Utilities feeling pain from environmental policy volatility
These are confusing times for those involved in capital planning at utilities. Core to utility capital planning is forecasting investments in energy generation, transmission and distribution infrastructure. This energy resource planning is arguably more challenging now than it ever has been, due to regulatory uncertainty. Federal authority and willingness, or lack thereof, to regulate greenhouse gas (GHG) emissions in the power sector is driving this uncertainty. Volatility at the state regulatory and policy level on topics such as distributed energy resources (DER) further exacerbate uncertainty.
However, avoiding falling victim to regulatory and public policy uncertainty can be achieved through a disciplined focus on the long term environment and other value drivers outside of public policy, as opposed to responding to whichever way the regulatory winds are blowing at the moment.
The Clean Power Plan: what would take its place
The Obama administration EPA’s Clean Power Plan was cast into legal limbo in early 2016 when the U.S. Supreme Court granted a stay – effectively halting the implementation of the regulations – in a move that took many observers by surprise. While technically speaking, the fate of the regulations will be determined by the pending decision in the U.S. Court of Appeals for the District of Columbia Circuit, and the likely appeal to the U.S. Supreme Court, it should be no surprise that the incoming administration of President-Elect Trump will play an outsized role in determining the future of federal GHG emissions regulations.
At first glance, a fair question may be, “what federal GHG emissions regulations?” – as the President-Elect has made his desires to cut environmental regulations, including the Clean Power Plan, well known. However, Section 111(d) of the Clean Air Act creates a significant obstacle to eliminating the EPA’s role in GHG regulations.
Here again, a U.S. Supreme Court decision is paramount. This time it revolves around the classification of greenhouse gases as a threat to public health or welfare. In 2012 the court upheld the EPA’s endangerment finding. This determination laid the groundwork for the EPA’s Clean Power Plan, as Section 111(d) then created an obligation for the EPA to establish greenhouse gas emissions regulations for the power sector.
Thus, whether the court’s ruling is adverse to the Clean Power Plan or the Trump administration’s EPA seeks to withdraw the regulations, the EPA must still comply with its Section 111(d) obligations to regulate emissions – given that greenhouse gas emissions have been federally recognized to endanger public health and welfare. Eliminating this underlying obligation, or the endangerment finding, would not be an easy task and would almost certainly lead to years of legal gridlock.
Beyond the Clean Power Plan
The Clean Power Plan is only one example of the countless sources of confusion in the utilities sector, at the federal level alone. Add in the uncertainty around the EPA’s New Source Performance Standards and even the Mercury and Air Toxics Standards (currently in force), and the future of federal environmental regulations for utilities and power generators becomes more opaque than it perhaps has ever been.
The above examples of uncertainty reside at the federal level. The rapid changes in regulations at the state level can be even more challenging. Whether it’s the implementation of state renewable portfolio standards (which 29 states plus the District of Columbia have adopted) or policies surrounding distributed energy resources, state regulations are constantly in flux. For example, in the third quarter of 2016 alone, state regulators in 42 states plus the District of Columbia undertook 117 actions related to solar policies in utility rate design.
Utilities stakeholders disregard policy volatility
Capital investments in power generation, transmission, and distribution are long term investments. Companies, and their investors, will have to live with decisions surrounding where to deploy capital for the foreseeable future, and these decisions will help shape the long term success or failures of business.
While the extreme degree of regulatory uncertainty, especially at the federal level, is unquestionably making capital allocation decisions more difficult, utilities would be wise to escalate the importance of other drivers outside of public policy rather than attempting to predict, or being consumed with influencing, policy over the next two, five, or twenty years. This primarily includes heeding to other drivers related to environmental performance such as customer and investor priorities.
Regulations generally serve as minimum standards for compliance. Customers and investors expect such compliance, but do not define environmental performance based on whether or not a company is simply complying with regulations. Instead, customers have high expectations on the power sector’s environmental performance. Whether that’s 82 percent of the Californians that support the state’s RPS of 50 percent by 2030, or 73 percent of Americans that support alternative energy over fossil fuels, or the only eight percent of Americans that classify coal as an important source of energy for America’s future.
Investors on the other hand are increasingly incorporating corporate sustainability performance into investment decisions. One out of every six dollars under professional management in the U.S. incorporate environmental, social, and governance (ESG) issues into investment strategies, while 73 percent of institutional investors take ESG issues into account in their investment analysis and decisions.
Specifically, within the electric utilities industry, investors are keenly aware of the risks – both short and long term – associated with GHG emissions, among other environmental issues. There is widespread acknowledgement that a slashing of federal environmental regulations in the near term does not alter long term risks and opportunities – and potentially not even short term risks, depending on the local regulatory regime and customer base. A consortium of institutional investors labelled “decarbonisation strategy” as the second most important investor expectation regarding electric utilities companies.
A recent Credit Suisse research report (“Key ESG risks and megatrends: What keeps our utilities analyst awake at night?”) even highlighted views on analogous public policy volatility in Australia: “What keeps our utilities analyst awake at night? Policy flip-flop and inconsistency…our utilities analyst is most concerned about the serial inconsistency and ever-changing nature of ‘Green’ policy in Australia which has led to a collapse in policy confidence.” The report continues on to describe opportunities arising from decarbonisation and risks driven by carbon emissions – despite policy volatility.
Additionally, the Sustainability Accounting Standards Board’s (SASB) standard for Electric Utilities industry recognizes GHG Emissions & Energy Resource Planning as a sustainability issue with financially material impacts for companies in the industry. The industry working group participants, which participated in the development of the standard, ranked it as the highest priority issue in the industry, with 98 percent of individuals describing it as a material.
How utilities confront uncertainty matters
Utilities would be wise to discount the importance of short term changes in regulatory policy when contemplating capital planning and energy resource planning – especially those changes that are counter to long term trends. The likely failure of the Clean Power Plan serves as a prime example of such policy volatility, while the uncertainty surrounding future regulations required by the Clean Air Act further exacerbates this example.
Instead, utilities would be prudent to recognize that public policy often establishes only minimum compliance and is only one of many drivers of risk and opportunity. The lowering of regulatory-mandated standards does not indicate other key drivers (in this case, customers and investors) will also lower their standards or disregard associated risks and opportunities. It may very well be the case that customer and investor pressure on utilities ramps up to counter volatility in federal policy – prudent utilities would then benefit for not capitalizing on policy reversions but instead striving for a long term, sustainable vision.
Ofwat allows retailers to raise prices from April
Retailers can recover a portion of excess bad debt by temporarily increasing prices from April 2022, according to an Ofwat statement.
The regulator confirmed its view that levels of bad debt costs across the business retail market are exceeding 2% of non-household revenue, thereby allowing "a temporary increase" in the maximum prices. Adjustments to price caps will apply for a minimum of two years to reduce the step changes in price that customers might experience.
Measures introduced since March 2020 to contain the spread of Covid-19 could lead to retailers facing higher levels of customer bad debt. Retailers’ abilities to respond to this are expected to be constrained by Ofwat strengthening protections for non-household customers during Covid-19 and the presence of price caps.
In April last year, Ofwat committed to provide additional regulatory protection if bad debt costs across the market exceeded 2% of non-household revenue.
Georgina Mills, Business Retail Market Director at Ofwat said: “These decisions aim to protect the interests of non-household customers in the short and longer term, including from the risk of systemic Retailer failure as the business retail market continues to feel the impacts of COVID-19. By implementing market-wide adjustments to price caps, we aim to minimise any additional costs for customers in the shorter term by promoting efficiency and supporting competition.”
There are also three areas where Ofwat has not reached definitive conclusions and is seeking further evidence and views from stakeholders:
- Pooling excess bad debt costs – Ofwat proposes that the recovery of excess bad debt costs is pooled across all non-household customers, via a uniform uplift to price caps.
- Keeping open the option of not pursuing a true up – For example if outturn bad debt costs are not materially higher than the 2% threshold.
- Undertaking the true up – If a 'true up' is required, Ofwat has set out how it expects this to work in practice.
Further consultation on the proposed adjustments to REC price caps can be expected by December.
"While it’s great that regulators are helping the industry deal with bad debt in the wake of the pandemic, raising prices only treats the symptoms. Instead, water companies should head upstream, using customer data to identify and rectify the causes of bad debt, stop it at source and help prevent it from occurring in the first place," she said.
"While recouping costs is a must, water companies shouldn’t just rely on the regulator. Data can help companies segment customers, identify and assist customers that are struggling financially, avoiding penalising the entire customer in tackling the cause of the issue."
United Utilities picks up pipeline award
A race-against-time plumbing job to connect four huge water pipes into the large Haweswater Aqueduct in Cumbria saw United Utilities awarded Utility Project of the Year by Pipeline Industries Guild.
The Hallbank project, near Kendal, was completed within a tight eight-day deadline, in a storm and during the second COVID lockdown last November – and with three hours to spare. Principal construction manager John Dawson said the project helped boost the resilience of water supplies across the North West.
“I think what made us stand out was the scale, the use of future technology and the fact that we were really just one team, working collaboratively for a common goal," he said.
Camus Energy secures $16m funding
Camus Energy, which provides advanced grid management technology, has secured $16 million in a Series A round, led by Park West Asset Management and joined by Congruent Ventures, Wave Capital and other investors, including an investor-owned utility. Camus will leverage the operating capital to expand its grid management software platform to meet growing demand from utilities across North America.
As local utilities look to save money and increase their use of clean energy by tapping into low-cost and low-carbon local resources, Camus' grid management platform provides connectivity between the utility's operations team, its grid-connected equipment and customer devices.