Disruption – Part Two – Electric and Gas Utilities

I started a trend of posting on disruption with the taxicab industry being walloped by Uber. While disruption is everywhere in the press, the question is – when is disruption truly real and where is it a distraction? Let’s move on to the electric and gas utility industry.

The electric and gas utility industry is the “exact opposite” of the classic “disruption” thesis… although disruption and revolution have been promised many times over the years, they have failed to materialize. Let’s look at the characteristics of this industry and find the salient facts that either “enable” or “defeat” disruption.

I worked in the electric and gas utility industry throughout all of the 90’s. I traveled to over 100 public, private and municipally owned utilities (there aren’t that many left today because there have been many mergers in the industry space). Since then I have followed them through business publications and public sources of information.

The electric utility industry has 4 main components:
1. Generation – the generation of power through nuclear fuel, coal, natural gas, hydro or solar / renewable
2. Transmission – moving power via high voltage lines from where it is generated (remote) to the cities where people live
3. Distribution – the local city with overhead and underground wires and substations and physical trucks
4. Customer Service – who you call and how they dispatch crews and respond to incidents

The electric utility industry also is characterized by “real time” surges and the fact that power can’t be stored (yet) on a large scale; thus peaks occur on the hottest days or the coldest days and power is needed exactly at that moment at your particular location. These peaks can results in demand far higher than during a “typical” day.

The natural gas utility industry is conceptually similar to the electric energy industry with two main differences. Generation isn’t handled by them (exploration companies find natural gas and get it to their system through their own processes and methods) and natural gas is much less “peak sensitive” and can be stored near the point of demand and injected into the system.

Broadly speaking, there have been many attempts to “de-regulate” the electric and gas utility markets over the last THREE decades. Let’s start with natural gas.

A solid history of natural gas regulation through 2013 can be found here. Key elements:

1. Natural gas utilities have long been recognized as a “local monopoly” with virtually all cities having a single supplier for distribution and customer service and with utilities receiving a guaranteed but regulated profit
2. The price of natural gas used to be regulated which limited exploration to the point where the US government stopped allowing new customer hookups in the 1970’s because they believed we were “running out” of natural gas; after price controls were lifted, exploration companies found vast new stores of natural gas and brought them to market under the profit motive
3. Pipelines (transmission) were opened up to customers for bidding in FERC Order 636 in 1992 which reduced bottlenecks and allowed for transport of natural gas to end users who were not utility customers (such as large commercial enterprises). This allowed them to seek and source their own gas without having to build their own transmission network
4. The current regulatory environment allows customers to source gas from other than the local utility; you may have seen ads for this. They are still using the utility’s transmission (if they own it), distribution and customer service functions and paying a fee – but you can lock in a different provider of natural gas and lock in a different rate / unit with different terms if you want to do so

Today, gas utilities have benefitted immensely from the plummeting costs of natural gas which is due to all the innovations of fracking that also caused the price of oil to plummet from over $100 / barrel to under $30 / barrel. These innovations came from outside the regulated energy industry, since exploration has been effectively de-regulated since the 1970’s, enabling vast new supplies to enter the market. Roughly half the costs to an end consumer is the gas transmission / distribution / customer service component and half is the cost of natural gas itself. Thus there have been large savings to end customers of natural gas over the last few years.

While there has been vast innovation in exploration, there has been limited innovation in the other elements of the gas utility space, which is typical of a regulated entity with little to no competition. There are some huge difficulties coming for the industry, however – their distribution networks are old and have been allowed to deteriorate in many areas and giant investments in pipes and systems will be needed over the next decade. In Chicago, for instance, the cost of upgrading the old systems have ballooned from $2B to over $8B and rising and are years behind schedule. Note that in the current regulated utility model customers bear the costs of these upgrades through rising bills and charges, unless regulators decide to disallow the charges.

The electricity industry was always larger in size and scope than the gas industry because the utilities themselves (mostly) built and were responsible for their own generation plants, which can cost billions of dollars. The electric utilities were also responsible for transmission, distribution and customer service. This article summarizes the history of electric utility regulation. Some highlights:
1. Electric utilities were hit hard with inflation and high costs of new generation (primarily nuclear plants) in the 1970’s and 1980’s and since then investment in “traditional” baseline generation such as nuclear, hydro, and coal plants have been muted. We are essentially leveraging generation assets that are 40+ years old or greater (with the exception of natural gas)
2. Electric utilities are regarded as local monopolies with guaranteed returns and profits on their transmission, distribution and customer networks; in many places generation has been partially de-regulated and prices can fluctuate significantly with demand
3. While there has been some investment in distribution and transmission, these investments are very difficult to make due to prohibitive local costs and regulations and a lack of financial incentives in many cases for transmission. There are exceptions on a state level but it is generally the case that we are leveraging past investments
4. At the local level there is some customer “choice” but it is on the provider of generation and this is often more “financial” than “real” – the network still is interconnected and requires real time monitoring and supply for peaks
5. Some states and municipalities are increasing the use of “green” power which is almost always far more costly, particularly on peak, than standard base-load resources. To the extent that this becomes the norm, electricity rates will rise to end users

On the electric utility side, their failures of de-regulation have been more prominent, including the spectacular meltdown in California with the collapse of their ill-fated spot regulatory system amid gaming from Enron. It even has its own wikipedia page you can read here. I have written many articles on the failed “nuclear renaissance” and our nation’s failed energy policy and you can read a good summary here. In general, our overall failed electric energy plans have been (mostly) bailed out by the plummeting cost of natural gas, which led to a new and (relatively) efficient baseload model. Note that this benefit has been earned by the private sector outside of our regulatory or government research model; private sector investors did the research and built the infrastructure that “changed the world” by unlocking US resources at a reasonable cost. Our model of incenting land owners through mineral rights, meaning that they receive profits for oil and gas under their lands, means that this private sector model received encouragement not discouragement that it would have received elsewhere (such as in Europe, where these rights mainly belong to the state).

What can we learn about “disruption” and the “barriers to disruption” from the perspective of a review of the electric and gas utility industry? Here are some thoughts:
1. The main response by regulated entities to competition was to buy up adjacent companies, remove back office staff and facilities, and become “bigger oligarchs”. Rather than invest in market-changing disruptions, the key was to become larger and use financial engineering in an attempt to increase profits. Both the electric and gas utility markets have undergone massive consolidation over the last 3 decades
2. Another way to increase profits is to decrease investment; the US is basically living off investments made decades ago in generation, transmission and distribution networks and some day these bills will come due, or there will be a (continuing) fall in reliability which is just another symptom of disinvestment
3. Regulatory capture and regulatory meddling (renewables, etc…) may have mutated over the years but there is little or no semblance of a free market especially at the transmission, distribution or customer service end, and as a result there is little innovation and disruption
4. The largest POTENTIAL source of disruption would be competition between natural gas and electricity, or between new entrants (such as backup home systems with the potential to switch between gas and electricity). Sadly, this has been muted, because typically regulated industries care more about their regulators’ opinions than the market and lack entrepreneurial skills and even if they were successful the profits would likely be capped by the regulator

It can be safely concluded that our electric and gas industries have walled themselves off against disruption through regulatory barriers and any claims of disruption from new entrants clamoring for investment opportunities should be treated with more than a grain of salt. Thankfully our unregulated exploration business has effectively “bailed out” our failures on the regulatory side with the plummeting costs of natural gas (in fact mainly a by-product of our relatively unregulated oil industry). While someone may point to “Nest” (and Google likely has a valuation bigger than the combined market caps of gas and electric utilities in the USA) this is a marginal not game changing technology since it still utilizes the regulated “pipes and wires” from start to finish, although it can help on the customer service side if integrated in the longer term (and is absolutely a welcome player).

Cross posted at LITGM

11 thoughts on “Disruption – Part Two – Electric and Gas Utilities”

  1. I don’t know nearly as much about the topic as I should, but isn’t the terminology “natural gas” indicative of a prior art in some sort of generation of “un-natural” gas in a local “gas works” by a “gas company”? Methane or carbon monoxide or even hydrogen,(or some mixture of these) produced by burning coal-fuel to make some energy then using the energy to make the gas?

    Surely the advantages of natural gas, carried in a “transmission” system of pipelines, was disruptive to the local “gas works” who had been both “producers” and “distributors” in that prior (19th century?) market.

    So, I’m wondering what would happen in the contemporary market if a disruptive innovation arose — say, using smallish thorium nuclear fission plants during hours of non-peak electrical demand to produce “gas” of some sort instead of electricity. Or, more simply, if the rules about siting power plants away from cities were relaxed such that the “used” steam left over from industrial processes were applied to residential heating.

    Aren’t there disruptions still foreseeable on the horizon?

  2. California is the idiots’ lesson in what not to do.

    Gray Davis completely wrecked the electricity utilities in California with a lunatic scheme devised by a Democrat assemblyman who had made his money as the producer of the movie “attack of the killer tomatoes.”

    Wiki, as usual, is in trying to blame it on Pete Wilson, a Republican.

    At least they got this part right.

    As a result of the actions of electricity wholesalers, Southern California Edison (SCE) and Pacific Gas & Electric (PG&E) were buying from a spot market at very high prices but were unable to raise retail rates.

    Davis required them to buy on a daily spot market instead of long term contracts they had had for decades,

    The result was panic, especially in San Diego where prices spiked to thousands.

    David wound up being recalled and replaced by Schwartzenegger, who was not much smarter. Democrats have run the state ever since with predictable results.

  3. “Or, more simply, if the rules about siting power plants away from cities were relaxed such that the “used” steam left over from industrial processes were applied to residential heating.” A friend of mine, born about 100 years ago, grew up in Minnesota with that system. It’s also used quite a lot in Russia, I believe.

  4. You did not mention the real (and damaging disruptor) of government subsidies and mandates for so-called renewable power. In this case subsidies and mandates are inseparable and continue to distort the markets. Wind and in some markets Solar electric are mandated purchases by electricity suppliers. Typically you are required to have at least 15-25% renewables in your mix. Since wind and solar power are not dispatchable they are must-take power. The power markets must buy their power regardless of need. Wind subsidies are huge and of a form that encourage overbuilding (i.e. $/MW-hr produced). Solar net-metering is also a harmful disruptor. Rooftop solar can sell power back at a price which includes the cost of transmission and distribution even though the solar producer did not provide these services.

    Since wind dies and the sun sets (as billboards in Pennsylvania coal country correctly point out) any Wind/Solar capacity must be backed up 100% by conventional power plants. The old 15% reserve requirements rise rapidly.

    So the old line utilities see themselves no choice but to buy renewable capacity and increase oligarchical dominance.

  5. Michael,

    Someone had to defend our glorious governor from the calumnies of that legal immigrant. Thus my nom de plume. Thank you for remembering his liberal fantasies and their dramatic impact on the Goldenrod State.

  6. The disruption that worries me is the so-called smart grid. If household systems can be remotely accessed and controlled, by anyone at all, leftist busybodies will ensure that they are accessed and controlled by the government. “For the sake of the planet”, “For the sake of the children”

    I see the fire pit of hell opening up before me.

  7. Anyone currently using Georgia Power is paying for the retirement costs for a nuclear plant that is still under construction, some $millions over budget, and some year(s)behind schedule. Over-runs must be par for the course on nuclear plant construction as the request was approved by the PUC without much brouhaha.
    The local Co-Op is offering monthly payment to customers who allow a remotely controlled load-limit switch to interrupt their air conditioner power. The monthly is something like $20/mo for the three hottest summer months. I had one previously on the old heat pump, since demised, but the installation turned out to be about on par with the Three Stooges erecting the Empire State Building without use of a level. The box was placed in the most inconvenient spot, with wires so short the access panel could not be moved out of the way for service. The ‘technicians’ had to leave to acquire a drill bit that was not dulled… after making a 20+ mile trip to the site.
    I regretted that decision almost immediately, and did not replace the switch with installation of the new unit.

    Currently, ‘clean’ power is offered as an option on the monthly bill. You can pay more to feel good about the power you use, even though it is only remotely connected to the ‘clean’ power provided to the system. “Feel Good” carbon credit marketing at work. Get out the beads, the leather vest, the headbands and the flowers, we are all hippies now…

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