The business of electric power in the age of resiliency and climate risk
The article below offers a business perspective on the hard realities facing an industry moving from a leading contributor to climate change to one devalued by it. While CO2 has overwhelmingly dominated investor focus on environmental risk related to the electric power industry, water risk will likely pose more serious constraints on thermoelectric power over the coming two decades than carbon regulations. In some areas, such as the US Southwest, H2O risks alone will prompt fundamental power technology and business model changes for industry.
Although the regulated industry has adapted to environmental challenges in the past, competitive power is best suited for delivering the innovation and deployment necessary for navigating industry’s existential challenges posed by H2O and CO2. In this sense, US industry can anticipate movement towards decentralized business models for electric power structured similarly to those developing in the European Union.
On a hot June afternoon President Obama reaffirmed the Environmental Protection Agency’s mandate to regulate GHG emissions from new and existing power plants under the Clean Air Act (CAA). Splashed across investor news terminals across the world, the executive announcement reinvigorated the term “carbon risk” for energy companies and shareholders alike. Yet, for an industry that has changed more in the past decade than the three prior, the President just read the writing long-inscribed on the wall. Carbon concerns are not new for the power sector. If anything, the Georgetown address seemed to cap several years of difficult industry introspection about the business model for electric power. As industry introspection continues and expands to decision-makers on Wall Street and in Washington D.C., the water risks posed by climate change must become part of core power industry valuation model. Climate change will impose a “new normal” on the power sector, not just in the United States, but around the world. More storms, more droughts, and less predictable weather - and water - will disrupt not just the industry’s operations, but also its traditional business model. For many companies, this disruption will far surpass whatever politically imposed social costs of carbon come through regulation. Uncertainties about water availability and quality will constrain thermoelectric power generation, and in doing so, push the industry’s status quo further away from the past century of regulation and centralized facilities towards competitive disruption through resilient, distributed power technologies. Investors, policymakers, and ratepayers - put on your seatbelts.
Shaken and disrupted
US wholesale and retail power dynamics have shifted and will continue shifting away from traditional norms. The costs of conventional power generation are set to keep rising, while sales and revenue decline. Sustained, low natural gas prices have caused wholesale power prices to plummet. At the same time, a host of new environmental regulations, such as the Mercury and Air Toxics (MATs) rule, will result in 40-50 gigawatt of coal-fired capacity to retire over the next decade, and strain the gross margins of those remaining online. Post-Fukushima safety upgrades and poor market conditions have put up to 5GW of nuclear capacity in short-term risk of retirement, with up over double that by 2020. Renewable portfolio standards and mandated utility efficiency targets will further increase costs for regulated companies and their ratepayers.
Transformation is hardly limited to the wholesale side of the business. Sluggish post-2008 demand, improved energy efficiency, and new competition from cheaper distributed energy resources (DERs), like rooftop photovoltaics, has meant that utilities must actually compete to sell fewer kWhs - a paradigm shift for a quasi-monopoly industry generally accustomed to high demand growth. Spurred by policies to mitigate GHG emissions, like net-metering, the potential for technological disruption from behind-the-meter DERs has never been greater. Higher costs and fewer sales spell inevitable rate increases, which in turn further exposes utilities to competitive threats and the infamous regulated utility “death spiral.” If unfamiliar with the death spiral, US readers should simply look across the Atlantic. Policies and commodity prices have resulted in uncompetitive rates and lower sales, decapitalizing traditional European utilities, particularly in Germany. However confused or counterproductive the transition, Europe’s power industry has moved towards a competitive, decentralized model. While it is unlikely that CO2 regulations alone will break up the traditional power industry model in the United States, it is very conceivable that multiple stressors like those mentioned above will do so. Concerns about water quality and water availability only introduce further, relatively unanticipated avenues for technological change into an industry already in the midst of tectonic business model shifts.
The new H2O normal
Looking forward, the power sector will begin shifting from contributing to climate change to reacting to it. For an industry with global supply chains and trillions of dollars of fragile fixed assets, climate change is nothing short of a nightmare. Climate change expresses itself through water. As recognized in recent reports from the US Department of Energy, the energy industry’s assets are highly vulnerable to climate-related droughts, floods, storms, and sea-level rise. Power issues are water issues, and vice versa. Almost 4% of US power consumption treats or transports water, and thermoelectric power facilities often depend on available supplies to withdrawal anywhere between 15-24 thousand gallons per second to operate generation and/or pollution control systems.
In many US states, surface water supplies will decrease, and groundwater pumping will exhaust aquifers like the Ogallala far beyond recharge levels. Treating water via reverse osmosis (RO) or like systems for multi-reuse will become more common; such water systems are energy-intensive, and hence, the interdependency of electric power on water, and society’s demand for clean water tie water and energy together like a Gordian knot. Studies from Sandia and Argonne National Labs have evaluated water bodies across the United States. Rising temperatures will increase electric demand, primarily for air conditioning, while water supplies will decrease. In some states, like Texas, New Mexico, Utah, Colorado, Arizona, and California, thermoelectric power generation could face serious water supply constraints. Hydrological modelling has highlighted that the last 30 years represent the wettest in the past century in the Western US. The driest days lay ahead. Between demands from fracking, farming, and the fastest-growing population in the United States, thirsty power plants in the US Southwest will compete for limited water supplies.
If average temperatures in United States increase to scientifically predicted levels, the US DOE estimates that electricity demand will increase by 34GW - further driving up water demand for electric power - while available water supplies decrease from changing precipitation patterns and more evapotranspiration. Outside of the West, extreme water and flooding have already led major metropolitan areas, like New York City, to release comprehensive climate change adaptation plans. Whether NYC, New Orleans, Miami, or San Francisco, climate adaptation plans call for action against sea level rise and flexible, building-level generation sources organized into microgrids to keep on the lights.
Hundreds of scientific reports have documented the innumerable dimensions of the energy-water nexus. However, few have connected the H2O risks from climate change to the broader existential changes occurring in the business of electric power. One need to look no further than the 2011 Texas drought, which caused parched power plants to curtail operations, or Hurricane Sandy, which washed away critical power infrastructure, to understand the links between water risk and today’s water-vulnerable, centralized power system.
Conventional power systems have few cost-effective technical options through which to address decreased water availability. As documented by ERCOT, PJM, and CAISO, retrofitting conventional coal- or gas-fired water cooling technologies with H20-independent air-cooled systems is cost-prohibitive for nearly all fossil generators. Air-cooling comes with trade-offs in the form of decreased thermal efficiencies and parasitic load penalties of 7% or higher. This means that generators net power output is lower, yielding less electricity per unit fuel input. Water quality issues, both regarding plant cooling intakes and discharge systems, will also present costly challenges for industry. If precipitation patterns change, intake water may become less pure, meaning more thermoelectric power stations may need to pre-treat steam water to remove heavy metals before boiler injection. Generators in several states have already seen increased heavy metals in intake injections in regions currently in sustained drought.