Is the utility death spiral real? Two recent events lend credibility to the idea that utilities have something to fear from the growth of energy efficiency and distributed generation.
First, Morningstar couldn’t have stated more clearly that it sees trouble ahead: “Investors beware: Distributed generation could kill utilities as we know them today.” Those were the opening lines of its February 2014 report, “Distributed Generation: The Death Spiral.”
And while the investment advisory firm warned about the problem, two influential organizations joined forces to offer solutions. The Edison Electric Institute (EEI) and the Natural Resources Defense Council (NRDC) issued a joint strategy to protect utilities from financial harm at a Feb 12 meeting of the National Association of Regulatory Utility Commissioners in Washington, D.C.
These are just two examples of heightened talk within the energy industry about the death spiral – the idea that utilities could suffer severe financial pain as their electricity sales drop because of energy efficiency and distributed generation. Clean energy advocates worry that if utilities see distributed energy as a threat, they will try to block its growth.
Other industry insiders say that utilities are crying wolf; economic circumstances are not so dire. But Morningstar sees certain utility economic “moats” – competitive advantages – already shrinking as a result of distributed energy. As the moats contract, utility earnings diminish, cash flow wanes, returns fall, and interest and dividend payments become less certain.
“The death spiral ends when investors—equity and credit—are left holding an empty purse of dormant power plants and copper wires,” the report said.
The threat comes from programs that encourage growth in distributed energy – financing innovations, net metering, clean energy tax benefits and technology advances. Real harm may be at least 10 years away in the US, but in Europe utilities already face “change-or-die challenges, Morningstar said.
Winners and losers
Utilities that have regulatory support will survive; those that figure out how to extract value from distributed energy may even prosper. Morningstar cites NRG Energy and Edison International as such innovators.
The losers? Utilities with large merchant coal and nuclear fleets. The value of such centralized baseload generation falls as distributed energy expands, Morningstar said. It names Dynegy and Exelon as vulnerable.
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Survivors may use distributed energy as a way to avoid costly replacement of central generation plants and infrastructure. Or they may follow the new business model of German utility RWE to manage and integrate renewable energy for customers rather than invest in centralized generation.
Regulators are key to utility survival, Morningstar said. So utilities need to educate their state public utility commission about changes needed in utility business models. Regulators in Arizona, California and Colorado appear open to such changes, Morningstar said. The report also sees certain utilities well positioned with regulators: Southern Company, NextEra Energy and Wisconsin Electric.
Fixing the problem
Like Morningstar, NRDC and EEI see state regulators as key to keeping utilities whole, as distributed energy advances. In a joint statement they called on regulators to rethink the way utilities recover costs. Specifically, they said utilities should not be in the commodity business, which makes them dependent on growth in electricity use. Instead, they recommend utilities focus on service businesses that earn their profits by maintaining and improving the electricity grid.
NRDC/EEI also emphasized “reasonable cost-based” payment by distributed generators to utilities when they use their wires. And conversely, utilities should fairly compensate distributed generators for imported power, they said.
Some other elements of the NRDC/EEI strategy are:
- Continue to develop rate designs that reward customers for using electricity more efficiently: real-time pricing and variable demand charges that take advantage of digital meters
- Expand utility earnings opportunities through performance-based incentives tied to energy efficiency, clean energy generation, and grid improvements.
- Ensure that energy efficiency services reach underserved populations
- Ensure that electricity users take advantage of all cost-effective energy efficiency
- Support reasonable utility investment in smart meters and smart grid
So we’ve given you a look at the problem and some solutions. Are you a death spiral believer or doubter? Please join the discussion on our LinkedIn group, Energy Efficiency Markets.