How Do You Invest $400 Billion? – Part III: Planning Assumptions and Trade-Offs

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Dominic Geraghty

 

What Is the Transition to SG 2.0 About, in Reality?

The transition is not just about an orderly, four-stage SG architecture change, driven by logical change-outs of information and communications technology, as presented in Part II. It is important to have thought this through, but it is not enough, and the transition will likely look quite different. This road-map will have detours.

It won’t happen that way because economics will determine in what parts of the system the transition will occur – the changes will take place through “cherry-picking” the highest benefit-cost ratio SG 2.0 applications. Realizing cash benefits will be a priority to offset the high capital requirements of power systems, i.e., to create “avoided costs”.

IMG_2597-150x150Neither will the transition be just about architecture and economics – it will be about the timeliness of supportive regulatory and policy changes. Regulations and policy deeply affect the economic incentives and outcomes of SG 2.0 applications.

The transition will be also mediated by tougher requirements on technology readiness. To date, value-added applications that were supposed to be provided by AMI installations have had mixed delivery results. SG 2.0 vendors will be increasingly required to demonstrate value propositions, to “prove” them. Demand for “pilot demonstrations” will increase, and “system acceptance tests” will become more stringent. Certification of functionality and interoperability will become the norm.

And lastly, a successful transition is about end-use customers, who are concerned about the size of their electricity bills and about receiving an adequate level of service reliability – will the continued polarization of the political processes that govern power system investments create a reliability crunch in stressed locations? Customers have already exhibited hardening resistance to AMI installations, in part because they do not see benefits. Will customers increasingly “self-optimize” by building more DG in the light of higher bills and the potential for lower reliability?

To understand how the transition will occur, and at what pace, we need to build in assumptions about all of the above determining factors as we develop corporate and individual business cases for SG 2.0 applications.

Competing for the Capital Required for Utility SG 2.0 Installations

The top-down SG 2.0 deployment budget presented in Part II of the dialog series will compete against mission-critical infrastructure investment requirements of the power system, primarily the replacement of aging plant and equipment.

As we discussed in Part II, there are some positive and negative offsets to these capital requirements. Let’s discuss several of those first.

Examples of Positive and Negative Offsets

DSC_1086-150x150Some of the new capacity requirements will be offset by the capital investments of end-use customers installing distributed generation (DG) and other distributed energy resources. Such investments will also create operating cost savings as delivery losses are reduced.

However, DG investments may also contribute to another kind of cost: the potential to create “stranded assets” at utilities.

The RPS policy mandate in place in most states will increase investment requirements for the power system in two ways: (1) higher capital costs relative to traditional production technologies, and (2) the need for increased reserves to maintain reliability levels in the light of the variable and intermittent nature of renewable resources.

Long-term Budget Forecast for the Power Sector

The following table presents a budget scenario for the power system as a whole in five-year intervals. It includes the SG 2.0 deployment that we presented in Part II and infrastructure replacement previously presented here. It also includes potential collateral benefits and costs not previously accounted for in the base SG 2.0 budget.

Conceptual Budget Forecast for the U.S. Power System ($ billions – nominal $)

 Cash Flow Through Each 5-Year Period

Year 5

Year 10

Year 15

Year 20

Year 25

Year 30

SG 2.0 Transition (from table in Part II of this dialog series) – Net Cash Flow

-66

-66

66

198

198

198

Infrastructure Investments (total = $1.6 trillion)

-267

-267

-267

-267

-267

-267

 

Total Cash Requirement

 

-333

 

-333

 

-201

 

-69

 

-69

 

-69

 
Other Potential Savings and Costs
Offsetting capital investment in DG by End-Use Customers

+X

+X

+X

+X

+X

+X

Savings due to DG-related reduced delivery losses

+Y

+Y

+Y

+Y

+Y

+Y

Higher capital costs of renewable production mandated by RPS and increased transmission capacity requirement* (see here)

-A

-A

-A

-A

-A

-A

Lower operating costs of renewable production (see here and here)

+B

+B

+B

+B

+B

+B

Increased reserve requirements for variable and intermittent renewable resources (see here)

-C

-C

-C

-C

-C

-C

Costs of potential utility stranded assets

-Z

-Z

-Z

-Z

-Z

-Z

Qualitative benefits of policies such as RPS (many of these benefits accrue in perpetuity)

+P

+P

+P

+P

+P

+P

R&D required for SG 2.0 and non-SG 2.0 technologies

-R

-R

-R

-R

-R

-R

Cost of potential regulatory lag for SG 2.0-enabling policy changes, e.g., implementation of dynamic pricing, harmonization of retail and wholesale power markets

-RL

-RL

-RL

-RL

-RL

-RL

Other sources of costs and savings

 

 

 

 

 

 

Net Cash Flow

TBD

TBD

TBD

TBD

TBD

TBD

*Some of these capital costs may already be accounted for in some of the cited projections of infrastructure investment requirements

8. DSC_0873-150x150Some good work has already been done to estimate the increased capital costs (generation and transmission) associated with RPS mandates and the additional reserves required for maintaining service reliability as more variable and intermittent resources are added to the generation mix.

However, most of the “Other Potential Savings and Costs” in the table above either have not been estimated, or are difficult to quantify.  We expect that some of them will be significant, and that some of them may not be material relative to the total costs that we are dealing with here.

While this holistic “40,000 foot” budgeting approach would not be used to make investment decisions, it could be used by individual utilities to estimate the overall investment requirements of their SG 2.0 and new infrastructure deployments.

Within this context, business cases of individual SG 2.0 applications could then be assessed and prioritized to support investment commitment decisions that appropriately manage the costs and risks of the modernization program to a specific schedule, subject to maintaining satisfactory service reliability levels.

Electricity Bills Will Continue to Increase

The above table suggests that if we deploy SG 2.0 and, at the same time replace aging infrastructure in an orderly manner, electricity customer’s bills will continue to increase sharply for the next 15 years and still increase after that, albeit at a slower rate. That is, the expected cost savings from more efficient management of the power system, while substantial, will not be sufficient to offset the enormous capital expenditures needed to modernize the grid.

But we really need those cash savings created by SG 2.0 applications. Otherwise, electricity bills would be even higher – that is, the applications create “avoided costs”.

Two-t-lines-56-mauve-New-Image1-e1355772451904-150x150On the positive side, it is likely that the deployment of SG 2.0 applications will be more selective/surgical, driven by benefit/cost optimization (see below). That is, a bottom-up analysis based on the aggregation of viable business cases will require less capital and thus may mitigate (but not eliminate) this top-down forecast of increasing electricity bills.

 

We Will Be Dealing with Major Planning Uncertainties Through an Extended Period of Time

There will be winners and losers as SG 2.0 is deployed – the political processes of regulatory and policy change will have the responsibility to make the trade-offs that lead to an acceptable equity balance.

Major stakeholders, such as utilities and vendors, will presumably have a regulatory and policy strategy (and an end-use customer marketing strategy) that they pursue to affect these outcomes. One of the difficult challenges in this process will be developing a consensus around the value of the qualitative benefits noted above, if it is even possible. Since much of this will take place in a judicial setting, time-frames will be protracted.

As we’ve previously discussed, there are a lot of other uncertainties affecting the ultimate realization of SG 2.0 benefits/savings, not the least of which is the extended time horizon over which SG 2.0 will be deployed. In high uncertainty environments, one builds into the plan some “pivot” options, similarly to what one would do in a “lean start-up”, and also extra flexibility (at a cost).

Generally speaking, these situations also incentivize delaying decisions related to major commitments while awaiting some resolution of key uncertainties.

We can expect lengthy, uncertain decision cycles.

Some Conclusions from the Holistic, Top-Down Budget Picture

We’ve shown that in the context of overall grid modernization, the CEO of the “National Smart Grid” will be competing for capital against high priority infrastructure investments.

Some of us have been in a similar position as CEOs of under-capitalized early-stage companies. It required a hardly-affordable increase in monthly cash burn to fix it.

What did we do? We adjusted our time-line, reducing or delaying our development programs; we re-purposed assets to get more out of them and leveraged others’ existing assets where possible; we looked for allies with whom to share costs; and we re-prioritized operations. In short, we went to a “bare-bones” budget -- reducing our previously built-in flexibility/contingencies, since they add to costs.

We suggest using some of the key themes of this “bare-bones” budgeting approach for planning the deployment of SG 2.0. Also, we will want to focus only on quantitative benefits.

This should result in a “least cost deployment” plan which takes account of market, technology, regulatory, and policy risks and uncertainties, factors that could change the outcomes of even the best-laid plans.

Plus we need to get beneath the hood of SG 2.0 and look at individual business cases for SG 2.0 applications. Most utilities already have an intuitive feel for the most beneficial SG 2.0 applications for their systems. We can start with those, and quantify their benefits and costs, especially their near-term benefits.

Some Positive Relief from the 80%/20% Rule

DSC_0316_2-150x150While it is an over-asserted cliché, it is likely that the 80%/20% rule will apply, i.e., that 20% of the SG 2.0 applications will have the potential to deliver 80% of the benefits of SG 2.0. Assuming this to be the case, the surgical deployment of SG 2.0 applications solely in viable locations will likely result in a substantial decrease in the capital cost of deploying SG 2.0, relative to the holistic, top-down budgets presented above and in Part II.

Managed Deployment Strategy

Bottom line: we are suggesting that our prudent CEO will embrace a least-cost, risk managed approach for the deployment of SG 2.0.

We call this approach a “Managed Deployment Strategy”, and we will discuss what it might look like in the Part IV of this dialog series.

As always, your comments are welcome and appreciated.

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