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ScottMadden Energy Industry Update February 2011


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In this the February 2011 issue: The ScottMadden Energy Industry Update looks at at how utilities plan to grow in the “New Normal” economy. In the wake of a slowly improving economy, a change of …

In this the February 2011 issue: The ScottMadden Energy Industry Update looks at at how utilities plan to grow in the “New Normal” economy. In the wake of a slowly improving economy, a change of political control of the U.S. House of Representatives, and tightening environmental requirements, the energy industry is looking at ways to expand business opportunities while keeping a rein on escalating costs. In this issue, we reflect upon the aspirations of energy and utility companies for growth in a “New Normal” economic environment.

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  • 1. The ScottMadden Energy Industry Update gy y p Highlights of Recent Significant Events and Emerging Trends February 2011 Vol. 12, Issue 1Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 2. Table of Contents Executive Summary/View from the Executive Suite E ti S /Vi f th E ti S it 2 Executive Summary Economic Outlook: Turning the Corner Energy Industry Stock Prices—Electrics, Diversifieds Continue to Languish Trends in Dividends, Earnings, and Valuations Among Selected Energy Sectors Mergers and Acquisitions—Speeding Up? Behind-the-Meter Products and Services: New Opportunity or Dot-Com Redux? Residential Utility Customer Satisfaction: A Mixed Bag Energy Supply, Demand, and Markets gy pp y, , 10 Natural Gas: A New Normal or About to Make the Turn? Two Views of the Impact of EPA Regulations on Power System Reliability in the U.S. Infrastructure 13 Smart Grid 2.0: Integrating Smart Grid Into Utility System-Wide Business Planning NERC Reliability Standards and Compliance Violations: A Roundup Rates and Regulatory Issues 16 Electricity Cost Trends, Fuel Mix, and Regulatory and Market Models Energy Costs and “Share of Wallet”: A Pushback Coming? Climate Change, Environment, and Sustainability 19 Renewable Portfolio Standards: Comparing Resources with Goals Energy and Environmental Policy: A Grand Bargain or Guerilla War on the Piece Parts? Solar Development Remains on a Roll, But It Still Requires Subsidies1 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 3. Executive Summary/View from the Executive Suite2 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 4. Executive Summary Enhancing Value  The economy is brightening, as the world continues to dig out of the “Great Recession.” Energy consumption has begun to recover, but only modestly  Electric utility valuations have lagged the broader indexes; for some companies, this presents potential opportunities f reasonably priced acquisitions t ti l t iti for bl i d i iti  In this slow-growth environment, utility companies are looking for growth opportunities. Some options include both corporate mergers and acquisitions or asset acquisitions. Also, utilities are pondering behind-the-meter products and services opportunities as growth vehicles, enhanced by smart grid capabilities (if and when those capabilities come to fruition) Diverging Trends in  Natural gas continues to be cheap and plentiful, with continued modest demand combined with Costs plentiful resources, including shale gas  These plentiful supplies, and the slow economic rebound, helped keep end-user gas and p power costs tame in 2010. However, the broader trend is that energy is taking a larger , gy g g proportion of the consumer “wallet”  In the renewables sector, solar photovoltaic module costs continue to fall, little by little. However, the overall installed cost of solar remains high. Solar development, which had a strong 2010, continues to require significant subsidies to achieve grid parity The Beat Goes  Regulatory activity continues in both the environmental and energy arenas Regulation  The U.S. EPA continues to push tightening emissions requirements for power generators, with unknown impacts on reliability and price of energy. The Administration’s rapprochement with business and concern about economic growth might lead EPA to delay implementation. However, However various interest groups may use the courts to keep the regulatory “train” going  FERC is engaged as well, focusing on more aggressive enforcement of reliability standards and also trying to resolve years-old issues regarding transmission cost allocation3 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 5. Economic Outlook: Turning the Corner Economic Growth Is Picking Up E i G th I Pi ki g U U.S. Economic G US E i Growth A l t I t 2011 th Accelerates Into  Economic growth is expected to continue into 2011, aided U.S. Real GDP Growth – Actual and Selected Forecasts (%) by compromise over extension of tax credits and extended 4% unemployment insurance benefits Year  While some forecasts are quite bullish (4% to 5%), the 2% Growth Rate median among economists is 3% for 2011 Year-Over-Y R 0% CFOs Are Optimistic but Cautious 2007 2008 2009 2010 2011 2012  CFOs expect increased growth in both revenues and profits, -2% Actual OECD but have a slightly negative view of business conditions Conference Board Wells Fargo -4% BofAML WSJ Median  Biggest concerns: healthcare costs, revenue growth, cash costs growth flow, consumer confidence, and corporate taxes Interest Rates May Increase Sooner Than Expected  There are fewer downside risks in the near term, as most believe a “double dip” has been avoided Ten-Year Treasury Yield (2000–Early 2011) (%) 2011 Forecast  A key near-term risk to the world economy: a significant Blackstone ~5% 8 economic deceleration in China BofAML o 4% % 6 Northern Trust 3.7% Yield (%) Capital Spending Expected to Increase 4 Wells Fargo 2.98%  Continued growth in capital investment is expected as credit loosened, especially for large firms, as well as tax 2 incentives. This may bring forward some capex from 2012 - into 2011 2000 2002 2004 2006 2008 2010  M&A activity is expected to continue as well Interest Rates Are a Worry, Inflation Less So Commodity Prices Are on the Rise  Increasingly, analysts are expecting interest rates to Iron and Steel Scrap and Copper Prices (Jan. 2009–Aug. 2010) increase, increase especially as 60% of U.S. federal debt matures in US $4 $400 the next three years and must be rolled over $3 $300 $/Pound  Rising rates are expected longer term: By 2020, OECD $/Ton expects a large gap between savings and investment $2 $200 needs, especially as investment in developing countries $1 Copper (COMEX) ($/lb.) $100 accelerates Steel Scrap (Am. Metal Mkt.) ($/ton) $0 $0  Core inflation has faded as a concern, but some key raw materials and food prices are rising, as developing countries post strong economic growth Sources: OECD; IMF; Kiplinger’s; Wall Street Journal; Wells Fargo; The Blackstone Group; Bloomberg;4 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Northern Trust; Bank of America Merrill Lynch; The Conference Board; U.S. Geological Survey
  • 6. Energy Industry Stock Prices—Electrics, Diversifieds Continue to Languish Diversified and Electric Utilities Tracking The Dow Since 2005 Small Diversified, Gas Companies Ahead of the Dow Since Crash Diversified 5-Year Sector Performance 3-Year Sector Performance Normalized Daily Index Values (Dec. 2005–Dec. 2010) Normalized Daily Index Values (Dec. 2007–Dec. 2010) 200% 200% DJ Industrial Avg. SNL Energy Large Diversified SNL Energy Small Diversified S&P Gas Utilities 175% Peaked at 206%  Peaked at 206% 175% SNL Merchant Generator S&P Electric Utilities In May 2007 DJ Utility Index Citigroup MLP 150% 150% 125% 125% 100% 100% 75% DJ Industrial Avg. 75% SNL Energy Large Diversified SNL Energy Small Diversified 50% 50% S&P Gas Utilities SNL Merchant Generator 25% 25% S&P Electric Utilities DJ Utility Index 0% 0% Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Gas Upstream and LDCs Continue to Outpace DJIA, Electrics Trail Ending Index Value (Start of Period = 100%) Since  Since  Since  18-Month Sector Performance Mid‐2009 End‐2007 End‐2005 Normalized Daily Index Values (Jun. 2009–Dec. 2010) SNL Energy Large Diversified gy g 116% 75% 95% 200% SNL Energy Small Diversified 132% 103% 115% 175% S&P Gas Utilities 142% 95% 134% 150% S&P Electric Utilities 105% 68% 95% SNL Merchant Generator 88% 40% 70% 125% Citigroup MLP 161% 117% * 100% DJ Industrial Avg. 134% 86% 105% DJ Industrial Avg. DJ Utility Index 114% 74% 96% 75% SNL Energy Large Diversified 50% SNL Energy Small Diversified S&P Gas Utilities Despite low natural gas prices, gas LDC and gas MLP S&P Electric Utilities SNL Merchant Generator SNL M h G stocks have done well. Moreover, electric and 25% Citigroup MLP DJ Utility Index diversified utility stock prices continue to lag the 0% Dow, despite improving economic numbers. Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Note: All index values are 100% at beginning of relevant period. * means not available.5 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Sources: SNL Financial; ScottMadden analysis
  • 7. Trends in Dividends, Earnings, and ValuationsAmong Selected Energy Sectors Price-to-Book Valuations E ilib ti g Post-Recession P i t B k V l ti Equilibrating P t R i Small Diversifieds B ki g Earnings Growth Decline S ll Di ifi d Bucking E i g G th D li Year-End* Price-to-Book Value Year-over-Year Net Income Growth Rate (Capitalization-Weighted) (%) (Capitalization-Weighted) (%) 600% 250% Large Diversified Large Diversified 500% Small Diversified S ll Di ifi d 200% Small Diversified Electric Electric 400% Merchant Merchant 150% Gas Utility Gas Utility 300% 100% 200% 50% 100% 0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 0% -50% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 3Q 2010 -100% Dividend Growth Down but Still Positive  Utility valuations, as measured by multiples of book value, are down from the mid-2000s Year-over-Year* Dividend Growth — A key question is whether these valuations are a return to (Capitalization-Weighted) (%) normal or some inflection point that signals a bottom or 20% buying b i opportunity t it Large Diversified 15% Small Diversified  Dividend growth declined in response to the “Great Recession” Electric — Another driver is the desire to retain funds for the next wave 10% Gas Utility of capital investment 5%  As one might expect, net income g g p , growth has trended downward 0% — While slightly negative for most sectors in 2009, it was not as negative as many had feared -5% — Early returns for 2010 show improved sales, especially -10% among industrial classes -15% % — Small diversified utilities, however, seem to have been able 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 3Q to sustain positive earnings growth d i the d i ii i h during h downturn 2010 Notes: *3Q 2010 is for quarter end. Sectors are derived by SNL Financial: SNL Large Diversified (electric & gas utilities > $4 billion capitalization); SNL Small Diversified (< $4 billion); SNL Electric (electric only); SNL Merchant; and gas utility components of the SNL Energy index.6 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Sources: SNL Financial; KeyBanc Capital Markets; ScottMadden analysis
  • 8. Mergers and Acquisitions—Speeding Up?  The first half of 2010 saw continued merger activity with large transactions like Asset Deals C i g B k Slowly: F A t D l Coming Back Sl l Fewer but Larger b tL g PPL/E.ON, FirstEnergy/Allegheny, and Exxon/XTO. The second half continued this trend, with both asset and corporate acquisition activity continuing Power Generation Asset Deals (Announced and Pending 2008–2010)  Some large transactions were announced at valuations that, for the most part, represented very modest premiums. This could reduce the need for huge 147 143 ons) synergies and perhaps lessen the risk of regulatory “claw back” $25 160 on Value ($ Billio  Deal drivers were often related to scale: 117 140 $20 $21.8 — Increase balance sheet size to support infrastructure investment (NU/NSTAR, 120 No. of Deals for example, expect $6 billion in combined spending over the next several $15 100 years) 80 — Acquire assets or reserves in pursuit of growth (renewables, $10 60 shale gas) or while valuations are depressed (merchant generation) $9.5 $9 5 Transactio s — Expand base across which to spread fixed and corporate costs $8.5 40 $5 20  The weak economy requires savings without layoffs and could pressure public service commissions $0 0 — Despite synergy potential, many acquirers are relying on attrition, not politically 2008 2009 2010 unpalatable layoffs — With ratepayers strapped for cash, regulators may require compelling savings cash Total Transaction Value No. of Transactions passed along in rates, even absent large synergiesMajor Corporate Merger & Acquisition Announcements—Energy Companies M&A Announced Transactions (Corporate) Share DealCompanies Deal Value Price Announced Sector Size Value/ 2001 11 Premium Book Value 2002 26Exelon Corp./ 2003 23 Renewable 1.5 GW in various John Deere  $0.9B NA Aug. 2010 NA generation development stages 2004 37Renewables 2005 34Northeast Utilities/ $4.2B Electric 3.5 million  ~1.9% Oct. 2010 NM 2006 37NSTAR (plus $3.4B in debt) utilities customers combinedChevron Corp./ $3.2B  Upstream 9 TCF (incl.  2007 69 37% Nov. 2010 2.2xAtlas Energy (plus $1.1B in debt) gas shale gas reserves) 2008 36AGL Resources/ $2.4B Gas  4.5 million 2009 33 13% Dec. 2010 2.22XNicor, Inc.Nicor Inc (plus $0.7B in debt) (plus $0 7B in debt) utilities customers combined customers combined 2010 47Duke Energy/ $13.6B Electric  7 million 3.9% Jan. 2011 1.36x 0 50 100Progress Energy (plus $12.1B in debt) utilities customers combined7 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Sources: SNL Financial; The Wall Street Journal;; company websites; ScottMadden analysis
  • 9. Behind-the-Meter Products and Services:New Opportunity or Dot-Com Redux? Relative Technology Maturity of Behind the Meter Products Behind-the-Meter Companies, Companies in our sector and outside it are trying to determine whether the smart it, grid will create a new era of business opportunity for behind-the-meter (BTM) ESCO products and services. Some questions they have: services  When will smart grid be capable of creating BTM opportunities? Growth in Adoption Demand Distributed response resources  What is different now from prior retail “waves” in energy? aggregation Energy (traditional) Distributed monitoring/  How much integration is needed across value chain stages? d meter data Smart resources management  How will the revenue and profits of this BTM “renaissance” be divided among (emerging) appliances segments and players? What operating and business models will emerge?  How will customers respond? Which segments can, or will, participate? Maturity  What are the scale and scope requirements to profitably offer BTM products? Segment Description Example Players Some Drivers/IssuesDemand response Intermediators between customers and  EnerNOC  Energy market expansion, utilities/regional ISOs to pool demand response  cPower restructuring; ISO rolesaggregation capabilities and provide peak load management  Comverge  Transparent price signals; supportive rate structures and curtailment services, capacity bidding, and  Public policy p y other services to reduce firm energy costsDistributed Distributed generation and storage for primary and  Capstone  GE Energy  Installed cost (improving) stand-by power, heating and cooling applications, Turbine  FuelCell  Resistance to net meteringresources and grid ancillary services/renewables support  Caterpillar Energy buybacks and FIT structures(incl. renewables)  Siemens  SunEdison  Grid-parity costs (esp. renewables)Energy monitoring gy g Software, hardware, analytics, and customer y  OPower  eMeter  Improved technologyand management/ interfaces that provide signals, information on real-  GridPoint  Comverge  Clear interoperability standards time consumption  Smart Synch  Tendril  Privacy concernsmeter data  Google  Itron  “Performance contractor” stigma;management  EnerNOC customer investment required (also applies to ESCOs below)ESCO services Energy audits and consulting; energy equipment gy g gy q p  Utility affiliates  National  Subsidies and financing and installation, including energy efficiency  Global ESCOs ESCO  Agency issues retrofits, controls, HVAC, and building automation equipment  Local HVAC,  Pricing of efficiency providers electric cos.  Payback time, returnSmart appliances/ Facility appliances and devices with modernized  Whirlpool  Johnson  Clear interoperability standards electricity usage systems that monitor, protect, and  Honeywell Controls  Technology maturity/lifecycleshardware automatically adjust operations to the needs of its y j p  Carrier/  General  Customer and equipment service(incl.(incl facility/ Ice E I Energy Electric owner, including in response to price, utility  “New normal” frugalitypremise area  Microsoft  Transparent price signals; signals, and emergency power situationsnetworking) supportive rate structures Sources: Company websites; investment analyst reports; industry news; Cleantech Group, 2010 U.S. Smart Grid8 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Vendor Ecosystem (Sept. 2010); DOE Berkeley National Laboratory; ScottMadden analysis
  • 10. Residential Utility Customer Satisfaction:A Mixed Bag West d South Lead Residential El t i Utilit S ti f ti W t and S th L d R id ti l Electric Utility Satisfaction Customer Communication Helps Electrics Residential Electric Utility Average  According to J.D. Power, satisfaction levels have increased J.D. Power Rating* by Region and Utility Size (2010) year-over-year as customer bills have decreased and reliability has improved 750  J.D. Power also found that managing customer king Median Score High Low expectations around outages and restoration mitigates Customer Sat. Index Rank 700 declines in or even improves satisfaction 650  To improve satisfaction, a mix of proactive and event 600 communiqués is required. For example: ─ More scheduled outage notifications with the rising 550 number and frequency of grid upgrade projects r 500 ─ Announcements of reliability and operational response investments and their results (benefits) West: West: South: South: Midwest: Midwest: East: East: Midsize Large Midsize Large Midsize Large Midsize Large ─ More frequent status updates, even with limited information, during storm outages (e.g., radio or mobile devices—texting, Facebook, Twitter, etc.)  Helping customers with their overdue bills, as one might expect, substantially improves customer satisfaction; utility Gas Utility Satisfaction Has a Narrower Range Than for Electrics education and energy efficiency/management programs are additional, helpful high bill resolution options Residential Gas Utility Average J.D. Power Rating* by Region and Utility Size (2010)  Customer awareness of their local utility’s implementation of smart grid and smart meter technology remains low 750 ndex Ranking Median Score High Low 700 Satisfaction Improves for Gas Utilities 650  Lower bills, more frequent communication, and improved perceptions of corporate citizenship have led to higher satisfaction levels Customer Sat. In 600 550  Gas customers are also more familiar with energy savings programs and want more communication on how to reduce 500 bills and conserve energy West: West: South: South: Midwest: East: Midwest: East:  J.D. Power opines that emphasizing the value of service g Large Midsize Large Midsize Midsize Midsize Large g g Large g provided by gas utilities lifts overall satisfaction Notes: *Scores are out of a possible 1,000 points Source: J.D. Power and Associates, 2010 Gas Utility Residential Customer Satisfaction Survey (Sept. 22, 2010) and9 Copyright © 2011 by ScottMadden, Inc. All rights reserved. 2010 Electric Utility Residential Customer Satisfaction Survey (July 14, 2010); ScottMadden analysis
  • 11. Energy Supply, Demand, and Markets10 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 12. Natural Gas:A New Normal or About to Make the Turn? “Drill, B b D ill” P d i C i “D ill Baby, Drill”: Production Continues to Grow G Gas Prices P j t d t R G Pi Projected to Remain i th Mid-$4s to Mid $5 Through 2013 i in the Mid $4 t Mid-$5s Th gh  Onshore gas production continues to grow despite Actual Wellhead Gas Prices vs. Henry Hub Price Projections low gas prices and regulatory setbacks in by Selected Analysts (in $/MMBTU) Marcellus $10  Rig count is expected by some to level off and Natural Gas Week Scoreboard (Median) ultimately decline to a tipping point of abo t 800 ltimatel about $8 NGW Scoreboard (High Forecast) $/MMBTU rigs (U.S.) to stabilize gas prices $5.35 $5.35 $6 $4.72  However, horizontal gas drilling operations are more efficient and productive, yielding more gas $4 $4.36 $4.45 $4.45 per rig, so supply should be plentiful through 2012 Wellhead actual prices $2 (average) EIA Forecast: 2011:  $4.02 2011: $4.02 For Producers, First the Bad News, Then…? $0 2012:  $4.50 2005 2006 2007 2008 2009 Jan.-Oct. 2010 2011 2012  Enhanced revenues from rising natural gas liquids 2010 prices have lowered the breakeven dry gas (Avg.) production cost in some plays  Some producers looking to migrate from dry gas- gas only plays like Haynesville and Barnett to places Horizontal Rigs in January 2011 at 967, Up from Under 400 in Spring 2009 like Eagle Ford and Marcellus  Some analysts project that gas prices will firm after North American Rig Count by Type vs. 2012, buoyed by: U.S. Gas Rigs as % of Total Rigs — Coal power plant retirements 1,200 100% as % of Total Rig — Carbon constraints 1,000 North American 80% U.S. Gas Rigs — Step-down in drilling activity as wells mature Rig Count 800 60% — Hedges (i.e., forward sales) roll off 600 — Possible export (LNG) demand 40% 400 20% s 200 N gs Demand and New Large Players 0 0%  Demand remains suppressed, but is expected to 2006 2007 2008 2009 2010 2011 begin to firm with continued economic growth  Oil and gas majors are entering the market, % Gas Rigs Directional Horizontal Vertical acquiring shale players who need a larger balance % of Total Rigs % of Total Rigs Rig Count sheet and gaining experience to apply in shale fields inside and outside North America Sources: Energy Intelligence Natural Gas Week; Energy Information Administration; SNL Financial; Baker Hughes;11 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Deutsche Bank; American Gas Association; industry publications; ScottMadden analysis
  • 13. Two Views of the Impact of EPA Regulationson Power System Reliability in the U.S. Much attention has been paid to the potential retirement of power generation in the U.S. as a result of various pending US EPA regulations covering air, water, and ash. Two recent studies looked at possible consequences for reliability. A Comparison of Two Analyses of EPA Regulation NERC (Oct. 2010) ( ) Charles River Associates (Dec. 2010) ( )  A significant portion of coal-fired generation is currently slated for retirement, even without tighter environmental regulations Key Points  Certain reliability sub-regions will be affected much more than others of Alignment  The impact of greenhouse gas regulation is not included  Assessments did not project expected power cost, only retrofit vs. retire economics  Looks at all EPA regulations – MACT, coal combustion  Looks only at MACT and CATR Key Differences in residuals, cooling water (thermal) constraints,  Limited its analysis to the Eastern Interconnection Assumptions and Approach and Clean Air Transport Rule (CATR)  Analysis was national in scope  Regulations impact 33 GW to 70 GW (retire or retrofit)  Under an aggressive MACT policy, CRA projects 35 GW of coal  MACT alone could trigger retirement of 2 GW to 15 GW capacity in the Eastern Interconnection to be retired by 2015  Cooling water intake has the greatest impact on reserve — Retirements are small compared with historical net margins, as it impacts nuclear and could force derates capacity additions  By 2015, combined EPA regulations could cause 32+ GWs in — Average age of those units is 55 years retirements and derates (over 77 GWs under a strict case with  With retirements, 2015 reserve margins fall below required no compliance extensions) margins in some sub-regions, but are adequate on a regional Conclusions  Under a moderate case and assuming only deliverable (i.e., level existing plus planned) capacity: — Permitted projects development can reduce the shortfall — ERCOT, ReliabilityFirst, and SERC-Delta, are most — New gas-fired capacity, above that currently permitted, affected by retirements (in total GWs) can “easily address” the shortfall (about 11.5 GWs) — ERCOT, the Midwest, New England, and many of the  Other methods can be used to manage shortfall, including: Southeastern subregions fall below target reserve margins — Load management — Coal-to-gas conversion Leadership in the Republican-controlled 112th Congress has Key issues and uncertainties: announced strategies (or intent) to slow or moderate EPA  How long cheap gas will last regulation via:  Impact of better than expected electric demand  Appropriations: Limiting EPA funding on selected initiatives  Availability and cost of gas pipeline extensions,  Oversight: Conducting hearings on EPA activities before expansions to support new or repowered generation Energy & Environment, other Congressional committees Environment  R Required cost and ti i of t i d t d timing f transmission enhancements i i h t  Legislation: Mandating delay on some EPA actions (esp.  Realistic timing of new capacity resources “in the wings” greenhouse gas regulation)  Cost of power with shift in resource mix Sources: NERC, 2010 Special Reliability Scenario Assessment: Resource Adequacy Impacts of Potential U.S. Environmental Regulations (Oct. 2010);12 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Charles River Associates, A Reliability Assessment of EPA’s Proposed Transport Rule and Forthcoming Utility MACT (Dec. 16, 2010)
  • 14. Infrastructure13 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 15. Smart Grid 2.0: Integrating Smart Grid Into UtilitySystem-Wide Business Planning Advanced Energy C Ad dE Capabilities Enabled by Smart Grid bili i E bl d b S G id  Industry leaders believe smart grid and the advanced energy capabilities it enables can significantly benefit core utility value—reliability, efficiency/cost savings, Smart Energy compliance, and customer service Applications Current Applications Value – – Process / workforce efficiencies Operating savings   Utility scale renewables Extended storage  Many utilities have developed business cases valuing – Targeted event response Grid Reliability  Customer energy efficiency/management individual smart grid-enabled technologies ( g AMI, g g (e.g., demand response, etc.) – Reduced ffield service trips (truck ( rolls)  Dynamic rates  Event detection  “Load as Capacity” – Higher customer satisfaction and response – Improved issues resolution Grid  Distributed energy (DER) – Improved load planning Management   Demand response Ancillary services  and CHP Small-scale renewables  To date, this narrow scope has limited utility planning,Utility  Substation and DAI   Voltage mgt. Condition-based  Smart appliances and EVs acceptance, and investment in smart grid capability Customer  GIS management maintenanceValue  Advanced sensors Fast response  Focus has been on engineering “proof of concept” pilots. Services  and system monitoring storage for regulation Advanced conductors However, pilots do not clearly demonstrate the value of p y   Billing accuracy  Faster issue resolution Future Application Value larger (full) system deployments to the market Event  Energy information, IHDs, – Higher reliability Management web analysis portals – Operate grid closer to “true” limits  Power quality services – Early event detection and condition- AMI (2-way)  Utilities are now seeking a broader, comprehensive value   Load profiling and based response Distribution  Remote operations forecasting – Grid congestion management framework and planning approach to cohesively guide Operations (connect/disconnect) – T&D planning and IRP optimization  OMS / system restoration – Renewables integration   SCADA AMR – Digital power quality – Distributed resources/micro-grids this multi-year, multi-billion dollar, industry-wide system  Mobile dispatch – Reduced cost/carbon footprint capability investment, both on the utility and customer Smart Grid Functionality sides of the meter Smart Enterprise “Value” Framework and Planning Approach Aligning Smart Grid Functionality With System Business Needs in the Context of a Utility’s Market and Operations Advanced System Capabilities Key Utility System Business Models Enabled by Key Questions Smart Grid Current Applications Value – Process / workforce efficiencies – Operating savings – Targeted event response – Reduced field service trips (truck rolls) – Higher custom er satisfaction – Im proved issues resolution Grid Grid Reliability  Event detection and m anagement  Dem and response Smart Energy Applications  Utility scale renewables  Extended storage  Customer energy efficiency/management  Dynamic rates  “Load as Capacity”  Distributed energy/CHP  Small-scale renewables Market Operating Customer Regulatory  What are key market, operating, and customer value drivers or “sign posts” to monitor? – Im proved load planning Management and ancillary services  Smart appliances Model Model Model Model  Voltage m anagement y  Substation and DAI  Condition-based m aint. Customer  GIS m anagem ent  Fast response storage e Services  Advanced sensors and for regulation system monitoring  Billing accuracy Advanced conductors Event  Faster issue resolution Future Application Value Management  Energy information, IHDs, – Higher reliability web analysis portals – Operate grid closer to “true” lim its  Power quality services – Early event detection and condition-  AMI (2-way)  Load profiling and based response  Remote operations Distribution forecasting – Grid congestion m anagem ent (connect/disconnect) Operations – T&D planning and IRP optim ization  OMS / system restoration – Renewables integration  SCADA – Digital power quality  AMR – Reduced cost/carbon footprint for  Mobile dispatch supply Smart Grid Functionality Distribution  How do drivers impact a utility’s key business models and Operations Related metrics (e.g., market, operating, customer, regulatory)? Regulatory g y Event Management Reliability Compact Impacts  What are achievable opportunities to “operationalize” smart • ”Used and useful” criteria grid’s value today and in the future? Customer • Ratebase Compliance Services Identify requirements  Are clear, long-term system core values demonstrated to Costs • Business model impacts? • Ratemaking Grid • “Core” value benefits? and cost-of- service ratepayers, regulators, and stakeholders? Management methodologies Grid G id • New rate mechanisms  What are our business plans—market, operating, customer, and p , p g, , Reliability Customer Service • Regulatory regulatory—and supporting smart grid strategy/infrastructure engagement • Other “roadmap” for moving ahead, managing related enterprise risk, Smart Energy and gaining regulatory, community, and stakeholder support?14 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Source: ScottMadden analysis
  • 16. NERC Reliability Standards and Compliance Violations: A Roundup The Western U S Leads Other Regions in Compliance Penalties Th W t U.S. L d Oth R gi i C li P lti Critical Infrastructure P t ti C iti l I f t t Protection in Part Due to the Number of Registered Entities Has Been Oft-Cited Cumulative NERC Violations and Cumulative NERC Compliance Penalties Monetary Penalties* by NERC Region (No. of Assessments)* by Topic Area (June 2008–December 2010) (June 2008–December 2010) $2,500,000 1000 Protection and Control 428 No. of Assessm Penalties ($) Critical Infrastructure Protection 381 900 Facilities Design, Connections, and Maint. 267 nalties ($) $2,000,000 Penalties (No. of 800 Emergency Preparedness and Ops. 107 Assessments) 700 Transmission Operations 107 ments (vs. Requirem $1,500,000 $1 500 000 600 Transmission Planning Transmission Planning 104Total Monetary Pen Voltage and Reactive 99 500 Personnel Perf., Training, and Quals. 44 $1,000,000 400 Interconn. Reliability Ops. and Coord. 41 300 Resource and Demand Balancing 34 $500,000 $500 000 200 Communications 15T ments) Modeling, Data, and Analysis 12 100 Note: Includes violations that did not  Interchange Scheduling and Coord. 11 include financial penalties $0 0 WECC SERC RFC NPCC FRCC MRO TRE SPP 0 100 200 300 400 500  NERC and FERC have been trying to address friction as FERC seeks more timely standards development and aggressive enforcement (i.e., more significant penalties) of key focus areas like critical infrastructure protection  FERC, in reviewing NERC’s self-assessment of performance, had specific concerns about NERC’s reliability standards development process, specifically improving certain standards and their pace of development  At FERC’s insistence, NERC h now proposed a revamp of the standards d A FERC’ i i has d f h d d development process l  Only time will tell how these changes will affect registered entities and the regional reliability organizations  In addition to evolving standards, the industry is contending with alerts from NERC that may require swift and costly modifications to equipment and operating processes Notes: *Excludes FP&L’s $25 million settlement in October 2009. NERC violation count based upon each requirement violation.15 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Sources: NERC (as of Jan. 15, 2011); SNL Financial; ScottMadden analysis
  • 17. Rates and Regulatory Issues16 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 18. Electricity Cost Trends, Fuel Mix, and Regulatory and Market Models Compound A C d Annual Growth Rate in Total Retail Revenues per kWh (1994 2009) lG th R t i T t l R t il R (1994–2009) Chart Title and 2009 Average Revenues per kWh Avg. Revenue (Cents/kWh) 5% 25 Growth Rate Median Growth Rate 2009 Avg. Revenue (¢/kWh) 4% 20 Growth Rate (%) 3% 15 2% 10 h 1% 5 0% 0 CO MO NM AK AR CA DC DE GA IA ID IN KS KY LA MA MD ME MN MS NC ND NE NH NV NY OH OK OR PA SC SD TN TX VA WA WV WY AL AZ CT FL HI IL MI MT RI UT VT WI NJ AK AL AR AZ CA CO CT DC DE FL GA HI IA ID IL IN KS KY LA MA MD ME MI MN MO MS MT NC ND NE NH NJ NM NV NY OH OK OR PA RI SC SD TN TX UT VA VT WA WI WV WY Part  of RTO of RTO                                                    Restructured                    Retail RRA PUC                                                    Ranking 100% pe eneration by Fuel Typ 75% 50% 25%Net Ge 0% Coal Hydro Natural Gas Nuclear Renewable Other  The link between growth in revenues per kWh of electricity and Legend regulatory model is uncertain at best Part of RTO: Full or most  | Part  | None or insubstantial  Restructured Retail:  Full choice | Partial choice   Fuel mix has a bearing, especially where coal (historically cheaper) RRA PUC Ranking: Above average (constructive) | Average | Below Average or gas (historically more expensive) is a significant part of the mix  Interestingly, while revenues per kWh (rates) predominantly coal- Sources: E S Energy Information Administration; ISO/RTO Council; Compete Coalition; I f ti Ad i i t ti C il C t C liti fired jurisdictions remain relatively low for many their growth has low, SNL Financial/Regulatory Research Associates; Distributed Energy Financial Group, been above median Annual Baseline Assessment of Choice in Canada and the United States: An Assessment of Restructured Electricity Markets (Dec. 2010); ScottMadden analysis  Some lower cost jurisdictions—Alabama, Tennessee, Oregon, and Washington—have increased the most over the past 15 years 17 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 19. Energy Costs and “Share of Wallet”:A Pushback Coming? The Twenty-Year Trend for H Th T t Y T d f Household E h ld Energy Energy C t as a P E Costs Percentage of I t f Income A Ri i Now, Are Rising N Is in Keeping With Key Price Indexes a Trend Exacerbated by a Decline in Household Income in 2009 Average Annual Electricity Rates vs. Share of Wallet: Median Energy Costs as a % of Other Cost Measures (1990–2009) (Index: 1990=100) Median Household Income (Nominal $)* 500 4% Electric Rates (All Classes Avg.) ( ) Natural Gas Prices (Henry Hub Avg.) 400 Producer Price Index (Less Food and Energy) 3.2% 3.1% Consumer Price Index Index Value 2.6% 2.6% 300 2% 2.3% 2.2% 2.1% 2.0% .0% 1.8% 1.8% 1.7% % 1.7% % % 1.7% % 1.7% % 1.7% 1.6% % 2 % 1.6% 2 2. 200 1.4% 1.3% 1.2% 100 0% 1997 1999 2001 2003 2005 2007 2009 0 Electricity y Piped Gas p Fuel Oil 1990 0 1991 1 1992 2 1993 3 1994 4 1995 5 1996 6 1997 7 1998 8 1999 9 2000 0 2001 1 2002 2 2003 3 2004 4 2005 5 2006 6 2007 7 2008 8 2009 9 Regional Variations for Energy Costs In Comparison with Median Income Levels Can Be Significant Energy Costs Take a Larger Bite Out of Households  While household energy costs have kept p gy p pace with Share of Wallet: 2009 Median Energy Costs as a % of key inflation indices over the last two decades, “share Median Household Income (Nominal $)* of wallet” is increasing now 4% — Piped natural gas expenses, as a percent of income, have increased since the late 1990s 3.6% 3.5% — Electricity costs, which fell in the early 2000s, have increased rapidly since mid decade rising mid-decade, 2.6% % 2.5% 2.4% 2% 2.3% from 1.7% of income to 2.6% in four years 2.2% 2.2% 2.1% 1.9% 1.8%  There are differences by region in household energy “share of wallet” 1.2%  A tipping point is possible as stagnant incomes, 0% coupled with increasing costs squeeze households costs, Northeast Midwest South West  This could mean lower consumption, fewer rate case filings and less favorable ratemaking mechanisms Electricity Piped Gas Fuel Oil Notes: *Energy costs are for those households consuming this fuel type; median income is for all households Sources: U.S. Census Bureau, Annual Household Survey; U.S. Bureau of Labor Statistics;18 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Energy Information Administration; ScottMadden analysis
  • 20. Climate Change, Environment, and Sustainability19 Copyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 21. Renewable Portfolio Standards:Comparing Resources with Goals Renewable Portfolio Standards for 2012 and 2020 (% of MWhs) vs. 2008 Renewable Generation as % of Total Generation (% of MWhs) by State 60% Renewable Generation as %  ID: 84.5% OR: 63.4% WA: 74.5% of Total Net Generation 50% 2020 RPS target  TX Renewable Target: (small square indicates • 2013: 5,256 MW no 2012 target) • 2025:  10,000 MW 40% 2012 RPS target • 2008 (Actual): 8,380 MW 30% 20% 10% 0% TX AK ID IN IA KS KY LA PA TN VA WA WV WY AL AZ CT FL HI IL MI RI UT VT WI CO MO NJ NM AR CA DC DE GA ME MD MA MN MS NE NV NH NY NC ND OH OK OR SC SD  MT As the first target dates under various state renewable portfolio standards approach, states are positioned differently  States with a large portion of their energy mix from large hydro (e.g., the Pacific Northwest, New York, Maine, Vermont) are well positioned. However, positioned However dependence upon these resources make hydrologic conditions a crucial variable in whether the standards can be consistently met  Some states—Delaware, DC, Illinois, and Pennsylvania, for example—have a significant gap to overcome to achieve their 2012 renewable generation targets  Others with 2020 time frame targets have a similar gap but some time to put resources into place Sources: U.S. Energy Information Administration (EIA), State Renewable Electricity Profiles 2008 (Aug. 2010), at; EIA, State Electricity Profiles 2008 (Mar. 2010), accessed at;20 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Database of State Incentives for Renewable Energy
  • 22. Energy and Environmental Policy:A Grand Bargain or Guerilla War on the Piece Parts? Anticipated New Possible White House/ Congressional Wild The Bottom Line Agency Environment Cards Approach  Proposed boiler MACT p  House oversight hearings g g  Results of and reactions to  Compliance may p y rules in Q1 2011, finalize likely “listening” meetings be deferred out of by Mar. 2012  Potential limitation on EPA  Obama regulatory review concerns on impact  Final Transport rule in spending on U.S. economy EPA  Judicial action in response 2011 to EPA-sought delays and  But environmental Conventional  Some delays requested environmental organization intervenors may Emissions force continued (e.g., (e g biomass MACT) challenges thereto Regulations EPA action  No reversal of standards in next two years  “Clean” energy standard  Some bipartisan support in  Deficit concerns on  Some R&D funding expanded to include some Senate for clean energy additional funding  Clean or renewable types of non-renewable standard (with nuclear) energy standard generation  No strong advocate in less likely given Clean Energy  Continued investment in House opposition to R&D nuclear by the  Government-driven green environmental energy procurement t lobby  No cap-and-trade  No cap-and-trade  Carbon tax may be viable  No legislative legislation pushed legislation with deficit hawks, but approach, but EPA  EPA pushing tighter  House oversight hearings, industry will oppose pushes on standards on new sources potential limitation on EPA increased customer cost (inventory baseline) Regulation Of and implementation plans, spending on GHG  Supreme Court decision  Possible House Greenhouse G h BACT on existing regulation on GHG emissions tort vs. inquiry into climate Gas Emissions generators EPA regulatory pre- science emption  U.N. non-binding  Outcome of state lawsuits targets challenging GHG BACT  I Increased authority for d th it f  C ll t reform guarantee Call to f t  D fi it concerns: i Deficit increase  A challenge t get h ll to t Nuclear guarantees for new plants program, reduce role of may not be budget-neutral additional funding, Development OMB guarantees Sources: Van Ness Feldman; K&L Gates; Alston & Bird; SNL Financial; industry news; Senate, House committee21 Copyright © 2011 by ScottMadden, Inc. All rights reserved. websites; ScottMadden analysis
  • 23. Solar Development Remains on a Roll,But It Still Requires Subsidies  Solar development continued to grow in 2010 2010, Incentives and Tax Credits Cut N t I t ll d Commercial PV Costs in Half I ti d T C dit C t Net Installed C i l C t i H lf well above the 2009 pace — Solar PV installations totaled 525 Installed Cost of Commercial PV (>10 kW / All Technologies) MWs through 3rd Quarter 2010, up 1/5 Over Time ($/WattDC) vs. 2009 $16 $12.00 Cost ($/WDC) — One projection has U S solar capacity U.S. $12 $ $10.59 $9.59 $9 89 $8.83 $9.89 D $8.93 $9 59 Installed d $8.45 $8.02 $7.81 $8.10 $7.95 $7.95 reaching 44 GWs by 2020, requiring $100 billion in investment $8  Solar costs have been decreasing with scale $4 economies and expanded manufacturing $0 capacity 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 — Global PV panel capacity is projected to grow to 30 GWs by 2013 from 10.1 Net Installed Cost with ITC State/Utility Cash Incentive (After‐Tax) ITC (State and/or Federal) GWs in 2009 — Producers are mobilizing—e.g., GE is prioritizing solar business growth — European manufacturers are expected Solar PV Installations Helped by Grants and Reduced Equipment (Module) Cost to look abroad as European subsidies (especially feed-in tariffs) are reduced U.S. Utility-Scale ( 100 kW) Solar Projects (in MWs) amidst fiscal austerity by Operating Date  The U.S. market is still dependent upon favorable state policy and development is 400 Installed MWs s concentrated in a handful of states 300 — The top five states—CA, FL, NJ, AZ, 200 and PA—account for 76% of large (>100 kW) solar PV installations since 100 2000 0 — Policy support is still necessary: 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 CA, for example, allows up to 5% aggregate net metering and providing Solar PV Concentrating Solar $3 billion for “Go Solar” subsidies  Asian growth will fuel increased activity and pull equipment abroad: China is targeting 20 GWs of installed solar by 2020; India’s goal is Sources: Solar Industry magazine; Renew Grid magazine; SNL Financial; The New York Times; The Wall Street Journal; 1 GW by 2013 Bloomberg New Energy Finance; Energy Acuity; G. Barbose, N. Darghouth & R. Wiser, Lawrence Berkeley National Laboratory, Tracking the Sun III: The Installed Cost of Photovoltaics in the U.S. from 1998-2009 (Dec. 2010); Greentech Media, U.S. Solar Energy Trade Assessment 2010 (Nov. 2010), prepared for Solar Energy Industries22 Copyright © 2011 by ScottMadden, Inc. All rights reserved. Association
  • 24. Energy industry landscape:  sharpening contrasts and accelerating change   Every  day  in  this  challenging  and  exciting  environment,  experienced  ScottMadden  consultants  offer  our  clients  deep  energy  knowledge  and  practical  business  acumen,  collaborate with them, and help them succeed.  We  have  done  this  for  more  than  25  years,  served  more  than  200  energy  organizations— including  90%  of  the  top  20—and  completed  thousands  of  projects.  We  have  worked  with  the best in the industry and can help you succeed. Meet with us for industry‐leading practices  the best in the industry and can help you succeed Meet with us for industry leading practices and management insights.    Generation • Transmission • Delivery • Smart Grid • Markets • Utilities • Regulation • Gas  “They are p y practical; ; we can put their recommendations into play right away.” Industry Executive  AN EXCEPTIONAL CONSULTING EXPERIENCECopyright © 2011 by ScottMadden, Inc. All rights reserved.
  • 25. Recent ScottMadden Insights—Available at Fossil Coal Combustion Residuals, by J. Jacobi, Generation Coal Plant Shutdown—A Case Study: Why? How?, by S. Pearman & G. Robinson, Natural Gas Infrastructure Investment in the Gas Industry, by E. Baker & J. Davis, Renewables Biomass: Electricity Generation and Transportation Fuel, by J. Jacobi, Solar Photovoltaic Plant Operating and Maintenance Costs, by J. Jacobi & R. Starkweather, Resource and Resource Planning—Confronting Challenges and Managing Uncertainties, by R. McAdams & Supply Planning J. Davis, Uncertainties.html Uncertainties html Energy Improvements in Data Center Management, by J. Jacobi, J. Kerner, & Scott Wilson, Efficiency Energy Storage Applications: Where Is the Value—Now and in the Future?, by J. Jacobi,& Scott Wilson, Technologies T h l i http://www scottmadden com/insight/403/Storage Applications Where Is the Value Now and in the Future html Nuclear Improving Nuclear Maintenance Productivity—Insights from ANS, by C. Vlahoplus, published in Nuclear News, Generation Nuclear New Build, by E. Baker, Using Benchmarks in Gap-Based Business Planning, by J. Sequeira, I. Falk, & C. Carmichael, published in Nuclear Power International, Financial ScottMadden and APQC Article Series: Financial Shared Services, by B. DeMent & J. Davis, Shared Services © 2011 by ScottMadden, Inc. All rights reserved.
  • 26. Energy Practice Research The energy industry landscape is one of sharpening gy y p p g ScottMadden Research provides clients with valuable p contrasts and accelerating change. The shelf life for insight on developments, trends, and practices in energy conventional wisdom seems to grow shorter with each and sustainability. Through its semi-annual Energy headline. Every day in this challenging and exciting Industry Update and other occasional publications, our environment, experienced ScottMadden consultants offer research team helps clients discern and analyze critical our clients deep energy knowledge and practical business issues and inform their business decisions. acumen, collaborate with them, and help them succeed. We also provide customized, project-based research and We have done this for more than 25 years, served more analytical support on matters of interest to our clients. than 150 energy organizations, and completed thousands of successful projects. We have helped some of the best For more information about our research capabilities or in the business in nuclear and fossil generation generation, content, content see the Insights section of our website or renewables, transmission, distribution, gas, regulatory, contact: and a host of other areas. Brad Kitchens For more information about our Energy Practice, contact: President Stu Pearman 404.814.0020 Partner and Energy Practice Leader Stu Pearman 919.781.4191 Partner and Energy Practice Leader 919.781.4191 Jere “Jake” Jacobi Partner and Sustainability Practice Leader 404.814.0020 404 814 0020 Greg Litra Director of Research 919.781.4191 919 781 4191 scottmadden.comCopyright © 2011 by ScottMadden, Inc. All rights reserved.