Changing Business Models in the Energy Sector

Stephen DeAngelis

February 19, 2010

There remain a number of ongoing debates about achieving energy security in the United States and most of those debates surround oil. I constantly remind people that development depends on generating electricity — and power generation has little to do with oil. Oil is primarily used in the transportation sector. Other fossil fuels (i.e., primarily coal and natural gas) do play a major role in the generation of electricity and will for decades to come. Last April, James R. Schlesinger, America’s first secretary of energy, and Robert L. Hirsch, a senior energy adviser at Management Information Services Inc., reminded Americans that, despite all of the talk about renewable and alternative energy sources, fossil fuels would remain America’s principal fuel sources for generating electrical power [“Getting Real on Wind and Solar,” Washington Post, 24 April 2009]. They wrote:

“Why are we ignoring things we know? We know that the sun doesn’t always shine and that the wind doesn’t always blow. That means that solar cells and wind energy systems don’t always provide electric power. … Solar cells and wind turbines are appealing because they are ‘renewables’ with promising implications and because they emit no carbon dioxide during operation, which is certainly a plus. But because both are intermittent electric power generators, they cannot produce electricity ‘on demand,’ something that the public requires.”

Although Schlesinger and Hirsch are appealing to the sensitivities of the consumer, reliable, on-demand power is even more important for businesses and industries than it is for average citizens. They continue:

“If large-scale electric energy storage were viable, solar and wind intermittency would be less of a problem. However, large-scale electric energy storage is possible only in the few locations where there are hydroelectric dams. But when we use hydroelectric dams for electric energy storage, we reduce their electric power output, which would otherwise have been used by consumers. In other words, we suffer a loss to gain power on demand from wind and solar. At locations without such hydroelectric dams, which is most places, solar and wind electricity systems must be backed up 100 percent by other forms of generation to ensure against blackouts. In today’s world, that backup power can only come from fossil fuels.”

Schlesinger and Hirsch continue their op-ed piece using strictly economic arguments — the same basic arguments being used by the coal industry to stir up public support. They write:

“Because of this need for full fossil fuel backup, the public will pay a large premium for solar and wind — paying once for the solar and wind system (made financially feasible through substantial subsidies) and again for the fossil fuel system, which must be kept running at a low level at all times to be able to quickly ramp up in cases of sudden declines in sunshine and wind. Thus, the total cost of such a system includes the cost of the solar and wind machines, their subsidies, and the cost of the full backup power system running in ‘spinning reserve.’ Finally, since solar and wind conditions are most favorable in the Southwest and the center of the country, costly transmission lines will be needed to move that lower-cost solar and wind energy to population centers on the coasts. There must be considerable redundancy in those new transmission lines to guard against damage due to natural disasters and terrorism, leading to considerable additional costs.”

Eventually they do discuss environmental issues, but only to convince readers that renewable energy sources don’t achieve all of the benefits that their proponents normally tout.

“The climate change benefits that accrue from solar and wind power with 100 percent fossil fuel backup are associated with the fossil fuels not used at the standby power plants. Because solar and wind have the capacity to deliver only 30 to 40 percent of their full power ratings in even the best locations, they provide a carbon dioxide reduction of less than 30 to 40 percent, considering the fossil fuels needed for the ‘spinning reserve.’ That’s far less than the 100 percent that many people believe, and it all comes with a high cost premium.”

So exactly what point are Schlesinger and Hirsch trying to make? It seems like they are trying to convince the public to abandon programs that promote renewable and alternative energy. Although their arguments lead in that direction, they stop well short of that conclusion. Instead, they conclude:

“The United States will need an array of electric power production options to meet its needs in the years ahead. Solar and wind will have their places, as will other renewables. Realistically, however, solar and wind will probably only provide a modest percentage of future U.S. power. Some serious realism in energy planning is needed, preferably from analysts who are not backing one horse or another.”

I think most reasonable people could agree that an array of electric production options should be pursued (along with a vigorous research program focused on reducing emissions that can harm both the environment and health). David Crane, who, as president and chief executive of NRG Energy, a Princeton, N.J.-based wholesale power producer that owns and operates numerous generation facilities, including wind and nuclear, and is developing solar power, is one of the people who is “backing one horse or another.” In an op-ed piece, he offers his solution to America’s energy conundrum [“An Energy Plan We Can Start Now,” Washington Post, 25 August 2009]. As one might expect, he focuses less on economics and more on “energy security” than Schlesinger and Hirsch. His intention, no doubt, is to stir people’s emotions about “big oil” and Arab suppliers. Why do I think that? Because he writes, “If we are to focus on these types of God-given energy sources, we need to go to our energy rather than have our energy come to us, as we do with fossil fuels.” But as I noted above, oil is about transportation not electrical power generation. If the greatest concern the U.S. has is energy self-sufficiency, Crane should be touting the use of coal — which the U.S. has in abundance. Instead, he notes that “in recent years there has been a tectonic shift in our energy usage as our country trends away from fossil fuels in favor of ‘natural’ energy, such as wind and solar.” What a surprise — the very sectors his in which his company is involved. To be fair, however, Crane does eventually discuss the importance of coal.

One thing that Crane, Schlesinger and Hirsch do agree on is that Americans want reliable and affordable power. Another thing they agree on is that sources of renewable energy vary depending on the region of the country involved. In fact, Crane’s recommended energy strategy is broken down by region and provides five goals, which are:

  • The West gets the sun. Al Gore’s vision of a Sonora Desert covered in a 90-square-mile sea of solar thermal mirrors powering the entire country is admirably visionary, but transmission constraints would make this more practical, at least in the near term, at the regional level. So let’s set aside an area and get started. California provides sufficient scale; its peak electricity demand is coincident with sunlight, and it is only 250 miles from the Sonora Desert into the heart of the Southern California population center.
  • The Midwest gets the wind. Wind is the predominant renewable in the United States today, but for it to be a major factor in the energy mix of the future we need to tap into the wind resources of the upper Great Plains states, which are currently stranded. To date, the focus has been on getting wind resources from places like southeastern Wyoming to California. Instead, let’s take wind from the Dakotas and feed it into Chicago. It is 1,100 miles from Cheyenne, Wyo., to Los Angeles, but only 600 miles from South Dakota to Chicago.
  • The South gets nuclear. Democratic policymakers have focused like lasers on wind, solar and efficiency. They need to recognize that the South, still one of the nation’s most economically dynamic growth areas, lacks suitable wind and solar resources. The geology of much of the Southeast is not well-suited to sequestering the carbon emissions that must be captured by truly ‘clean coal.’ On the other hand, the populace of the South (and that includes Texas) is generally comfortable with nuclear power, and its incumbent utilities are deeply experienced in nuclear operations. Nuclear energy should be the ‘renewable of the South.’
  • The Northeast gets the electric car. The Northeast generally lacks good onshore wind and sun power options, as well as public acceptance for nuclear plants. So let’s exploit its singular competitive advantage relative to the rest of the country — the proximity of its population centers to each other. An electric car with a 250-mile range wouldn’t make it from Los Angeles to San Francisco, but it would make it from New York to Boston. For real progress, we need to build an infrastructure for the electric car in a few parts of the country. Let the Northeast be a lead ‘test’ region.
  • Pursue ‘clean coal’ as a national priority. We must set as a national priority — perhaps a ‘national project’ — the demonstration and large-scale deployment of ‘clean coal.’ All of the zero-carbon regional solutions described above, if forcefully implemented, could have a meaningful impact on U.S. carbon emissions, but only ‘clean coal’ can actually capture the enormous carbon emissions from the new coal plants coming on line in China and India. It comes down to a mathematical certainty: We cannot solve global warming through clean coal alone; but without clean coal, we simply cannot solve global warming.

Crane must have struggled to find something for the northeast, since electric cars have nothing to do with power generation. In fact, they are part of the challenge that lies ahead since they can add significant stress to the grid. One of the challenges faced by any energy plan is getting the public on board. Although everyone wants reliable and affordable energy, it seems that no one wants the facilities that produce that electricity next door to them — even projects that are environmentally friendly [“Renewable Energy, Meet the New Nimbys,” by Jeffrey Ball, Wall Street Journal, 4 September 2009]. Ball reports:

“Environmentally friendly energy projects are running into the same cries of ‘not in my backyard’ that stymied a previous generation of alternative-power efforts. Even as Americans tell pollsters they are eager for alternatives to fossil fuel, some are fighting proposals for solar and wind projects and for the thousands of miles of transmission lines that would be needed to carry the cleaner energy to market. The protests echo grass-roots opposition that has blocked nuclear plants and energy-producing trash incinerators for decades.”

Since building new facilities, be they coal-fired power plants or wind farms, is becoming more difficult, utility companies are trying new business tactics make a profit [“Rewiring the Utility Business,” by John Carey, BusinessWeek, 1 October 2009]. Carey reports on an interview he had with Peter A. Darbee, CEO of Pacific Gas and Electric (PG&E). He writes:

“Peter A. Darbee … is helping his customers buy less of his product. ‘When I tell big customers we would be happy if we sold them less electricity, they look at me like I’ve burned out a few brain cells,’ says Darbee. But the logic is inescapable. ‘You are not making a lot of money anymore building large power plants,’ says Jon Wellinghoff, chairman of the Federal Energy Regulatory Commission. ‘You have to figure out what business you are in, big time.'”

Figuring out new business models for the energy sector is becoming almost as important as generating and transmitting power. Carey continues:

“How can utilities make more by selling less? Instead of spending $2 billion on a new 1,000-megawatt power plant, it can use the money to insulate homes, pay customers to install more efficient equipment, and make the grid smarter. Those steps would slash power consumption, eliminating the need for the power plant. The CEO would then ask the state public utility commission to raise electricity rates enough to pay for the $2 billion investment—plus a negotiated profit—just as he would for a new power plant. If the commission agrees, the utility gets revenue from its investment.”

Sounds great for the utility company, but why should consumers help utility companies raise their rates? Carey explains:

“Even though the price of electricity will be higher, customers who comply will be using much less power—and those who don’t will effectively subsidize those who do. ‘Energy-efficiency programs cost electricity customers less than half what they pay to help fund a new power project,’ explains Darbee. Boosting efficiency also reduces greenhouse gas emissions, which will provide another monetary gain for utilities if the nation puts a price on such emissions.”

California is not the only state helping utility companies become meaner and leaner. Carey indicates that “other states are taking similar steps.”

“‘This is where we will make our money in the future,’ says James E. Rogers, CEO of Duke Energy. ‘The business model fundamentally changes in the 21st century.’ Success isn’t a sure bet. ‘Some regulators have not yet understood and embraced this,’ says Darbee. … What’s more, the same innovations that produce efficiency gains also bring competition. A number of companies have sprung up to work directly with customers to save energy, snaring the profits that come from efficiencies. And utilities will face rivals on the power generation side as entrepreneurs develop solar, wind, or other sources for homes and businesses that may be as common as refrigerators. … As a result of these pressures, many companies will suffer the fate of the dinosaurs, says industry consultant Roger W. Gale. David Crane, CEO of NRG Energy in Princeton, N.J., acknowledges the threat: ‘If we are not doing things completely differently by 2030, we will be in a world of hurt,’ he says.”

As Carey notes, the competition for traditional utility companies is changing. A good example is a company called SolarCity [“Little Green Dynamos,” BusinessWeek, 27 July 2009 print issue]. Instead of requiring homeowners to buy $30,000 whole-house solar panel systems up front, the company leases systems on long-term contracts. To demonstrate what the company does, the article tells the story of a suburban Glendale, CA, couple named Budwig:

“After the Budwigs put $1,000 down, the three-year-old startup installed panels on their modest ranch home that meet almost all the family’s electricity needs. SolarCity also took care of the many complexities that make going solar such a hassle. The company designed and purchased the system and lined up building permits, financing, and government tax breaks. In return, the Budwigs agreed to lease the system for 15 years at $73 a month–$95 a month less than they pay, on average, for conventional power. They expect to recoup their $1,000 investment in less than a year. Since 2006, SolarCity says, it has struck similar deals with 3,500 homeowners, businesses, and schools in California, Arizona, and Oregon. The goal, says CEO Lyndon Rive, is ‘to create a multibillion-dollar company in clean power.'”

SolarCity is but one of the new companies offering new business models in the energy sector. Another company with a new business model is BioFuelBox:

“BioFuelBox of San Jose … is betting on an innovative business model. It collects waste from facilities such as meatpacking plants and sewage processors, converts it to biodiesel, and then sells the fuel. The company wasn’t the first to figure out how to cook waste into useful stuff. But BioFuelBox realized the true value lay not in selling disposal systems to customers but in saving them money by taking their refuse for free. So it developed compact refineries that can be loaded onto flatbed trucks and sent to waste sites. Even if the government eliminates subsidies for biodiesel, the company says it can profitably sell its fuel for the same price truckers pay for oil-based diesel. Its first refinery is in Idaho, converting waste from potato processing plants. Given that the world produces 12 billion gallons a year of suitable waste that can be turned into diesel, CEO Steven Perricone hopes to ‘run a large network of microrefineries worldwide in three or five years.'”

According to the article, there has been “a burst of innovation that could rival the info-tech revolution.” It goes on to assert that “global demand for alternative energy is spawning a broad and bewildering array of tiny companies with big ambitions. Many are now hitting the market with products and services–in the thick of the worst U.S. recession in decades.” The article continues:

“Some of the outfits, such as Southwest Windpower, Solyndra, and Clean Current Power Systems, are chipping away at the technological obstacles that have made alternative energy systems–wind, solar, and hydro power–too costly. Others, such as SolarCity, are reinventing the business model behind alternative power. Still others, including SmartSynch, Verdiem, and Fat Spaniel Technologies, are harnessing the Internet to help utilities remotely manage the energy consumption of their customers’ PCs, office air conditioners, and factory lights. In addition we’ve identified a handful of manufacturers selling gizmos that help slash power usage, from Bridgelux–which makes low-cost solid-state lighting–to GridPoint, whose smart meters can track every electric appliance in your home.”

Clearly, the energy sector is changing in dramatic ways. I side with Schlesinger and Hirsch, however, whenever it comes to facing reality. We can’t ignore the things we know even as we search for better ways forward. I also know that we shouldn’t sacrifice the future for the present — something politicians and consumers demonstrate they are willing to do on a daily basis. That’s why I agree with Crane, Schlesinger and Hirsch that a number of different solutions need to be pursued.