Is Innovation in the Utility Industry Dead?

BY THOMAS MULHOLLAND

Is innovation in the utility industry dead or isn’t it? We think there are tremendous things happening in energy and its utility sector, but you have to pay attention.

Forbes magazine published an interesting article this week titled “Innovation Almost Dead, Perhaps Not So In Electricity” saying that the opportunity for innovation exists, and in some corners is moving ahead full steam. But the article goes on to say that there are many obstacles to innovation, especially its culture about which Forbes offers a trenchant assessment, a very worthwhile read.

Here’s an example of where the culture rubber hits the innovation road. In a seemingly unrelated article, the Chicago Tribune wrote in December that Ameren (AEE) is looking to divest its merchant generation portfolio. Ameren announced it would write-down as much as $2 billion of its investment in that business unit.

When the Illinois electricity market opened for competition, Missouri-based Ameren (formerly the Union Electric Company) bought generation in Illinois. This amounted to a very limited foray into innovation: Using the same plants and the same distribution network, it attempted to market electricity to essentially the same customers, but using a different, market-based pricing mechanism. It was a profitable move during the period when electricity prices (along with oil and natural gas prices) skyrocketed due to a perceived shortages. But, no longer guaranteed a return on its investment, Ameren was forced to rationalize essentially the entirety of the business when power prices dropped and they could no longer compete.

Sadly for investors, Ameren, and many other merchant generation companies, were not innovative with the companies they bought and especially with regard to the customers (not ratepayers) they serve. And now, a market that demands excellence and exerts its will through forces of creative destruction is compelling their withdrawal. They simply did not have what it takes to meet competition to stay in the game for the long haul.

Since that debacle, Ameren has been making the rounds in Springfield and Jefferson City selling ideas that it should make huge capital investments in 1) upgrades to its grid that probably won’t create benefits for its customers and 2) an extremely expensive and unneeded new nuclear plant to replace the unneeded coal plants it, and many others, are shuttering by the dozens in the Midwest. It sole innovation is audacity: It created new justifications, and methods to go over the heads of state regulators, for gold-plated boondoggles that it will force its customers to pay off over the next forty years.

This makes no sense. Innovation everywhere abounds. I just finished a book about the history of cancer (The Emperor of Maladies; a great read) that talks about how gene manipulation is emerging as the way, not to eradicate cancer, but to turn off its fecund reproductive pathways so that the patient can simply live with it in perpetual remission. The book says that therapies are catching up to advanced research in cellular biology conducted over the past couple of decades. Here is another example. The WSJ reported today that scientists have stored audio and text on fragments of DNA and then retrieved them with near-perfect fidelity. This is a somewhat esoteric example of the advance of technology, but let us not forget that the nature of DNA was barely even understood just a couple of decades ago.

The synthesis of basic research that is happening now will open up profound new insights into how things work, giving birth to not-as-yet-conceived new technologies.

And in the energy industry, even though the utility paradigm will not change quickly, there is tremendous opportunity for innovation. These are exciting times.

Contrast that sentiment to what you can imagine it feels like to have a meeting in the office of a utility chief executive these days. I’ve been there. The whole place feels dead. And no wonder. Faced with layoffs from bad investments and uncertainty about the future direction of the company, employees keep their heads down, speak in hushed tones, and hunt for the three of clubs—not exactly the environment in which one will find driven entrepreneurs, bristling with excitement about ideas for new growth businesses they are carrying around in their heads.

Entrepreneurs are having a heyday in today’s energy economy.

The EIA says that renewable resources now produce over 13% of US electricity supply. Hydro power is the largest renewable resource, but nearly all built before the mid-1970s, much of it at dams owned by federal agencies. Non-hydro renewables increased by more than 400% over the last decade—the vast majority built by entrepreneurs, not utilities—with enough capacity to meet the demand of Los Angeles. Wind generation, once considered a pesky annoyance to utilities, emerged as a real-time resource in some markets, and often drives marginal pricing to the point it competes with super-low pricing of nuclear plants.

Consider natural gas. Just a few short years ago conventional wisdom held that we were running out of natural gas, and priced accordingly. In 2008, natural gas prices peak at $13/MMBtu. Now gas hovers below $4/MMBtu. The seismic shift in prices led to a seismic shift in thinking. Utilities are using natural gas to fuel coal-fired plants. Electricity produced from natural gas, once considered uncompetitive, is forcing coal-fired generation plants to close. Natural gas is transforming vehicle fuels. The chemicals and plastics industries are making enormous investments in new plants (and new technologies).

And under the radar screen, we are continuing to develop a number of renewable fuels technologies and projects that will transform our small corner of the world—serving customers on their terms with innovations that unlock tremendous value. We believe further innovation will come to the utility sector. Change might be incremental. But under the right conditions it could come as an earthquake.

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