TODAY’S STUDY: WHAT UTILITIES THINK

2012 Strategic Directions in the U.S. Electric Utility Industry

Mark Gabriel, May 2013 (Black & Veatch)

Executive Summary

Everything Changes While Staying Relatively the Same

In the 12 months since the last Black &Veatch electric utility industry report, the industry has seen its primary fuel choice challenged and natural gas prices drop to levels not seen since 2001. A historically warm winter across much of the country drove down consumption (and hence revenue), creating a cash crunch for many utilities. Further, the industry’s hopes for some progress on the regulation of carbon continue to wax and wane in a U.S. Congress unable to make a decision.

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Yet for all of the changes across political, economic and cultural lines, results from this year’s report are strikingly consistent with those of the past three years in terms of concerns, worries and the potential impacts of regulation and other requirements. Perhaps it is the historic focus of the industry on reliability and safety; perhaps it is a return to back-to-basics management approaches; or perhaps it is the generally conservative nature of the industry, which results in this remarkable consistency from year-to-year. Black & Veatch conducted its sixth annual electric utility industry survey from 22 February through 23 March 2012. Analyzed survey responses are from qualified electric utility industry participants. Statistical significance testing was conducted and represented results have a 95 percent confidence level.

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Utility respondents represented a broad cross section of the industry (Figure 1) and country. The eight mainland regional reliability councils under the North American Electric Reliability Corporation (NERC) were represented in this survey. Figure 2 provides an overview of the percentage of respondents from each of these regions. Responses were also grouped by four geographic regions, as noted in Figure 3, to give additional insights into geographic differences.

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Key Survey Findings

The industry, according to the survey, continues to hold fast to some fundamental beliefs: that there will be some certainty on carbon; that prices for electricity will continue to rise; that while coal has a future, renewables have a growing but limited one; and that water is a critical environmental concern. There is also significant agreement in several interesting areas – interesting because undoubtedly a survey of the general public, regulators or legislators on the same topics would most likely yield different results. When it comes to “viable clean energy” technologies, for example, the “big three” that electric utilities project for 2020 are natural gas, hydroelectric and nuclear (see Figure 19 on page 29).

While conjecture, it is doubtful the general public would rate any of those choices as particularly “green” technologies. More than 90 percent of utility respondents believe, however, that renewables will increase prices for consumers anywhere from 5 to 30 percent, with the largest percentage (38 percent) assuming a 10 percent increase for their customers. This may tie to the 65 percent of utility respondents who reported rate increases during the past year, and the 92 percent who reported that the cost of regulations will cause prices to rise for consumers (see Financial Section). More than 60 percent of utility respondents believe they will hit their renewable energy targets – but a surprisingly 25 percent of utility respondents stated they do not know if it is achievable.

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One has to wonder whether the pending increase in rates due to renewables and the potential demise of the production tax credit are behind this uncertainty.

Reliability, aging infrastructure (not work force) and the environment continue their reign as the top industry concerns (Figure 4), followed closely by the need for long term investment. Interestingly, security and technology – inextricably linked in terms of deployment, are tied in the fifth position. While water did not make the Top Ten Issues list, it did come in second only to carbon emissions legislation in terms of environmental concerns. In fact, when water supply (second) and water effluent (sixth) are combined, they rise to the top of environmental concerns.

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The hope for certainty in carbon emissions legislation is common across all regions and, as it has since 2008, leads the ranking in environmental concerns followed closely by water supply (see Table 2 on page 40). Interestingly, when broken down into the four geographic regions, Northeast respondents rank disposal and storage of nuclear fuel as their top concern – an issue that does not even make the top three in the Midwest, South or West. The concern over nuclear disposal, overall, jumped significantly since 2009 when it was near the bottom of industry issues – likely due to the lingering influence of the unfortunate incidents at Fukushima, as well as the abandonment of plans for a national geologic storage facility at Yucca Mountain.

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The potential impact of environmental regulation continues to be a primary focus for utility survey respondents. It is interesting to note that the survey’s timeframe in March pre-dated (and yet predicted) the U.S. Environmental Protection Agency’s (EPA) and Department of Interior’s new hydraulic fracturing rules issued in May. More than 80 percent of respondents saw this coming in their crystal balls. Of course, 93 percent of survey respondents believe these new rules – and any subsequent rule additions, will have a significant or slight upward pressure on the price of natural gas (see Figure 17 on page 27). Respondents’ prediction on the price of natural gas in 2020 showed a virtual tie between $4-$6 per MMBtu and $6-$8 per MMBtu. More than one-fifth of survey respondents (22 percent), perhaps those who have been around to watch historical gas price fluctuations, reported not knowing where the price will be in the same period.

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Regulations are also causing concern regarding the operational effectiveness of utilities as well as concern for increasing rates. A full 86 percent of respondents believe there will be impacts on operational effectiveness with 16 percent believing it will be “significant” (see Figure 5 on page 13). Regulatory impacts are also key drivers in investment, the development of sustainability plans and the perception of utilities on Wall Street – either for stock price or bond ratings. Concern over whether or not utilities will be able to recover adequate returns on investment – or any costs for that matter - for smart grid investments, weigh on the minds of utility respondents. This is especially true now that American Recovery and Reinvestment Act dollars are almost gone.

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Smart grid, which burst onto the survey scene several years ago, continues to struggle from “a lack of customer interest and knowledge,” which utility respondents view as the single greatest impediment to investment programs. Yet, when pressed further, more and more companies are investing in systems to improve customer communications, which are driven by smart systems.

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More than three-fourths (76.9 percent) will be building customer self-service websites, expanding their web presence, social media and potentially implementing variable rates – all areas in which the smart grid is a key component or at least a primary enabler. It may be that the grudging acceptance of intelligent infrastructure is part of the historically conservative nature of the business when even “fast followers” are viewed as radically different and risk takers.

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Regulation at the federal and state/local level is also influencing the market for merger and acquisition (M&A) activity. The 2011/2012 timeframe has seen three significant mergers and acquisitions and, for the first time, the Black & Veatch survey looked at the impacts of these activities. With Exelon/Constellation, Duke/Progress and Northeast Utilities/Nstar each at some stage in the M&A process, all utilities are considering their own futures and what these mergers really mean. The vast majority see financial scale rather than operating synergies as a driving force of profitability in this area moving forward.

The benefits of scale are particularly apparent when considering that regulators require most utilities to either hand over, or at least share, cost cutting and operational savings with customers – especially in light of continued slow load growth or declining kilowatt hour sales.

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Looking at the numbers, the industry has changed remarkably in some capacities while remaining steady in its core function. For example, 58 percent of utility respondents believe “when fiscal realities are fully considered in the United States,” there is still a future for coal. This is a significant drop from the 81.5 percent who indicated this to be the case in last year’s survey. As noted within, the industry is taking more environmental concerns into account than ever before even though nearly a third (29.2 percent) believes that global warming is still “speculative.” It is not unexpected that an industry that prides itself on reliability, safety and long-term investment focuses so intently on certainty; potentially at the risk of missing dynamic changes. It could be as Voltaire once noted, “Doubt is not a pleasant condition, but certainty is absurd” with many more surprises to come in a rapidly changing energy market.

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