How Do You Invest $400 Billion? Part II: The CEO of the SG Develops a Budget Forecast

Final Avatar 80x80-Logo-SG-1-and-2-and-IX-LOGO-e1363114874895-150x150

 

Dom Geraghty

 

This is the second part of a four-part dialog series.

The first dialog in this series presented, from a top-down perspective, the costs and benefits of SG 2.0 deployment plans created by five different, credible groups.

This second dialog prepares and discusses a conceptual multi-decade budget for a national SG 2.0 deployment, an approach that could also be used by individual utilities.

The third dialog will provide a holistic budget forecast for the deployment of SG 2.0 and the replacement of aging infrastructure for the power system as a whole. Our final dialog will suggest a “Managed Deployment Strategy” for SG 2.0 that combines a least cost approach and risk management.

10. DSC_1334-150x150We have already noted that the only meaningful way to choose which individual SG 2.0 applications to deploy was from a bottom-up, project-oriented approach within the context of the regulatory, market and business environment, including taking account of the costs and benefits of any power system impacts. Our mission here at SGiX is to facilitate these project choices.

As a first step in fulfilling this mission, the “ground-work” as it were, we feel it would be useful to create an understanding of the “big picture” -- the national context within which these individual SG 2.0 business cases are to be evaluated and financed. That is the purpose of this current series of dialogs.

The CEO of the “National Smart Grid” Does Some SG 2.0 Deployment Planning

Imagine for a minute that you are the CEO for the entire ‘national smart grid’. You are concerned about the large capital investment requirement over a multi-decade period of time, how you are going to finance this multi-decade investment, and perhaps the “softness” of some of the benefits.

How would you go about evaluating an investment commitment, and determine the recommendations you’d want to present to your Board?

Well, for sure you’d want to prepare a budget forecast.

But to develop a budget, you would first need a road map of the expected deployment of SG 2.0.  So, you would review the road-maps that have been developed by various credible entities, and talk to the leadership of these efforts.

Some SG 2.0 Deployment Road-Maps

DSC_0026 150x150One credible road-map for the transition has been presented in the 2011 joint report by Cisco/IBM/SCE (link) entitled: “Smart Grid Reference Architecture: Volume 1”, referencing and making use of previously published seminal work by NETL, GridWise®, NIST, and IEEE. The Cisco/IBM/SCE proposed transition moves gradually through four stages -- a senior Cisco executive estimated that the transition would take about 30 years to accomplish:

(a)    Stage 1:  Today’s silo-ed architecture, e.g., metering/billing and EMS/SCADA as separate architectures

(b)   Stage 2:  An enterprise service bus structure e.g., upstream communication between the  back-office service data bus and the real-time service data bus, or, the integration of the back office and applications via a common service bus

(c)    Stage 3:  Converged field data using a common back-haul streaming to the enterprise service bus structure of Stage II - moving away from a series of single-purpose networks to a common communication infrastructure with on-demand data transfer

(d)   Stage 4:  The ultimate Smart Grid architecture converging to a layered, open standard, services architecture. It would provide capabilities across functional and organizational boundaries from a data/control center to edge devices and data consumers (both applications and end users)

Another useful presentation of a framework for the transition to a smart grid architecture is provided in the 2011 report of the Reference Architecture Working Group (SG-CG/RA) established by CEN, CENELEC and ETSI in order to fulfill the tasks laid down the Mandate M/490 of the European Commission. Their proposed transition doesn’t appear to be too different, in substance, from the Cisco/IBM/SCE staged transition above.

You might also consult with the Gridwise Architecture Council, NIST, DOE, IEEE, and EPRI, each of which have published their views on the deployment and ultimate architecture of the SG 2.0.

According to the Cisco/IBM/SCE report above as well as the other references cited, in deploying SG 2.0 it looks like we will be dealing for some time with hybrid systems in terms of interoperability, i.e., a combination of legacy systems and new architecture.

During an orderly transition to full interoperability, legacy systems would be connected to new SG 2.0 applications using protocol translators, or APIs. An existing example of this is the “Tower of Babel” translator offered by SubNet Inc. to link the plethora of distribution sub-station protocols in existence today at any one substation. Other examples might include the potential overlay of Itron’s AMR ERTs or Aclara’s PLC AMR systems with more capable functionality.

The focus of the above reports is on national and enterprise architecture roadmaps. Individual business cases for SG 2.0 applications are not evaluated. It has been assumed that the deployment of SG 2.0 will deliver an acceptable benefit to cost ratio – see our previous dialog on benefit to cost ratios.

The allocation of the benefits and the costs of an SG 2.0 deployment have not yet been addressed and will be challenging. A related white paper published by Cisco, entitled “Gridonomics”, predicts that some stakeholders stand to receive a disproportionate amount of the benefits relative to their burden of the costs as SG 2.0 is deployed. A benefits re-allocation/sharing will likely be negotiated/advocated within the difficult-to-predict judicial regulatory process.

Our CEO’s Business Approach: A Budget Forecast for the Transition Plan to SG 2.0

General Assumptions

57-dark-purple-two-towers-New-Image-150x150The CEO surmises that the top-down bundled costs of an SG 2.0 deployment (~$400 billion) would be greater than a bottom-up aggregated cost because, for the latter, not all SG 2.0 applications will pass project hurdles. That is, there will likely be less projects and less penetration of particular applications, representing a more surgical approach to deployment.

We might also agree with the CEO that the aggregated benefits of the bottom-up deployment analysis will be less than the top-down approach due to the lesser number of viable projects, but that the benefits will also have an offsetting increase due to the inclusion of correlated power system benefits hitherto not included in a top-down analysis.

An additional challenge is that a considerable proportion of the included benefits included in studies to date have been qualitative, and thus opinions will vary about their economic value, complicating the achievement of a consensus and the CEO’s presentation to the Board.

It doesn’t take a big leap of faith to conclude that in analyses of the business cases for individual SG 2.0 applications, and for the entire SG 2.0, the benefits will have a wider uncertainty range that the costs, and if history is any guide, the benefits realized will be less than the initial benefits’ forecast (!).

Finally, it is clear that costs will be incurred before benefits are realized for individual SG 2.0 applications, and for the case of the benefits related to deferred capital for new infrastructure requirements, they will arrive decades later. Moreover, as one moves out in time, outcomes will obviously become more speculative.

Developing a Top-Down Conceptual Budget for the SG 2.0 Transition

The CEO decides to develop an understanding of the timing differences between investment costs and realized benefits during the transition to SG 2.0 by creating a summary conceptual budget, presented in the table below. Agreed, it is a ~30-year budget and entirely speculative, especially after the first 5 years or so, but at least it provides a holistic, directional picture of what the CEO might expect to happen.

Conceptual Budget Forecast for a SG 2.0 Transition ($ billions – nominal $)*

 Cash Flow Through Each 5-Year Period

Year 5

Year 10

Year 15

Year 20

Year 25

Year 30

SG 2.0 Investment

133

133

133

Operational benefits

66

66

66

66

66

66

Deferred capital (benefits continue until supply/demand is re-balanced)

66

66

66

66

Qualitative benefits (in perpetuity), e.g., decreased environment pollution and service reliability

66

66

66

66

Net cash flow

-66

-66

66

198

198

198

 Other costs, e.g., R&D on SG 2.0 applications, subsidies (see Part III of the dialog series)

 

TBD

 

TBD

 

TBD

 

TBD

 

TBD

 

TBD

*List of Assumptions Underlying the Above Forecast

Assumes a nation-wide commitment to an accelerated deployment of SG 2.0 (a big assumption!), and that 100% of the total SG 2.0 cost (~$400 billion) is incurred in the first three time-periods (over 15 years), for a cost per 5-year period of $133 billion per period.

Assumes that the benefit to cost ratio for SG 2.0 is 3:1 per the previous top-down analyses by Perfect Power and EPRI. We are also going to assume that the operational benefits provide 33% of the total benefits, and the deferred capital expenditure benefits and qualitative benefits together comprise 66% of the total. (Note that the bottom-up analyses of the three CA utilities for SG deployment through 2020 show a benefit to cost ratio of 1:1, so we may be optimistic in choosing the 3:1 benefit to cost ratio above, but this conclusion depends on whether the utilities included the value of qualitative benefits.)

If total benefits of SG 2.0 are $1.2 trillion, i.e., a 3:1 benefit to cost ratio, then the operational benefits are $400 billion, and when linearized over 5 year periods amount to $66 billion per period.

We are assuming that the deferred capital and qualitative benefits begin to accrue after 10 years. Deferred capital and qualitative benefits together amount to $800 billion, assumed to be divided 50%/50% between deferred capital and qualitative benefits, and when linearized over 5-year periods, each amount to $66 billion per period. These benefits are assumed to begin at the start of the third time period (by year 11). The deferred capital benefits occur until the supply/demand curve completes its re-adjustment (assumed to be completed within the 30 year period). We assume that the qualitative benefits continue indefinitely.

T-Substation-mauve-clear-e1355772167388-150x150Yes, we know -- there are a lot of speculative assumptions above – each individual will have his/her own take on how the SG 2.0 roll-out will happen.  Though we do believe that the assumptions are “ball-park” reasonable and not overly conservative. We would welcome your opinions on that topic.

This conceptual budget suggests that, as a result of timing differences between incurring the costs and accruing the benefits, we would not begin to break even, in a nominal dollar sense, until somewhere the period from Year 16 to Year 20, i.e., for many years.

However, operating cost savings could contribute substantially to providing a relatively near-term return on the SG 2.0 capital investment, if we are right in our assumption that these savings could be generated soon after the investments were made.

Deferred capital savings could begin to provide a substantial return by the third five-year period.

The qualitative benefits, while valuable, do not represent cash flows in a budget sense and thus do not provide cash relief to the budget, regardless of their magnitude**.

**In reviewing any evaluation of the benefits and costs of SG 2.0 deployment, one should pay close attention to assumptions about the qualitative benefits that are expected to accrue, since they are substantial in every forecast that we’ve seen, and are difficult to monetize. From a budget, private financing and business perspective, we need to look at the cash benefits separately from the qualitative benefits.

We could conclude from the above conceptual budget that electricity customers’ bills would continue to rise in the near-term to pay for SG 2.0 deployment, but would decrease in the longer-term as SG 2.0 benefits accumulate.

Obviously, the above forecast will be heavily influenced by regulatory policy changes, energy policy, technology readiness, and market acceptance -- factors that would be taken into account when doing the due diligence analysis of business cases of situation-specific SG 2.0 application projects. The budget assumptions are also vulnerable to the advent of a disruptive technology, which a real possibility, in view of the lengthy time-frame with which we are working.

It’s worth reminding ourselves again that this top-down budget analysis of the costs and benefits of the smart grid is not a business case, because an SG 2.0 deployment will consist of a roll-up of individual SG 2.0 applications that are individually evaluated in terms of their benefits and costs, while taking account of any overlapping costs and benefits across these individual projects.

Our next dialog will extrapolate this SG 2.0 analysis into a conceptual budget that includes required power system infrastructure investments for the entire power system, and discuss some offsetting benefits and some as-yet un-budgeted additional incremental costs.

As always, your comments are welcome and appreciated.

Leave a Reply

Your email address will not be published. Required fields are marked *