Environmental squeeze prompts utilities to change tune

Electric utilities are in the business of selling electrons. The more they sell, the more they earn. But today, a whirlwind of forces is sweeping electron sellers into counterintuitive activities such as promoting conservation and offering rate structures designed to cut peak consumption. In other words, utilities are asking customers not to buy quite as much of the product they produce. While this appears environmentally altruistic, utilities may have more than planetary stewardship in mind. According to Kerry Smith, professor of economics at the W. P. Carey School of Business, smart utilities are "getting behind moves to solve the climate issue. They'll say they've turned Green, but it's actually a practical business strategy."

Early on in his Muppet career, the crooning Kermit the Frog had a hit single entitled, "It's Not Easy Being Green." You don't hear electric utilities singing that ditty, but they certainly could. Electric utilities are in the business of selling electrons. The more they sell, the more they earn. But today, a whirlwind of forces is sweeping electron sellers into counterintuitive activities such as promoting conservation and offering rate structures designed to cut peak consumption.

In other words, utilities are asking customers not to buy quite as much of the product they produce. It's an act that seems to defy a utility's bottom-line goals and in some cases regulatory mandates. While this appears environmentally altruistic, utilities may have more than planetary stewardship in mind.

According to Kerry Smith, professor of economics at the W. P. Carey School of Business, smart utilities are "getting behind moves to solve the climate issue. They'll say they've turned Green, but it's actually a practical business strategy." Smith sees eco-friendly actions as one of the ways utilities are dealing with the carbon-emission rules that are likely to come from regulators or lawmakers in the near future.

"Uncertainty costs money," he says, particularly in an industry where building generation facilities takes years of effort, and power plants must operate for decades to come. So, jumping on the Green bandwagon is more than good PR and environmental husbandry. It's a way to cut the risks that lurk in an unsettled and rapidly changing regulatory landscape.

Warming up to change

At issue is global warming and the electric-utility industry's hefty impact on it. According to the U.S. Environmental Protection Agency's most recent greenhouse gas inventory, carbon dioxide represents almost 84 percent of total greenhouse gas emissions in this country. In 2005, electricity generators spewed out 41 percent of the country's CO2 emissions. Cutting consumption is easier said than done, however.

"A lot of our customers will tell you that they're really not using more energy," says Ed Fox, a vice president of Arizona Public Service (APS). "They'll say that the reason their energy bill is up is because of higher energy costs." But in fact, people really are using more energy today. For one thing, we have more electronics running non-stop. Household computers, printers, TVs, VCRs — many of these devices operate with a stand-by mode, so they never truly quit drawing electricity.

Researchers from the Lawrence Berkeley National Laboratory, an energy-industry think tank, have found that stand-by power eats up between 4 percent and 10 percent of an average home's electric bill. What's more, some of today's consumer electronics are energy hogs. A recent article in The Wall Street Journal noted that a 42-inch plasma TV could use more energy than a household refrigerator — even if the TV is only running a few hours per day.

And, air conditioning is more prevalent than it used to be, which may be one reason why APS has seen summer peak consumption grow 9 percent year-over-year for the past three years, Fox adds, while base load has been growing about 4 percent: "We have one of the fastest growing electric demands in the nation," he maintains. But, Arizona isn't alone in grappling with increased electricity requirements.

The North American Reliability Corp. estimates that, over the next 10 years, peak electricity demand during summer months will rise by almost 18 percent. Plus, peak demand isn't something utilities can ignore. They're not allowed to run out of electrons, as a toy store might sell out of Wii video games or Tickle-Me-Elmo dolls. Regulated utilities can be fined for poor service quality and excessive blackouts.

Meanwhile, electric utilities have to generate their product in the same moment that it is consumed because, so far, no one has figured out a good way to store such relentless energy in bulk. "As you look forward between now and 2020 or 2025, you have to look at how you're going to meet growing demand, knowing there aren't a lot of choices that don't have a penalty associated with climate or some other environmental impact," Fox says.

"It seems inevitable that there is going to be a program — national, state or regional — dealing with the need to reduce CO2 emissions," he continues. "Any resource decision you make is going to have at least a 20-year life. So, you're buying into a technology that, at some point during its life, is going to have a significant increase in costs associated with it" to conform to regulatory mandates.

Controlling costs

"Every time you introduce a regulation that affects a product or process, it's like increasing the cost of production," the W. P. Carey School's Smith says. He uses regulations on auto emissions as an example. "If you have a fuel-economy standard, you can only think about responses to safety regulations that are within a particular weight class," he explains.

Adding a heavy safety feature may be the best way to reduce crash impact, but it could "confound your ability to meet the fuel-economy standard." According to Smith, the same give and take plagues electric utilities trying to meet rising demand. "It may take six years to eight years to plan new generating capacity and bring it online," he notes.

But, "the regulations could change during that time period, which makes all of the plans irrelevant, or at least more costly to implement." Utilities will need to adapt to what they think the regulatory environment will be when the power plant comes online. And, he says, there's no guarantee regulators will allow plants that are in process now to operate without adaptations later.

Trading places

He adds that there are many ways of dealing with such uncertainty. For utilities, one is participation in the Chicago Climate Exchange (CCX), the world's first market for trading allowances of greenhouse-gas-emissions. Through CCX, companies vow to reduce their greenhouse-gas emissions by a certain amount. If they don't make their targets, they pay the Exchange a predetermined amount or buy "permits" from another organization. The permits allow firms to be less Green than they anticipated.

If market participants exceed their target reductions, they can sell their excess "permits" to the less effective and sootier firms. Why would utilities join such a market, write contracts with it, then pay up if they fail to meet voluntary targets? "There are a whole series of economic reasons," Smith says. One is the learning about the process and its full implications. "They need to get experience with the process of keeping score" and transacting in carbon credits.

Smith doesn't think those lessons alone are worth the cost of participating in CCX, but there is another, more valuable, outcome from the program: It gives utilities a third-party witness to their good-faith efforts at reductions in greenhouse-gas emissions. "They have displayed in a contractual way that they had a baseline of emissions one year, and they started reducing emissions from that baseline," he explains.

Through the market, utilities gain third-party validation of their carbon starting point and subsequent cuts. "Virtually all legislation will pay attention to those commitments and baselines." This benchmark, Smith believes, offers utilities a way to mitigate some of the regulatory uncertainty they face. Another solution to building capacity to meet growing demand, he says, "is to look at alternative pricing mechanisms that allow you to put off long-term investments" in electricity generation.

Such pricing schemes often involve time-of-use rates that expose end-use customers to the higher peak electricity rates utilities face. Through such pricing, Smith adds, utilities might be able to shave the size of their peaks, thereby reducing the need for adding peak plants to meet rising demand. In order to have time-based pricing of electricity, you need meters that track how much electricity was used, as well the time period during which the power was consumed, Smith notes.

Arizona Public Service and dozens of other utilities worldwide are in the process of deploying such meters. They herald "a fundamental change in the way utilities and their customers interact," Fox says. "It is the beginning of a two-way dialogue between customers and their electric utility." And, as the conversation begins, the utility line isn't "buy more electrons." Instead, utilities are urging consumers to buy less, and use power much more prudently.

Bottom Line:

• Electricity generation accounts for some 40 percent of CO2 emissions in the U.S.
• Global warming concerns will likely lead to more regulation of electricity generation.
• In response to regulatory uncertainty, utilities are jumping on the Green bandwagon.
• Conservation programs, participation in carbon markets and technology deployments are some ways utilities are meeting their uncertain future.