Lately, the energy press has been full of stories about utilities seeking regulatory approvals for a number of new projects they’d like to build. While I’m sure utilities have great justifications for why their proposals make sense, at least to them, it’s clear the existing regulatory paradigm allows utilities to shift untenable business risks to customers, while privatizing profits. It is time to change the regulatory paradigm and to expose utilities to disruptive innovation. Here’s why.
Southern Company is proposing a coal gasification plant in Mississippi. Ameren is proposing a new small-scale nuclear plant in Missouri. Ameren and Excelon received approvals in Illinois for grid modernization under which they will invest $4 billion. What do these proposals have in common?
All of these projects 1) are huge and risky investments, 2) take decades to pay off, 3) use questionable business logic and offer dubious customer benefits, and 4) rely on captive customers with no ability to change suppliers in the following decades. And, without this last feature, brought about by the utility regulatory paradigm, it’s doubtful any of these projects would go forward.
Southern Company’s investment in coal gasification at its Ratcliffe plant will total $2.4 billion. Southern’s CEO Tom Fanning says “I can’t bet [natural gas] is going to be cheaper forever.” But in fact he is betting—and betting big—that natural gas will cost more in the future than coal converted to gaseous fuel. He’s betting coal prices will be consistently lower than natural gas prices for 40 years. But wait: Utilities are closing coal-fired plants now because they can’t compete against natural gas. Hmm…funny bet. Guess he intends to make it up on volume. This is a risky, risky commodity price speculation, the kind that violates fundamental risk management principles. He is willing to make (and probably lose) that bet because he knows customers must backstop potential losses.
Consider Ameren’s proposal to build a new nuclear plant. They’d like to build a new $1 billion, 225 MW nuclear plant at the same time they’re shuttering 5,000 MW in coal-fired capacity. The plants are closing because they aren’t profitable. The Midwest market is awash with overcapacity. One study estimated 12,000 MW of capacity will close in Illinois, Michigan and Ohio as a result of EPA air emissions rules, ill-fated by low market prices that make compliance with EPA rules uneconomical. Yet, at the same time, Ameren is proposing a new plant at $5,000,000/MW. Oh, the new plant won’t be on-line for ten years. Can Ameren assume markets won’t change during that period? Perhaps they should talk to Progress Energy about the nuclear plant it’s building. It’s now 8 years late and 5X the original cost, clocking in at an astounding $24 billion, or more than $10,000,000/MW.
The only explanation is this: If a utility has a captive customer base, it can afford to write-off fully amortized plants that don’t contribute much to earnings, and replace them with shiny new gold-plated ones that do. Customers can thank a faulty utility regulatory paradigm for the opportunity to pay for expensive, unneeded assets for the next several decades.
A utility customer is to the energy industry what taxpayers were to the financial bailout: the financial backstop of last resort. The post-2008 financial bailout brought forth a firestorm of criticism that the financial services industry privatized profits but socialized risks. The utility industry is doing the same thing, but without a whimper of protest from customers or the press. Notice also, that regulators aren’t looking to change things up either (see the comment by Missouri Public Counsel Lewis Mills Jr. here).
Let’s look at competitive markets for a minute. Clayton Christensen, in his great book The Innovator’s Dilemma, discussed how to gain and maintain market leadership. Christensen defined the rules of “disruptive innovation.” Regulation, however, shields utilities from most disruptive forces within industry verticals.
But competitive pressures affecting long-term investments are between verticals. Innovation in the natural gas industry radically altered supply and demand, and is keel-hauling the coal industry. Forces of change are there, but they aren’t incremental. They are fundamental sea-changes to which the industry has difficulty responding except through massive dislocations and write-downs. It is ironic that their response to write-downs is to re-invest in the same fundamental technologies, and to tee up another day of reckoning four decades down the road.
There is another way. Customers are expressing desires for new products—notably energy efficiency and renewable products—that threaten utilities’ entrenched interests. Rather than digging in and resisting change, utilities must seek ways to embrace emerging customer needs, develop creative solutions, and propose them to regulators. In this way, we stand a chance of avoiding the buildup of new stranded costs through big bets gone wrong that depend on a captive customer for a bailout. Let’s treat customers like what they are: customers, and give them real, meaningful choices.