looking at current natural gas prices as predictive of a long-term trend is pure folly,” she said.
The report generally recommends:
- Diversifying energy resource portfolios rather than “betting the farm” on a narrow set of options (e.g., fossil fuel generation technologies and nuclear);
- More emphasis on renewable energy resources such as onshore wind and distributed and utility-scale solar;
- More emphasis on energy efficiency, which the report shows is utilities’ lowest-cost, lowest-risk resource.
- At its heart, this report is a call for “risk-aware regulation.”
- To be effective in the 21st century, regulators will need to be especially attentive to two areas: identifying and addressing risk; and overcoming regulatory biases.
- Risk arises when there is potential harm from an adverse event that can occur with some degree of probability. Put another way, risk is “the expected value of a potential loss.”
- Higher risk for a resource or portfolio means that more value is at stake or that the likelihood of a financial loss is greater, or both.
The report also includes what it describes as “seven essential strategies for state regulators.”
- Diversifying utility supply portfolios with an emphasis on low-carbon resources and energy efficiency.
- Utilizing robust planning processes for all utility investment.
- Employing transparent ratemaking practices that reveal risk.
- Using financial and physical hedges, including long-term contracts.
- Operating in active “legislative” mode, continually seeking out and addressing risk.
- Reforming and reinventing ratemaking policies as appropriate.