U.S. Utilities: The Future Begins in California

Historians may one day record that California was the place where the U.S. electric utility industry was reborn. But that will hinge upon whether one of the boldest state proposals to reduce carbon emissions in the U.S. is successful in stimulating revolutionary new technological advancements.

In part two of our special series, we look at the technology that will be crucial to achieving California’s expansive low-carbon vision.

Of course, our aim isn’t merely academic. Developments in California could have far-reaching implications for utilities throughout the U.S. That’s because if the state is successful, then its experience could serve as a model for the rest of the country—or, if not, a cautionary tale.

But that’s a more open-ended consideration. In the more immediate future, we’re also trying to determine whether the Golden State’s three big investor-owned utilities, PG&E Corp. (NYSE: PCG), Edison International (NYSE: EIX) and Sempra Energy (NYSE: SRE), which have a collective market cap of nearly $80 billion, will become the most valuable companies in the sector thanks to operating at the vanguard—or whether they’ll share the same disturbing fate as some of their European peers.

In our first report, we established that rather than being disrupted by these new policies, California’s utilities are actually leading the way, which would seem to bode well for their continuing viability as well as shareholder value.

In this report, we examine whether utilities can implement such policies profitably, particularly since some renewable technologies are still in their early stages and cannot at present meet these goals.

Seasoned utility investors will already be attuned to the issue of potential disruption to the old utility business model from renewable and distributed technologies. In our past appraisals, we’ve noted that the industry has plenty of time to respond.

Indeed, with the legal delays in implementing the Obama administration’s Clean Power Plan, the so-called green revolution has always been just beyond tomorrow.

But with California’s new carbon-emissions law, signed by Governor Jerry Brown last month, the future may come faster and more furiously than anyone planned. California’s new rule will require significant technological advancement to meet its tougher standard, which has set a goal of reducing carbon emissions by at least 40% below 1990s levels by 2030.

California’s latest rule is in addition to last year’s decision to require utilities to produce at least 50% of their energy from renewable resources by 2030.

That’s up from the previous renewable portfolio standard of at least 33% by the year 2020, a goal which the industry had been on track to meeting. In 2013, for instance, California’s Big Three collectively served 22.7% of their retail electricity sales with renewable power.

Could California be at the forefront of a technological transformation that will lead to sweeping changes in the electric utilities industry—or is this yet another example of well-meaning policymakers far exceeding the limits of technology and economics?

Fortunately, other countries have had experiences from which we may be able to draw some conclusions.

Germany, for example, has one of the most aggressive carbon-reduction programs in the world. Renewables’ share of the country’s electricity generation mix is twice that of the U.S.

And Germany’s ambitious “Energiewende” program, which commits the country to meeting 80% of its electricity needs with renewables by 2050, offers a model that makes us cautiously optimistic that California is on the right track.

Where Germany Goes …

Whenever the subject of the Carbon Revolution comes up, some pundits declare that Germany is an example to avoid, given the disruption to its utilities, while others cite it as an example to follow, for the same reason.

But there’s an important distinction between Germany’s experience and what’s happening in California.

As one German utility CEO explained, the reason the country’s utilities were disrupted was because they failed to invest in renewable technologies. By contrast, as we noted earlier, California’s utilities have been leading the charge toward adopting these new technologies.

From an investment standpoint, the question is how effective California utilities will be in implementing these technologies and earning higher returns, thereby increasing shareholder value. Thankfully, Germany’s experience suggests that service quality and cost concerns are manageable.

Renewables could also give California utilities a growth kicker from higher rates. A recent Stanford study that compared Germany’s energy policies to California and Texas found that Germany’s increases in renewables led rates to rise two to three times as high as those in California and Texas.

However, because higher rates encouraged greater energy efficiency, Germany’s average household electric bill is only slightly higher than in California and actually lower than in Texas.

One area where renewables could pose a problem is grid reliability. Utilities are concerned that ramping up the share of weather-dependent, intermittent renewables such as solar and wind could jeopardize the stability of the grid. But such fears may be overblown.

A recent Financial Times report found that last year renewables provided more than a third of Germany’s electricity, and the rising proportion of renewable generation has not so far led to any noticeable reduction in reliability.

In fact, from 2006 to 2013, wind and solar generation in Germany tripled, while average annual outage time fell from 22 minutes to 15 minutes, according to a 2014 report by the German energy network regulator.

At the same time, the reason that Germany has been able to accommodate such variable resources is that the country has good grid connections, an area where California needs to improve.

But the most interesting result to emerge from Germany’s utility experiment is that the country’s solar installations manage to generate electricity at an overall cost similar to that of California and Texas, despite the fact that the country receives only half as much annual sunshine as these two U.S. states.

“Germany makes up for its deficits in solar resource quality through favorable treatment of ‘soft costs,’ such as the cost of financing, permitting, installation, and grid access,” the study concludes. This suggests that California, and even Texas, still have the opportunity to greatly reduce the cost of renewable technologies simply by eliminating bureaucratic red tape.

Of course, even if such streamlining is achieved, technological innovation will still be key. To that end, most agree that advancements in battery technology, in particular, will be necessary to support intermittent technologies such as wind and solar.

A study conducted by the consultancy E3 confirms this, finding that renewable integration challenges are likely to emerge at a renewable portfolio standard above 33%. “The most important challenge is overgeneration during daylight hours,” the study found, which is when too many energy resources are operating at the same time.

In the third and final part of our report on California, which will be published two weeks hence, we take a look at various battery technologies and how even today the cost of such technologies is not fully understood.