What exactly do you mean by a ‘utility death spiral’?
I think you need to go back to the origin of the energy sector to appreciate fully what it means. So in the electricity sector, as it was designed a century ago by Thomas Edison, the way it was done was that it was based on the virtuous circle [a virtuous circle is a recurring cycle of events, the result of each one being to increase the beneficial effect of the next], which at the time involved very fast, rapidly increasing demand for electricity.
That demand was satisfied by utilities that were able to produce more and more electricity at lower cost per kilowatt hour, as they were using bigger plants. So it was all about economies of scale. It was a virtuous circle because the price per kilowatt hour was dropping and that fuelled an even faster increase of demand. So, fast demand, economies of scale, lower prices, faster demand and so on. That virtuous circle allowed the electricity sector to become very prosperous and at the same time bring huge value to society. Frankly, the electricity system is the most complex machine that mankind has ever built, and a modern society cannot function without electricity. So you understand that the value of electricity was tremendous.
Now, what’s going on today? A number of things. The various premises upon which this virtuous circle was based, all of them have collapsed, and that is a problem for the utilities. Problem No 1 is that demand is not growing. If anything, I predict that demand is going to go down for electricity. Why? Because we have invented all sorts of new technologies, over the past century, that make it possible for us to control demand much more effectively. For example, being able to spend much less energy on lighting. To give you an idea, lighting represents 11 percent of the energy consumption in the US and LEDs are 90 percent more efficient than incandescent lighting. So, just there, you can remove 10 percent of the electricity consumption in the US. And we are in the process of doing just that.
Another nugget of information – HVAC systems. HVAC means heating, ventilation, air conditioning and so on. Those systems represent 26 percent of the electricity consumption in the US, and I believe we can reduce electricity consumption in this area by 40 percent. That is because we can control them more efficiently, by switching your air conditioning or your heating system off while you are not at home, and adjusting the system according to your needs, so that you don’t even spend a pound more.
That is one area, and another area that we haven’t even started to look at when we look at HVAC systems is remote operation and maintenance, where with IT, I can monitor and lower your system in your home and I can send a technician to change the features of your system instead of it using 2-3 times more electricity than it should to get the same amount of heating and cooling.
With PV, cheaper and cheaper batteries means that your PV system at home is even more able to match your needs, to the point where some people will start to defect. That is starting to happen in Hawaii for example, where electricity is very expensive, grid connection is cheap, and people start to say “okay, I will start to disconnect from the utility and serve my own electricity needs myself”. So if I go back to the utility, it’s exactly the virtuous circle I was talking about, going the other way around. You start to decrease the demand, but the cost per kilowatt hour is going to increase, so you get the same amount of electricity from the utility, but at a higher price.
As a customer, you have more and more choices, so you start to become more and more energy efficient because the cost per kilowatt is higher, or you take your future in your hands and you decide to generate yourself. All of that decreases demand, so the nice virtuous circle of a century ago is transformed into a vicious circle of lower demand, higher prices and even lower demand. This is why we call it the ‘death spiral’ for utilities.
What kind of sums are being lost in this ‘death spiral’? Has it meant any fossil fuels companies going bust yet or is that still some time away?
If you look back a year or two ago, there was an article in The Economist about the demise of, or the pain the utility sector in Europe is facing. If I give you the example of the company I used to work for, E.ON, in June 2008, the stock price was at 42 Euros. It’s at 9.5 Euros today. And that’s not the worst. We have not seen any utilities go bust yet, but it has been dreadful. In the US, you should look at the stock price of coal mining operations. This has also seen bloodshed. People are shifting away from coal and so those companies were physically beaten. During the year the gas prices went down, so with the combination of coal being perceived as dirty, the coal mining operators were basically destroyed. Massive bloodshed there. It’s not a small change. It’s big.
What is happening is that when Wall Street financial investors start to realise that your business will not necessarily be there in the future, they start to remove the cash now. They don’t wait. The investors are fleeing the losing side of the sector beforehand, in anticipation of what is going to come.
Is this a sign that the battle to decarbonise the power sector is being won?
I think there is still a way to go but there are signs that people are starting to understand what is happening. There was one refugee from Berkshire Hathaway Energy, which is the subsidiary of Berkshire Hathaway, who was on video on Youtube and he was saying that the battle around coal has been lost or won. We are no longer fighting the battle. What we are doing, if I quote him properly, is basically writing down the conditions of surrender.
So the Clean Power plan has been passed in the US by the Environmental Protection Agency (EPA). Europe has come down pretty heavily on its coal power generation, not so much because of CO2 but because of the requirement that coal plants should be equipped with de-NOX units and so on, which cause a lot of money, so many operators are just letting their plants die, and this will happen by next year, I think July 16th. In China, it isn’t because of carbon, but if you look at photographs of China today, you will see that people cannot breathe the air. An old Chinese colleague of mine told me that the first thing they do in the morning is to look at the pollution to decide whether or not it is safe to bring their kids outside to play in the back yard. So this kind of thing is going to lead to the massive decline of coal, for the duration of the planet. And India is even worse than China, I’ve heard now. It’s just killing people, so at some point people will say “I don’t think it’s such a good idea”.
You see also the move towards criminal prosecution of Exxon Mobil because of the way they provided funds to NGO’s to say that climate change cannot be proven, while all the research was actually revealing all the evidence of climate change. Also Bill Gates now has changed his mind. So I think you can see the tide moving, especially with Paris in a couple of days. It’s going to show significant progress, because of all these reasons, and the last reason being that global warming is now affecting the poor more than anybody else. They might like global warming in Stockholm, but in India and Africa, the temperatures are reaching levels where the people are just dying.
What implications does this have for energy prices – both business and domestic?
We’ve got to figure out the right way to pay for our bills. So, for example we just pay for the roads through our taxes, and it may be that part of the energy infrastructure will move in that direction. We don’t know yet. The problem we have today is that 50 percent of the electricity infrastructure cost is made of wires that make up the transmission and distribution grid. So unless you decide to island yourself and generate your electricity yourself, it makes sense that you pay your fair share. That is a fixed cost, so whether we make it proportional to your energy consumption or we make it a flat monthly fee is a technicality. At the end of the day, it is a fixed cost, it is a socialised energy structure in that everybody shares it and everybody needs to pay a fraction of it.
So the bill is going to increase, collectively, as the grid becomes more expensive. So the question is, how can you maintain the grid without increasing the cost to the grid. There are two drivers. First of all the cost of the grid has nothing to do with how much energy is actually transmitted and distributed, because they are just wires hanging there. So if you decrease consumption, the cost of the grid is the same. Energy efficiency will not therefore make the grid cheaper.
You could use distributed energy to avoid having to invest in grid reinforcement. For example, in areas of London you may have an electricity substation that is reaching capacity, the grid operator will be obligated to invest in a new substation. That can cost, especially in the middle of London, half a billion pounds. It can be a very expensive thing. So instead you could anchorage load flexibility, so that you don’t need to increase the capacity of the substation and neither do you need to replace it. That will cost you 100 million pounds, instead of 500 million pounds.
That approach is completely new because, so far, utilities have not thought beyond the meter. They’ve just forecast the load and invested to meet the demand. What we need to do now, moving forward, is to use all the new technologies to manage load behind the meter to prevent or delay those large infrastructure investments. As a consequence, the bills don’t need to increase, but the way we regulate utilities needs to change. What the UK should do is what the State of California is doing, what the State of New York is starting to do, the way we regulate the change needs to take into account what can be done behind the meter. That is not being done today.
On the power generation side, which is the other half of the equation, where, as you know, we put more and more renewables connected to the grid as part of government policy, in the short term that costs money. However, after 20 years you get a lot of solar farms and wind farms that are still running fine but cost you nothing. It’s an investment that you make now for the future, not only you avoid the cost of the fuel, you also reduce your CO2 emissions.
How many companies are seeking to defect and why it makes economic sense to do so?
We have written an article entitled The Economics of Grid Defection in which we show that over the next 30-40 years, most residential customers in the US will have an economic interest in defecting from the grid. We don’t say that it will happen immediately, it is already economically interesting in Hawaii but it is not the case in Vermont. However, over the course of the next 30-40 years, it will happen in most geographic regions of the US. You might say that it’s not happening today, but the point is that what you do today decides the future investment of, say, a coal-fired plant. So over the next 15-20 years, people will be thinking twice about investing in a new coal or nuclear plant.
Tell me about the Business Renewables Centre and what it does
For the time being, the BRC is focused on the US market and we are looking at ways to expand, but basically what is happening in the US is that Fortune 500 companies are under increasing pressure from their shareholders, their customers, to act on investing in sustainability. The best example is a year or so ago, the headquarters of Amazon in Seattle was asked to upgrade its data centre, so it has started within the IT sector, it’s started with B2C companies. More and more companies are scratching their heads about what to do. When they look around at what they can do to green up their electricity bills, they think about energy efficiency, because it’s profitable and they think about on-site generation, such as PV on their roofs, because it’s also reasonably profitable.
The problem with those two things is that they both pretty tough to do. If you cover all your roofs with solar panels, you will only cover 5-10 percent of your energy needs. It’s not enough for quick action, so people are looking more and more at offsite renewable deals. Now companies started some years ago to buy renewable energy credits (REC’s). That was the first way in which to go into renewables. In recent years, over the past 2 years I would say, companies are saying that the problem they have is that there are no direct links between RECs and wind and solar farms. This is why over the past two years or so there is a trend towards direct involvement whereby corporate buyers find power project agreements with wind and solar farm developers and these allow the developers to finance the construction of these assets and corporate buyers can claim those assets are additional, meaning they would not have existed without them signing the contract. This means they can make a much stronger claim that they are taking action. That is basically what has happened.
The BRC is basically a platform where we bring together corporate buyers and large project developers together so that we can accelerate the pace at which we sign such contracts. In 2013, these contracts represented roughly 500 MW. Last year, we were at 1.2 GW and this year my forecast is that we are going to exceed 2 GW. We have 67 members at the BRC today and out of the 17 connections that were signed this year, all but one of those connections involved at least one BRC member. So, we are really at the core of what is happening in this market. What we are doing is providing tools to buyers and sellers so that they can connect more quickly. We would like to recruit more corporate buyers. I think its important if we want to green up our world, it’s important that the corporate sector participate. We should not just wait for government. The BRC can really help them, and we are non-profit. I think we are in a really good position to help them participate in this market.
Hervé Touati is Managing Director of RMI’s Business Renewables Centre (BRC). Mr Touati held senior positions at E.ON, Germany’s leading utility, including COO of the non-wind businesses at E.ON Climate & Renewables and founder and CEO of E.ON Connecting Energies, E.ON's new distributed energy business. Earlier, he served as advisor for the financial and energy sectors with McKinsey & Co. Touati will focuses particularly on disruptive business models and technologies within RMI’s electricity practice.
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