May 26, 2014

ELECTRICITY: N.Y. Energy Czar Sheds More Light on 'Restructuring 2.0'

New York's energy czar this week peeked out from the shadows of state government to explain and justify Gov. Andrew Cuomo's (D) plans for sweeping regulatory changes aimed at the state's sprawling electric grid.

Richard Kauffman, a former partner in Goldman Sachs' Global Financing Group, made two public appearances here this week to pitch the governor's still-fresh vision for a major overhaul of how electricity is bought, sold and delivered in the state.

That plan, called REV for "Reforming the Energy Vision" and just announced last month, has already been likened to state and federal power market restructuring efforts in the 1990s that unbundled generation from transmission and distribution to prod open the once-monopolistic behemoth to competition.

But this time, potential changes to how the industry conducts business appear to be even more dramatic, as renewable energy and energy storage costs continue to drop, smart grid technologies blossom, demand response tools vie for footing, and the massive transportation sector looks to plug into the grid to make vehicles go.

Some have started calling the changes to come "Restructuring 2.0" as utilities, independent power producers, consumers and new players enter into a future with less hard infrastructure, more microgrids, fewer baseload power plants, and more customer choice and control over how power gets consumed -- not to mention potentially less guaranteed revenue for the utilities that count on ratemakers to ensure their bottom line.

Cuomo has floated REV, still very much a concept, as a means to get ahead of these changes on a quick timeline, with regulators here charged with completing the plan by early next year. Kauffman is in many ways the brains behind this operation and brings decades of experience in finance -- in other words, outside-the-box thinking -- to a complex industry that hasn't always been willing to embrace innovation.

In a 91-page report about the whole picture, officials at the state's Public Service Commission said the plan is to revamp ratemaking to acknowledge innovations in the information technology sector and "promote more efficient use of energy, deeper penetration of renewable energy resources such as wind and solar, wider deployment of 'distributed' energy resources, such as micro grids, on-site power supplies, and storage."

That's a daunting task, to say the least, which raises many questions, according to Jonathan Raab, president of Raab Associates Ltd. These include:

  • Should REV be seen as a threat to core utilities or independent power producers, or as a new set of business opportunities for third-party or ancillary business?
  • How big a splash is distributed generation (DG) likely to make and over what time horizon?
  • Will DG resources under REV get subsidies that favor them over old-style generation?
  • How will DG be integrated into wholesale markets, if at all?
  • Will utilities and independent power producers be able to own and operate DG sources, or just stick to wires and traditional power plants, respectively?
  • What role will carbon-reduction policies and renewable portfolio standards play as storage batteries and DG make it increasingly likely some parts of the country could simply leave the grid behind over the next decades?

Other factors to be dealt with include the climbing cost of electricity in New York as baseload sources fueled by coal and nuclear fall out of favor; whether and how to finance major power lines to Canada to access plentiful hydropower; and the cost of hardening infrastructure to make it more resilient to extreme weather events.

With all that in mind, at least one skeptic here during two days of meetings on the subject found Cuomo's timeline at the PSC hard to swallow.

"I expect this proceeding to take a whole lot more than six months," said state Sen. George Maziarz (R), chairman of the New York Senate energy committee.

Capacity Utilization
Nevertheless, REV has won advance praise from some seasoned New York observers, including the New York Times editorial board. The gist of the feedback has been a prevailing fear that the second-highest power costs in the country could climb higher with the loss of coal and nuclear as acceptable fuel sources to this state's Democratic majority, while old transmission lines get older, natural gas might become too dominant and climate change puts New York City networks in jeopardy.

Kauffman has been charged with helping to spearhead this process, along with PSC Chairwoman Audrey Zibelman, both of them relatively new to their roles following appointments by Cuomo last year. The former Goldman Sachs executive outlined his pitch for the plan over two days this week but did little to answer Raab's set of questions with specifics. His argument as this point was more conceptual, with specific policy prescriptions to come.

To Kauffman, one of the core problems in the electricity industry is capacity utilization -- how excess power and the infrastructure that supports it have to be available to back up the grid in times of peak demand in the summer and winter.

Kauffman said utilities operate with a 57 percent capacity utilization rate, compared with 71 percent for all U.S. manufacturing and 79 percent for auto manufacturing. He cited REV and other policies as means to raise that percentage, as New York eyes $30 billion in investments it will need over the next decade in electricity.

Kauffman also cited several "disturbing trends" in the state, among them a cost for power delivery that is 4.5 times higher than the commodity itself. He noted that Oklahoma is generating wind power at 2 cents per kilowatt-hour, with Austin Energy in Texas recently signing a power purchase agreement for solar at 5 cents per kWh.

Moreover, he referenced declining energy storage costs, with batteries dropping in price by about 20 to 30 percent a year, to less than $200 per kWh by 2020 -- a far cry from $1,000 per kWh in 2009-10. He also cited New York's position as a center of capital that should help prod technology incubation on energy and ways to connect to the grid without hurting reliability.

Even if the availability of such technologies has not reached "the appliance kind of manufacturing-scale economics," it will, Kauffman predicted.

"The surprises are going to be very likely on the downside in terms of cost," he said. "There's an opportunity for economic development that we're not taking full advantage of."

He added: "It would be very good if we try to think about things to get ahead of some of these trends, so that we can take advantage of the opportunities as opposed to having our fate handed to us."

A big part of that calculus is developing better price signals through the PSC so that distributed sources can play in the market, he said. But Kauffman does not necessarily think more regulation will be the answer in this sector.

"I would like the utilities to think about how they can shrink the amount of regulated business as much as possible," he said, explaining that he sees "valued-added services" in a future market as an upside for utilities looking to recover stranded costs.

"That's another way of asking the question about what business they should be in," he said.

Restructuring 2.0
Such talk didn't seem to weigh too heavily on Craig Ivey, president of Consolidated Edison Company of New York Inc., who was also in Albany this week and noted that his company already pays its customers to use less of its product and has a number of smart grid, energy efficiency, demand response and DG programs in play.

Ivey said he supports the REV concept as an "opportunity for review and customer engagement." He added that ConEd is "OK with outside new solutions" because it already operates the most extensive underground power and gas distribution system in the country.

"New Yorkers don't particularly like us digging up the street, we'd just as soon not do it," he said.

Janet Gail Besser, vice president of government affairs at the New England Clean Energy Council, also sees "tremendous opportunity" in REV and compared New York's fledgling effort to Massachusetts' grid modernization plan. That said, she and others see part of the problem with DG not being integrated into the grid linked to the need for more investment in power lines -- and utilities would need a way to recover that investment.

She also wondered whether more DG would undermine competitive wholesale makers or whether customers really want to own their own generation sources. That would mean a bigger role for third parties -- but which parties would be allowed to play in that space?

"It's feeling a lot like Restructuring 2.0," she said. "I don't say that to start a panic."

To this, Kauffman said the REV process will seek to set the right price signals "appropriate to know the difference between central stations and distributed solutions."

"That's one of the things we want to do, as a state in these proceedings," he said. "As a policy matter, we understand that there's a bridge. There's a lot of stuff that needs to be figured out."

Also weighing in this week was the former chairman of the Federal Energy Regulatory Commission, Jon Wellinghoff, now a partner at Stoel Rives LLP. On the question of what to regulate, Wellinghoff said the wires will have to remain as a monopoly, and he worried that utilities might not be compensated for stranded assets along the lines of utilities in Germany, which have seen their business models tank as that nation looks to expand renewables at an unprecedented clip.

"Those are the inevitable risks of an entity that is more largely vertically integrated," he said. "There may be some losses there."

He added: "But I think there's also an opportunity for shifts," explaining that utilities could participate and diversify into new businesses.

As for the role of FERC, Wellinghoff advised the commission to support New York as best it can.
"The most effective thing that FERC could do is sit down with [New York officials] and see how ultimately they can help and help with this restructuring," he said.

On the German approach, the PSC's Zibelman said during a talk at the Albany Law School that it might be viewed as an example of how not to proceed.

"For me, the lessons learned from Germany are that if you start with mandates without thinking about the consequences of the mandates, then you end up with inefficiencies," she said. "That's exactly what we're trying to avoid here."

Zibelman also contested the notion that distribution utilities here might see a reduction in equity along the lines of German utilities or be unable to recover costs stranded in assets.

"We're looking for opportunities to grow those companies as well as other companies and think about it in a new way," she said.

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