Strategies to Modernize your Grid - B&M
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Strategy & Planning

Benchmarking Your Rate Case

With regulators reluctant to OK rate hikes, utilities can better justify an increase – if it compares well with the utility’s peer group.

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Figure 1 - SP&L’s Rate-Case Benchmarks
Figure 2 - Average Retail Rates of Benchmark Utilities
Figure 3 - Distribution of Retail Rates
Figure 4 - Retail Price Trend
Figure 5 - Load Growth Forecast
Figure 6 - Changing Load Factors
Figure 7 - Renewable Portfolio Standards
Figure 8 - Projected Reduction in Sales Attributable to DSM
Figure 9 - First Year of Need for New Capacity
Figure 10 - Annual Capacity Additions
Figure 11 - 2010 T&D Costs
Figure 12 - Projected Price Changes
Figure 13 - Cost Drivers in Rate Increases
Figure 14 - Historical and Projected Average Retail Rates
Author Bio: 

Ahmad Faruqui is a principal and Ryan Hledik is a senior associate at The Brattle Group. This article reflects the authors’ views and not necessarily those of The Brattle Group.

Show the PUC how your filing stacks up against the others.

Defying the Odds

Reports of coal’s demise are exaggerated. This summer, Dominion cleared the regulatory gauntlet to start up a new coal plant. Whether the example can be replicated might hinge on state incentives—and the forward price of natural gas.

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Figure 1 - Coal-Fired Emissions Progress
One of very few coal-fired power plants commissioned in recent years, the Virginia City Hybrid Energy Center uses air-cooled condensers (the green-topped structures) to reduce water consumption to one-tenth that of a comparable coal-fired plant.
A wood tipper delivers wood waste to the Virginia City circulating fluidized bed plant, which can burn up to 20 percent biomass along with coal.
The Virginia City plant’s fluidized bed boiler produces a much larger volume of solid waste than a most comparable pulverized coal plant would, due to the higher ash content of the coals used and partly because of the limestone sorbent mixed with fuel during combustion. At Virginia City, solid waste is stored onsite in a specially designed, 158-acre landfill.
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Coping with Carbon at Virginia City
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The Virginia City Hybrid Energy Center was already under construction when EPA issued its proposed rule regulating carbon dioxide at new sources, and therefore it isn’t subject to those restrictions. This facility is, however, well situated to deal with its carbon dioxide emissions, and the station’s owner, Dominion Resources, has supported research to establish a viable means of capturing and storing CO2.

While plans for the power station were proceeding and the permitting process was underway, carbon sequestration research funded in part by the U.S. Department of Energy was being undertaken near the Virginia City site. This work was conducted by the Virginia Center for Coal & Energy Research at Virginia Tech, and led by the Center’s Director Dr. Michael Karmis. It was coordinated by Southern States Energy Board and was part of the Southeastern Carbon Sequestration Partnership (SECARB). Dominion Resources provided matching funds for the investigation.

Karmis and his team succeeded in establishing the feasibility of sequestering carbon dioxide in un-mineable coal seams in central Appalachia. Estimated capacity of nearby seams to sequester carbon dioxide far exceeds the production of this gas over the lifetime of the Virginia City facility. The Virginia Tech team now is working to demonstrate using CO2 injection to enhance production of coal-bed methane from the area, while also sequestering the carbon dioxide.

Carbon capture technologies haven’t yet been tested at the Virginia City site. But to position the facility to take advantage of its proximity to coal seams that have proven suitable for sequestration, Dominion designed the plant with carbon capture in mind, and space has been set aside for installation of such equipment when it becomes commercially available—and upon approval by the Virginia State Corporation Commission.–HW

Author Bio: 

Herbert Wheary (haggiscat@live.com) is a private consultant on energy policy in Richmond, Va. The opinions in this article are the author’s and not necessarily those of the Commonwealth of Virginia or Dominion Resources.

Virginia brings a new coal-fired plant online.

Demand Growth and the New Normal

It’s tempting to attribute the recent slowdown in electricity demand growth entirely to the Great Recession, but consumption growth rates have been declining for at least 50 years. The new normal rate of demand growth likely will be about half of its historic value, with demand rising by less than 1 percent per year. This market plateau calls for a new utility strategy.

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Figure 1 - Electricity Sales Growth (Two-Decade Distributions)
Figure 2 - Cumulative Demand Growth (2010-2035)
Figure 3 - Arc of Price Responsiveness
Figure 4 - Impact of Codes and Standards on Electricity Consumption
Figure 5 - Efficiency Gains of ENERGY STAR Qualified Models
Figure 6 - ERCOT Loads in Texas (3/9/11 and 8/3/11)
Author Bio: 

Ahmad Faruqui is a principal at The Brattle Group, and Eric Shultz is a research analyst. This article was revised from Faruqui’s presentation at the Goldman Sachs Power & Utility Conference on Aug. 14, 2012. The authors acknowledge research assistance by Jennifer Palmer.

Five forces are putting the squeeze on electricity consumption.

Perfect Superstorm

Since Obama won reelection, we must ask whether we’d rather have EPA cracking down on carbon emissions, or whether a legislated framework would be better for everyone.

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Frontlines
Author Bio: 

Michael T. Burr is Fortnightly’s editor-in-chief. Email him at burr@pur.com

Could carbon taxes emerge in the election aftermath?

The Old Drawing Board

PUCs are concerned that a rapid shutdown of coal-fired plants will start a full-tilt dash to gas—similar to the one that caused bankruptcies among independent power producers in the late 1990s and early 2000s. But this time around, ratepayers and not IPP investors will be stuck with the risk, if utilities rush to add all that new gas-fired capacity to rate base.

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Frontlines
Author Bio: 

Michael T. Burr is Fortnightly’s editor-in-chief. Email him at burr@pur.com

Portfolio planning in the age of gas.

Last Call

Conditions are ideal for utility financing—but not forever. Although interest rates remain low, policy changes weigh on capital structures.

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Figure 1 - 10-Year Bonds
Figure 2 - 30-Year Bonds
Figure 3 - Utility Bond Tenors
Figure 4 - Utility & Power Ratings Snapshot
Rising interest rates and unknown dividend tax policies could be a headwind for utility stocks. –Brian Tate, Wells Fargo Securities
Utilities have a  significant amount of capex planned in the near term, and bonus depreciation is not a funding strategy. –David Nastro, Morgan Stanley
There’s good reason to believe there will be a lot of M&A activity around contracted renewable assets in 2013. –Frank Napolitano, RBC Capital Markets
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Pay It Forward
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One way that some utilities have been getting ahead of market changes is by issuing equity to pre-fund costs they expect to incur later. This generally takes two forms: equity forward contracts, and mandatory convertible offerings. Examples include Pepco Holdings, which sold about $350 million in shares on a forward basis in March, and PPL, which sold about $270 million in April. Also, NextEra Energy issued $600 million in three-year, mandatory convertible bonds on May 1, and another $650 million in September.

Both approaches carry a premium, but they allow utilities to capture today’s high stock prices in a forward sale. And some issuers have found banks hungry enough to participate in equity deals that they’ll take a substantial haircut for the opportunity. (See “BofA loses $12m on bought convert,” IFR 1932, May 2012.)

However, terms likely will normalize as soon as the current confluence of forces drives utilities back into the equity markets in earnest.–MTB

Author Bio: 

Michael T. Burr is Fortnightly’s editor-in-chief. Email him at burr@pur.com.

Utilities are enjoying some of the best financing terms anybody’s ever seen. Is the party winding down?

A Virtuous Cycle

Data and experience show that serving customers well translates into better rate case outcomes. Conversely, poor performance starts a downward slide. J.D. Power and Associates research shows the correlation between customer service and financial returns.

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Figure 1 - Approved ROE And Customer Satisfaction
Figure 2 - Customer Expenses And Satisfaction
Figure 3 - Profitability and Customer Satisfaction
Figure 4 - Virtuous Cycle of Customer Satisfaction
Figure 5 - Rate Case Gap And Customer Satisfaction
Author Bio: 

Andrew Heath, Senior Director, Energy Practice, J.D. Power and Associates

How customer satisfaction drives returns on equity for regulated electric utilities.

Views from the Bond Side

Bond investors are keen for signs of a legitimate recovery, and will be looking to move into holdco bonds.

Category: 
Op Ed
Author Bio: 

Josh Olazabal is a vice president in the credit research group at PIMCO’s Newport Beach office. Previously he was a consultant with McKinsey & Co., and worked in corporate development at Duke Energy before that.

How fixed income investors view the utility sector.

Dividend Double-Take

Congress again is embroiled in another hyper-partisan food fight that threatens to blow up into a fiscal crisis. And once again dividend-paying companies like utilities are caught in the crossfire.

Author Bio: 

Michael T. Burr is Fortnightly’s editor-in-chief. Email him at burr@pur.com

What happens when the Bush tax cuts expire?

The Race to Consolidate

The industry’s slow-and-steady pace of mergers seems to be picking up speed, as larger and well-positioned players overtake smaller and weaker targets. Realizing the greatest value from consolidation requires companies to assess their strengths and weaknesses and focus on performance improvement—both before and after a deal gets done.

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Performance Improvement through M&A
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Although analysis is subject to the imprecise nature of publicly available information, it does offer relative insight into how utilities benchmark against each other. In particular, it highlights the potential for untapped value in the utilities industry, specifically with respect to improvements in operational performance. Accenture defines untapped value as increasing the performance of all bottom-half performers to the bottom of the next performance quartile—that is, all fourth quartile performers decrease spending to the top of fourth quartile, and all third-quartile performers decrease spending to the top of the third quartile.

As seen in Figure 4, there’s significant variance of performance across the three major operations and maintenance (O&M) categories, transmission and distribution O&M per customer, customer care O&M per customer, and administration and general O&M per customer. In all cases, there’s a long tail of performance in the fourth quartile.

Taking the viewpoint that overall company performance should be improved, at least to some extent, by M&A, we find that there’s significant untapped value in the industry. Industry-wide, there’s approximately $3 billion in annual O&M untapped value, which is roughly 10 percent of the annual O&M spending for the industry. Delivering on this untapped value will be a prerequisite to driving significant shareholder value through future M&A deals.

By definition, green flag companies have a lower untapped value per customer than either yellow flag or red flag companies. This is due to the fact that operational performance—which drives untapped value—is part of the M&A strength criteria. Interestingly enough, untapped value is equally spread across industry players from size (revenue), customer count, and region perspectives. In other words, no single factor explains why some companies have higher untapped value than others. As such, the field is wide open for performance improvement.–JA, WS, and TW

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M&A Drivers
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Looking ahead at future whole-company transactions, several factors likely will drive the fit between future M&A partners.

• Executive Ambition: The number-one driver of M&A activity remains the C-suite’s ambition and compatibility—including factors such as personal focus, interest in M&A, and willingness to partner.

• Access to Capital: Increased ability to access more and cheaper capital is necessary to support capital project programs, which frequently are very ambitious.

• Integration Value Potential: Going beyond the more obvious rewards helps drive toward a consolidated operating model and processes.

• Pure P/E Plays: Companies with higher multiples buying companies with lower multiples can get an immediate value bump from P/E alone. This likely will happen both across categories—for example, a green flag company buying a yellow or red flag company with a lower P/E—as well as within each category.

• Regional and Portfolio Plays: Mergers can increase value by enabling access to renewables, diversifying the generation portfolio (for example, balancing environmental risk), balancing wholesale positions (long vs. short), and hedging retail and wholesale positions.

• Suitability and Strength of the Acquirer: Clarity on which company is the acquirer consistently produces greater integration benefits and returns.

• Physical Proximity: Two neighboring utilities offer greater synergies than those located many miles apart, since they can derive economies of scale by sharing local crews and other distributed functions.–JA, WS, and TW

 

 

Sidebar Title: 
Performance Improvement through M&A
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Although analysis is subject to the imprecise nature of publicly available information, it does offer relative insight into how utilities benchmark against each other. In particular, it highlights the potential for untapped value in the utilities industry, specifically with respect to improvements in operational performance. Accenture defines untapped value as increasing the performance of all bottom-half performers to the bottom of the next performance quartile—that is, all fourth quartile performers decrease spending to the top of fourth quartile, and all third-quartile performers decrease spending to the top of the third quartile.

As seen in Figure 4, there’s significant variance of performance across the three major operations and maintenance (O&M) categories, transmission and distribution O&M per customer, customer care O&M per customer, and administration and general O&M per customer. In all cases, there’s a long tail of performance in the fourth quartile.

Taking the viewpoint that overall company performance should be improved, at least to some extent, by M&A, we find that there’s significant untapped value in the industry. Industry-wide, there’s approximately $3 billion in annual O&M untapped value, which is roughly 10 percent of the annual O&M spending for the industry. Delivering on this untapped value will be a prerequisite to driving significant shareholder value through future M&A deals.

By definition, green flag companies have a lower untapped value per customer than either yellow flag or red flag companies. This is due to the fact that operational performance—which drives untapped value—is part of the M&A strength criteria. Interestingly enough, untapped value is equally spread across industry players from size (revenue), customer count, and region perspectives. In other words, no single factor explains why some companies have higher untapped value than others. As such, the field is wide open for performance improvement.–JA, WS, and TW

Author Bio: 

Jack Azagury (jack.azagury@accenture.com) is Accenture’s North American Management Consulting lead for the resources industries, and Walt Shill (walt.shill@accenture.com) is global senior director at the company. Ted Walker (ted.h.walker@accenture.com) is a senior manager in the Accenture Utilities Strategy group. The authors acknowledge contributions from Jan Vrins, Accenture Utilities Management Consulting group, and Jason Allen, Accenture Research.

Positioning to win in the contest for scale.

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