August 2006

Mini-Merchant Maximization

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2006/10/27)
 

As the lazy, hazy, crazy days of summer, of August 2006 threatened to turn into August 1914, official Washington took leave of its energy policy making duties for a while. True, oil was approaching $80 a barrel, domestic security threat incidents were seriously increasing, and public opinion was swinging to the view that US energy policy was affecting the warming of the planet. No matter, maybe EPACT would be further amended or US ingenuity would pull a cellulosic ethanol rabbit out of the hat.

Nature abhors a vacuous thought bubble, and therefore coming forward again battered but unbowed are the proponents of the racehorse Distributed Generation (“DG”) bred out of Total Energy, and claimed forbearer of Renewable Energy. The thought returns: maybe a MW saved is a MW earned and a barrel of oil not imported, or C02 not exhausted into the atmosphere. But there is a twist; there are trends to allow entrepreneurs to maximize the opportunities created by these mini-merchants.

These are trends, now tenderly afoot which could, with appropriate cultivation, actually be fostered by government to enhance DG. The most important, identified in a recent Distributed Energy Financial Group’s recent market survey is the continued change in the regulatory environment. The first trend that naturally comes to mind are “renewable portfolio standards.” However, this is a very blunt instrument indeed, if the objective is energy efficiency through DG. The top driver, in actuality, is innovative rate making.

Why is that? We are at an inflection point in the power plant development cycle. There is again an emerging need for new capacity. There is an increasing desire for industry. The new era of rate cases is also upon us — hunkered down in their “back to basics” mode, utilities have cut costs, but now need regulatory approvals to raise the funds to pay for delayed investments (not the least of which is efficient T&D) and for new growth opportunities (including construction and acquisitions). Moreover, the withering of the deregulation rate caps rose has thrust them back into the public eye along with the economically justified need for increased rates, the more so since rate increases have gotten caught up on the latest post-PURPA consolidation lunge.

It is in this emerging rate case context that the role of DG as a sop to regulators, as an actual or alleged source of cost reduction, and as a first cousin of incentive-worthy renewables, is achieving attention. As a result, taken together with EPACT-mandated rate proceeding related requirements, greater attention is being paid to demand response, demand management, and energy efficiency. Not surprisingly, this is true in the same regions that previously drank deepest of the deregulation kool aid, in an effort to contain costs. These are all trends associated with existing technologies, in which investments can be made near term; implicit government credit support (and sometimes loan guarantees and guaranteed incentives) can be provided; financial results can be obtained. In the right scale, and with the right ratio of capital expenditures to savings, DG can become a type of activity merchants can become interested in.

Besides need and greed, the other great motivator is fear — a commodity in great supply these days. Increasingly there is recognition that a robust backbone grid (central stations, long distance transmission) does not address the particular vulnerability of high population and industrial centers, special reliability situations (telecom, chip makers), and continuous operation of key protection centers (hospitals, police stations, key utilities). Flash briefly on the havoc we have seen done with pinpoint bombing as well as indiscriminate natural hazards, and the importance of these concerns is clear.

Concern with system vulnerability has led to renewed attention to micro-grids: the tying of multiple devices together and operation of them as a utility with storage, power electronics and advanced automation. Utilities are not cut out of the power loop by such arrangements — they maintain the customer interface. The story of DG is a story of power companies’ lack of interest if not opposition to efforts in this field. Now practical reasons for its support are surfacing.

Some of this interest comes from the new concern with the security of energy facilities, derived and still driven by national security applications. Interruption of power at a base can affect bases worldwide. Sandia Labs has activily been at work on this issue. Micro-grid hardening has been found to be an expensive, difficult solution, whose very complexity would serve to further endanger reliability. It is the micro-grid which has been found to be best responsive to distribution system security. Work is being done specifically to beef up the storage and other capabilities which optimize micro-grid “surety,” e.g. diversely located “agentbased” control systems that cannot be easily disabled. Of course, putting aside technical issues, it’s easier to do things by fiat in the military community than by consensus in the civilian community. There is no comparable military mission managed by a base commander. But there is in the military experience the model of how a market can be created — always a matter of the greatest interest to those of the merchant disposition.

DG just won’t happen, even though from a public policy standpoint, it absolutely should. Both from a macro energy security standpoint and from the standpoint of on-the-ground physical security. Merchant developers (which may include large firms) would profit from a DG boom, as well as would transactional entrepreneurs. Therefore it is appropriate to focus on what collectively is  needed to make it happen — governmental action.

A few thoughts in this regard: Suppose Congress supplemented its follow up on the State Demand Response Programs under EPACT (described in this column last month), with a program to mandate (and perhaps also incentivize) state DG/DR incentives. Suppose there was a direction to Sandia Labs to assist applicant governmental jurisdictions in doing this. Suppose RTO’s were incentivized to focus on micro-grid coordination as well as traditional grid coordination. Or suppose at least there were a Federal Commission to make recommendation in these regards. Suppose this effort was limited to a “white tag” program to which DG and environmental activities were linked.

“Micro-merchants” maximization of the several trends identified above would be the response.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.