TODAY’S STUDY: HOW ELECTRICITY WILL TRANSITION

The transition to a New Energy economy hinges on what utilities do. In other words, the nation’s energy future is in the hands of people who have for centuries relied on coal and for decades relied on nuclear power and for years essentially disdained New Energy. This is not ideal.

An energy infrastructure built around distributed generation would be ideal. Every power consumer could be a power supplier, through ownership or co-ownership of rooftop or community New Energy. Unfortunately, this will not be a reality for the foreseeable future.

The report highlighted below outlines the foreseeable future as foreseen by the people who run the utilities. As such, it warrants attention. And it is encouraging. Despite the overwhelming burden that comes with the responsibility for keeping the TV on and A/C running, the electricity-keepers have been paying attention.

They noticed Fukushima. They heard that Iran and some U.S. data centers got hacked. They read that coal emits toxic byproducts. They got reports that water is getting scarce. They noticed that every time they turned on one of those TVs they power, there was a new story about another tornado or hurricane or drought or flood or wildfire. Most of all, they noticed the prices of new coal plants and new nuclear plants going through the roof.

They started wondering if there aren’t safer ways to generate electricity before the unforeseen strikes them like it did Japan’s TepCo utility.

They started wondering if there isn’t a more secure way to transmit electricity before somebody gets at them. Their natural inclination to worry about delivering power got them thinking about the aging U.S. grid’s reliability.

Maybe they started wondering if they would be sued for the toxic spew of the coal they burn or maybe they started wondering how they might feel if somebody they loved got cancer from breathing coal’s poisons. Or maybe that happened.

Maybe they started wondering if those tornadoes and hurricanes and floods and droughts and wildfires might have something to do with climate change.

The evidence is in the report: They’re thinking about the Smart Grid and they’re learning about New Energy and Energy Efficiency and they’re asking about Sustainability.

Here it is: Humans are terribly destructive, perhaps even self-destructive, but they have a remarkable capacity for self-correction.

With faith in that fundamental human capacity, the fight for the energy future of this great nation and this good earth goes forward.

Mary Chapin Carpenter said this: “We got this far not by luck but by never turning back / And everything we got, we got the hard way.”

Have a great weekend celebrating a revolution led by people who would not turn back.

2011 Strategic Directions Survey Results
June 2011 (Black & Veatch)

Executive Summary By Richard Rudden

Trend Lines

Black & Veatch’s fifth annual survey marks a significant transition in an evolutionary fashion from prior years. This year Black & Veatch has expanded with a more global presence in its perspectives, focused on the issues that prior surveys indicated were important ones and dived more deeply into the responses. This enabled Black & Veatch to identify and better appreciate the numerous interconnections among the issues covered in the survey.

In this survey, Black & Veatch has seen a greater intensity of general concern about industry issues, as well as significant shifts in respondents’ views. Black & Veatch also has seen the emergence of new issues, a few of which were prompted, no doubt, by the insightful questions asked. Other responses were likely influenced by the earthquake, tsunami and nuclear crisis in Japan, because the survey was conducted shortly thereafter. Still other responses could have been affected by recent world cyber security events, such as the sophisticated, high-profile hacking of one of Iran’s nuclear facilities, the Wikileaks releases and a number of security breaches at commercial data centers. This year’s results paint an interesting and complex mosaic of the often-conflicted state of mind of utilities and other industry leaders.

This Executive Summary provides a high-level perspective on the most compelling issues addressed in the survey and, where appropriate, places this year’s responses in the perspective of prior years’ results. In many cases, the 2011 results were an affirmation of trends identified previously, while in other cases, new and important issues emerged. More in-depth discussion of the issues will be found in the topic-specific sections following this Executive Summary.

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The “Top 10” – Is There a Black Swan Here?

In 2006, Black & Veatch undertook an analysis of the issues that would drive change in the U.S. power industry in the coming years. It convened a group of Black & Veatch thought leaders, and also engaged outside professionals, to help identify and better understand how the industry environment was evolving. This resulted in a white paper and list of the “Top 10” issues. As Black & Veatch explored these issues in 2006, the team agreed that it would be valuable to survey industry leaders to obtain the views of the people in the field – executives, managers and staff who had to plan around industry trends and who also had to grapple with the issues head-on, every day. This created the first Strategic Directions in the Electric Utility Industry survey.

As will be discussed in more detail later in this report, “Aging Infrastructure” occupied first place among all respondents this year (when non-utility respondents are included), with “Reliability” in second. Perhaps driven by advances – and failures – in Smart Grid and related IT development, “Technology” has advanced rapidly toward the top of the list, moving from eighth place in 2008 to fourth in 2011.

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With recent cyber security publicity, “Security” has moved up only slightly, ranking last in 2006 and 2007, to only ninth place in the 2009/10 and 2011 surveys. Perhaps the industry regards the potential for a successful cyber attack as a “Black Swan” – an event regarded as highly unlikely, but with consequences that would be severe were such an event to occur. The highly improbable trifecta of the huge Oshika earthquake, the resulting tsunami and the impact on the Fukushima power plant is an example of bad things happening that no one expected. Recently, Rhode Island Representative and House Armed Services Committee member Jim Langevin expressed concern over the security of the nation’s infrastructure when he said:

“The utilities don’t have (the incentives that the financial sector has) to secure their systems. The owners and operators of electrical grids don’t get it. Their risk calculation is not the same as what the government has in protecting the public. The regulatory agencies don’t have the authority to require standards or guarantee safety.”1

The power industry may disagree, but there is food for thought here.

Nuclear and Carbon Are Major Areas of Concern

Even though respondents viewed the Washington, D.C., landscape as more utility-friendly as a result of last year’s elections, concerns over carbon dioxide legislation and nuclear waste disposal and storage were at the top of the list in virtually every respondent group. Carbon legislation and nuclear waste policy are both areas in which the federal government plays a significant role, but so far has not shown its utility-friendly stance on these matters. Carbon legislation is a significantly larger concern than physical carbon emissions.

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Water Continues To Bubble to the Surface

Confirming the trends shown in previous years’ surveys, water supply issues continue to creep up the list of future concerns. IOUs appear less concerned about water as a pressing environmental issue than their brethren in other utility sectors. Perhaps public power systems are more concerned due to their geographical proximity to water supplies that have been threatened, because proportionately more of these utilities either rely on hydropower, or are affiliated with municipal and federal water supply departments or agencies. While water supply ranks only fourth among IOUs as an environmental issue, IOUs expressed the most concern about the broader issue of water management. Water effluent is far less of a concern among all of the survey sectors.

Toxic and Particulate Emissions

After water supply, nuclear waste and carbon legislation, particulate and toxic chemical emissions (such as mercury, nitrogen oxide, sulfur dioxide and particulates), occupy the next most important group of concerns. The relative scores among them are neck-in-neck along a narrow range of 3.30 to 3.34 (out of 5.0). Respondents are least concerned about coal-related production, transportation, ash handling and disposal. The concern level surrounding coal-related issues is somewhat elevated relative to prior years, perhaps because of recent Environmental Protection Agency (EPA) rules regarding the control of emissions. Notwithstanding these concerns, more than 80 percent of all respondents believe there is a future for coal, once the economic and financial realities of competing fuels are considered.

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Utility Industry Macroeconomics and Policy Influencers

The macro-economic factors that respondents believe will have the greatest impact on their enterprises include three related to state and municipal finance: state and state agency deficits (in first place, with a score of 3.70); municipal deficits (in second, with a score of 3.65) and bond and credit markets (in fifth place, with a score of 3.52). Two other factors relate to greenhouse gases (GHG): federal GHG regulations (third place with a score of 3.58); and state and regional GHG regulations (fourth place with a score of 3.54). While the three factors related to state and municipal finance impact the public power segments the most, the IOUs share many of these as their top concerns.

Global Warming – Opinions Move at a Melting Glacier’s Pace

During the span of the survey, a gradually decreasing percentage of respondents believe that global warming is occurring as the result of a natural cycle, dropping from 56 percent in 2007 to 51 percent this year. While this trend suggests more respondents are moving into the “global warming is caused by man” school of thought, the small majority (51 percent) believe global warming is a natural, cyclical phenomenon. Utilities as a group remain more skeptical, by a fair margin, of global warming as a long-term anthropogenic phenomenon than other nonutility respondents. Part of this shift may be attributed to the fact that this year’s respondents had proportionally more nonutility participants, who tend to be stronger believers in anthropogenic warming.

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Fuels of Choice

This year, natural gas overtook nuclear as the preferred, “environmentally friendly” fuel, according to all of the respondents (although the utilities as a subgroup regarded nuclear as slightly more preferable, than natural gas). Nuclear had been in first place since the survey began in 2006. The displacement of nuclear with natural gas is consistent with respondents’ rising concern about nuclear waste disposal and cost. A vast majority of IOUs and municipalities felt that shale gas would remain available at a reasonable cost. In the longer term, municipalities were slightly more bullish: 53 percent of municipal respondents stated shale gas would be available at reasonable costs beyond 2030, while 49 percent of the IOUs agreed.

Hydraulic fracturing (fracking) was seen as a major impediment to shale gas by 24 percent of all respondents. Nearly half of all respondents (45 percent) said fracking would not be a major problem; however, they did expect the issue to create some upward price pressure.

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Cyber Security Concerns Increase Significantly

Concern about cyber attacks has increased substantially, with greater concern expressed about the vulnerability of utility computers and networks, as well as command and control centers. Even though transmission remained second among security concerns, the strength of the concern over command and control vulnerability increased by more than 25 percent since the 2009/10 survey. The overall increase in concern across all categories about cyber vulnerability (including command and control, transmission and other components of utility systems) was nearly 11 percent, as measured by the change in the arithmetic average of the scores within the five cyber security categories since last year.

Obstacles to Significantly Increased Use of Renewable Energy Technologies

The low cost of coal and other competitive fuels, such as natural gas, is regarded by all respondents as the greatest barrier to significantly increased use of renewable energy technologies. IOUs and municipalities largely disagreed with the statement that renewable energy would become unquestionably competitive with more traditional energy sources during the next five years. It appears that nonutility respondents were far more optimistic.

As discussed later in this report, there are a number of new technologies which, although not technically “renewable,” will improve the coordination and effectiveness of renewable energy sources or create new clean energy opportunities, such as storage and electric vehicles (EV).

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Electric Vehicles – A Huge Opportunity, Assuming Everybody’s Crystal Ball Is Working

Optimism about electric vehicles was confirmed when respondents provided their estimates on the saturation of EVs in their markets during various future time frames. The IOUs estimated EV market shares will grow from 1.03 percent in 2012 to 8.11 percent by 2025. The municipalities were more optimistic in the short run, but less so in the long run, indicating a share of 1.23 percent by 2012, but only 6.79 percent by 2025.

The G&T (Generation & Transmission) Cooperatives and Federal Power Marketing Agencies (FPMA) were, on average, most optimistic. They projected a 1.29 percent saturation in 2012 and 10.87 percent by 2025. This may be attributed to the fact that the FPMAs are more directly under the control of the federal government and therefore are more susceptible to executive orders mandating pro-EV programs.

Similarly, many municipal systems are affected by city and mayoral mandates to be aggressive in implementing EV technology (e.g., New York City). These market share expectations, if proven, represent an incredible source of growth for electric utilities, as well as potential challenges regarding load patterns and distribution system design challenges. Some think the Smart Grid will be the answer.

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Visions for the Smart Grid

The Smart Grid offers the promise of greater energy efficiency and power system reliability. However, a common vision of the Smart Grid and agreement on its economics continue to be somewhat evasive. All of the respondents, as a group, believed that the concept of Smart Grid is neither well defined within their states nor across the industry.

Municipalities viewed the Smart Grid as less well defined than the IOUs. Further, respondents did not think there was a shared, common vision for the Smart Grid between utilities and regulators. Just under a third of all respondents felt that utilities and their regulators were “miles apart,” while almost 38 percent felt the visions were “close, but needed to be closer.” Thus, more than two-thirds of respondents felt there was a distance between utility and regulator visions for Smart Grid.

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The Smart Grid Business Case – Very Much About Societal Benefits

The distance felt regarding Smart Grid may be in part because respondents seem to have little confidence in the business case made in the industry at large. All respondents gave low grades for the quality of the Smart Grid business case, possibly because they believe much of the net benefit associated with Smart Grid relied on the inclusion of “societal benefits,” a concept that is not always easy to define and usually difficult to quantify.

It may be perceived that the inclusion of societal benefits creates some fuzziness in the business case. On average, all respondents indicated that 48 percent of the net benefits identified in utility business cases were derived from societal benefits. In other words, only a little more than half of the total benefits are associated with direct, measurable (or reasonably estimated) utility cost savings.

Impediments to Smart Grid – It’s the Customer

According to all respondents, the greatest impediment to Smart Grid implementation is a lack of customer interest and knowledge, although the municipal utility subsegment regarded economic and financial issues as the primary obstacles. Among municipals, the two factors that tied for first place were the size of the upfront investment and the ongoing capital, operating and maintenance costs.

The second impediment within IOU and nonutility respondent groups was what to do with Smart Grid programs after stimulus funding from the American Recovery and Reinvestment Act of 2009 (ARRA) was fully expended. This concern is consistent with municipalities’ concern about ongoing capital, operating and maintenance costs.

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An Information-Centric Revenue Model for Utilities? Not Anytime Soon.

In many people’s minds, Smart Grid would serve as a great enabler for utilities wanting to enter into the “information business.” However, utility respondents overall do not see their businesses evolving into information-centric revenue models. Utilities grade this opportunity very poorly (about 2.5 out of 5.0 for all utility groups). On the other hand, the nonutility respondents appear to have a much higher expectation.

Sustainability – A More Common Set of Views than Expected

All respondents hold very similar views of how sustainability is defined and its objectives. More than 61 percent agreed that the objective of sustainability is to “Explicitly and systematically balance the interests of people, utility financial performance and the environment.” This combination of considerations is often referred to as the Triple Bottom Line (TBL).

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Approximately 20 percent of respondents felt the objective of sustainability was to “Assure the financial stability and continuing performance of the utility.” Only 17.5 percent of IOU respondents believed that assuring financial stability and performance was the primary objective of sustainability, while 26.7 percent of municipal respondents believed so.

There was unanimity among all respondents that balancing financial, societal and environmental objectives was the first of three focus areas of their sustainability planning processes, while assuring financial stability was second. They were also unanimous that complying with regulatory reporting requirements was their third most important area. All respondents agreed that sustainability issues affected their overall business planning to at least “some degree,” “moderately” or “strongly.”

Where’s the Real Pay Off for Sustainability?

While all respondents indicated that meeting sustainability goals was most important to both social responsibility and local public image, the difference in scores for IOU and public power subsegments is striking. For IOUs, Wall Street perceptions were their most important factor. For municipalities, it was their actual financial performance that was most important. Both the municipal and IOU scores were very high (approximately 4.0), suggesting that financial performance and financial markets are of paramount importance in establishing – and meeting – sustainability plans and goals.

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Relevance of Sustainability to Resource Planning

When asked which elements of sustainability planning were most strongly considered in utility resource plans, the traditional utility issues came up first and foremost – virtually unanimously across all respondent sectors. Consideration of the impact of sustainability planning on financial performance was first (4.32); the impact on reliability was second (4.17); and the impact on air emissions was third (3.57). The integration of demand side management and energy efficiency came in as a distant fourth (3.49) and water requirements fifth (3.39).

Note the juxtaposition of water requirements in fifth place here, with water supply and management being identified as critical issues elsewhere in the survey. Other critical issues normally considered important to sustainability planning, such as employment, the local economy, local infrastructure development and other effects on local environment and populations, either barely eked out placement in the top five of one of the segments, or did not place at all. Water issues other than supply – such as groundwater quality and water effluent – also scored lower than might be expected in the context of sustainability planning.

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Are “Green” Business Opportunities Real for Power Utilities?

There has been much talk about utilities seizing the “green opportunity” to enhance revenue streams, so this year Black & Veatch asked some questions about it. Less than 13 percent of all respondents saw the green opportunity as real and unconditional, and a very large number of those holding this view were the nonutility respondents. Only about 9 percent of IOU and 3 percent of public power respondents believed this was the case.

A little more than a fifth of all respondents thought “yes (green opportunities exist), but they are limited for now,” and about a quarter of all respondents believed, “yes, but enlightened regulation will be required” to provide the proper incentives. It is clear that the utility subsegments were generally more bearish on green opportunities than the non-utility respondents. It’s hard to tell if the concern is with green technologies, the economics or the fact that utilities have little confidence that they will be permitted to keep any profits they may derive. It is probably a combination.

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The Urge to Merge Is Strong

The survey results suggest increasing pressure for utility mergers and acquisitions (M&A) in the United States. Just short of two-thirds of all respondents felt that M&A will be “important,” “very important” or “extremely important.” The respondents believe that the major drivers of M&A activity will be to improve balance sheets, reduce costs and achieve merger synergies, some of which can be retained by shareholders.

More than two-thirds of all respondents feel that strong balance sheets will be necessary to finance much-needed generation and transmission over the next five years. In Black & Veatch’s view, these investments will be critical in dealing with legislative uncertainty, carbon risk, the development of high-cost generation (e.g., nuclear and coal with carbon capture and sequestration) and the construction of significant new transmission to interconnect renewable energy.

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The need for further cost reduction is also feeding merger mania. While recent cost reduction programs have helped the bottom line, utilities continue to seek additional opportunities to control costs. More than half of IOUs feel “a lot more can be done” to reduce costs. But about 50 percent of all respondents are concerned that past cost cutting has reduced utility effectiveness “moderately,” “significantly” or “extremely.”

Given the need to build strong balance sheets and reduce costs without further harming utility effectiveness, it is no surprise that 41 percent of IOUs agree “somewhat” or “very strongly” that mergers are necessary to drive costs down further. Also, respondents agreed very strongly that acquisitions of U.S. utilities by foreign-domiciled companies will increase. It appears that money can be made for shareholders through both cost cutting and M&A synergies. Some 81 percent of IOU respondents indicated they have been able to retain at least some portion of reduced costs for the benefit of shareholders through the regulatory treatment of net cost savings. Additionally, 7 percent of IOUs indicated they have been able to retain all of their savings, while 74 percent have been required to share cost savings with ratepayers, still leaving some benefit for shareholders.

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Globalization – Some (But Not Too Much) Angst in the U.S. Power Industry

Respondents’ views on the effects of globalization on their business or the U.S. utility industry at large vary considerably, but the concern is not acute. Approximately half of all respondents, including IOU and G&T Cooperative subcategories, are “concerned” or “very concerned” about losing the manufacturing of renewable technologies to overseas businesses.

The public power respondents appear a little bit less concerned. That may be in part due to the fact that municipalities appear less involved with purchases overseas, possibly as a result of a higher incidence of “Buy American” provisions in municipal purchasing guidelines.

Depending upon the country from which equipment was purchased, between 30 percent and 38 percent of IOUs report having purchased significant amounts of energy equipment and technology from overseas, but only 22 percent to 31 percent of municipalities reported such purchases.

The purchases appear to be spread out evenly among a number of countries, with Germany the most and China the least. Opinions were fairly consistent among all respondents about which countries represented the greatest competitive energy threats to the United States. China was first, India second and Germany third.

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Globalization Continued

All respondents agreed with the statement that acquisitions of U.S. utilities by foreign domiciled companies would increase. The next highest point of agreement was that the United States was at risk of losing skills and capabilities to overseas companies. However, the distribution of concerns expressed by IOUs and municipalities were a bit different. The first point of agreement among IOUs was the loss of talent, but their second strongest point of agreement was that M&A would be vital to the viability of the U.S. utility industry.

Respondents expressed the sentiment that acquisitions of U.S. utilities by foreign domiciled companies would increase.

Municipalities also agreed most strongly that the United States is at risk of losing talent and capabilities overseas, but their second strongest point of agreement was that there would be an increase in acquisitions of U.S. assets by foreign interests.

In Which Areas Will the U.S. Retain its Global Leadership?

Even though respondents expressed some concerns about global competition and enterprise and asset acquisitions, they believed there were a few areas in which the United States would retain its lead, or at least hold its own in the future. The top three areas were solar, nuclear and wind, with comparable views held among all respondent subcategories. Electric vehicles and Smart Grid technologies ranked fourth and fifth, respectively.

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The Rest of this Report

The balance of this report addresses and amplifies all of the issues identified above, as well as others that are likely to be of interest. Each section was written by one or multiple experienced Black & Veatch professionals in the fields addressed, with an emphasis on in depth analysis and opinion.

This report contains a large volume of data, some of which is subject to subtle interpretation. Black & Veatch acknowledges that other, equally qualified professionals may come to different conclusions using the same data. As a result, the reader may find differences in the interpretations, conclusions and opinions expressed by the panel – or may even interpret the data differently. Black & Veatch hopes these differences will engage readers and help further illuminate the topics discussed and challenge intellectual curiosity.