Microgrid Financing Options to Facilitate Future Growth

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Michael J. Zimmer, executive in residence and senior fellow at Ohio University, was recently an invited speaker at The 4th Microgrid Global Innovation Forum held May 16-17, 2017 at George Washington University in Washington, D.C. Mr. Zimmer addressed issues and innovations on evolving microgrid financing options primarily in the U.S. With other experts on his panel, “Evolving Microgrid Financing Options,” he contributed to the deeper understanding of structures to secure microgrid financing and the changing infrastructure and policies affecting microgrids. Mr. Zimmer also serves as Washington Counsel for the Microgrid Institute since its founding in 2012, and advises its newly-created Microgrid Finance Group formed in 2016. Mr. Zimmer has guest lectured on microgrids in various classes at Ohio University, in local meetings sponsored by Upgrade Ohio, and in various national fora. In the following blog, Mr. Zimmer draws from and builds upon his recent forum remarks last month.

Microgrids represent one of the fastest-growing technologies in the electric utility industry today offering multiple benefits to the state, the utilities and the customers they serve. North America hosts the largest deployment of microgrids, closely followed by Asia and Europe. The key growth driver for the future will be in the commercial and industrial arenas that will grow to represent 30% of global markets. Commercial and industrial projects are primarily driven by cost and economic benefits of solar, combined heat power, energy storage and their interface especially for hospitals, data centers, military, universities, schools and healthcare facilities. Ohio has just started to examine these questions as part of it grid modernization proceedings launched in April 2017 by the Public Utilities Commission of Ohio (PUCO).

Noting that soft costs are 50% of the development costs for microgrids, there is an increasing quest to standardize the microgrid as service model including use of more sophisticated control systems, DC power flows, better storage technologies, and closer integration with advanced metering. For many decades, the transmission and distribution (T&D) sectors were solely served by the electric utilities. Now the question is arising as to who will modernize the T&D sectors in the future? Many  stakeholders, including energy service companies, equipment vendors, the five major technology and information management companies, foreign vendors and international utilities, startups, entrepreneurial companies and telecom companies, along with the electric utilities, are seeking to serve this $400 billion per year electricity sales and services market in the U.S. Electric power is one of the most capital intensive sectors in the national  economy today scheduled to spend up to $2 trillion by 2030 to modernize the aging U.S. electric system.

The microgrid derives its value from its interwoven complexity. This is exactly what makes quantifying its value so difficult and also makes the issues of capital access and financing more challenging. Government funding typically covers only a portion of the microgrid’s costs. For the remainder, microgrids tend to rely on variations of financing models that originated in other related industries. These include such tools as direct ownership, utility rate base treatment, vendor financing, energy service contracts, power purchase agreements, leasing, debt and bond financing, green and infrastructure banks and other clean tech energy model and tools in the state marketplace. As microgrids move from the pilot or demonstration phase to fuller commercial deployment, the quest arises for more financial models and disciplined structures to support financing ahead. Right now in the United States, that there are five major viable financing models:

  1. Special microgrid investment funds;
  2. Vendor financing;
  3. Energy service companies;
  4. Utility financing (in rate base or through unregulated special entities); and,
  5. Warehouse financing.

The best way to analyze microgrid financing is from the vantage point of risk management strategies. Key areas of opportunity to differentiate and create success for microgrid project financing include:

  • A capacity maintenance agreement with regular service for the project;
  • A minimum amount of capacity guaranteed from the microgrid system to ensure a minimum bill or baseline to support project financing;
  • A solid warranty from an investment-grade vendor ideally for 1-3 years;
  • An insurance policy covering certain extraordinary costs, performance and/or the efficacy of the system designed for the microgrid;
  • A battery disposal strategy of e-wastes associated with decommissioning batteries from the project as energy storage increasingly is part of a project; and,
  • Aggregation to create scale, diversify risk and support a more attractive regulatory outcome to diminish regulatory risks for the project.

Diving deeper into warehouse financing and performance—a form of integrated development finance for portfolios of sound, developed microgrid projects—is important for flexible financing at commercially-reasonable terms and interest rates to support project development and success. Warehouse financing should be coupled with smart incentives such as clean funding mechanisms (in the 21 states that offer that special funding), green banks or under the Smart Cities movement in the United States. Finally, technical assistance with small grants for technical services and predevelopment costs are desirable to support the warehouse financing strategy.

Warehouse financing builds a project pipeline that can access the capital markets more efficiently through securitization. Short-term development and aggregation of loans occurs that facilitate secondary market participation and lower the capital costs for projects. This financing could also be coupled with credit enhancement techniques to reduce risks and round out the capital stack for a microgrid project coming from foundation program-related investments (PRI’s), donor management funds or clean technology funds at the state level. These credit enhancements could take the form of guarantees, subordinated debt, loan loss and debt service reserves, or interest rate buy downs to diminish risks and attract private capital and lending.

Warehouse financing is already being used in the U.S. for energy efficiency, PACE loans, solar project development and also recently energy storage loans. Such loans often range from 10-20 years and carry interest rates of 5-6%, plus closing costs. The state repackages smaller loans to reach a certain value of closed loans at certain aggregated levels to create scale. These packaged loans are then securitized through the secondary capital markets and the loans are leveraged with ratios ranging from 4-8 times the original values reported by various sources in Connecticut and New York. Pennsylvania also participates in its energy financing strategy in a multistate warehouse for energy efficiency loans called “Warehouse for Energy Efficiency Loans,” or “WHEEL.” This program is administered by AFC First Financial and is used by states seeking access for clean energy lending and financing. WHEEL works through the National Association of State Energy Officials (NASEO), the Pennsylvania Treasury, Renewable Funding, and Citigroup Global Markets, to package these smaller loans that are sold to bond investors. Proceeds from sales after aggregated and bonds are issued, go to recapitalize original state funds. Strict lending criteria are followed and high minimum credit scores are sought for risk management. Contractors are trained in intake and origination to ensure quality control over such programs.

For microgrids to succeed in their financing goals, their financing strategies must be built from known successes, existing capital market frameworks and often states with Green Bank or Resiliency lending programs. Success in financing balances:

  • Leveraging existing contractor networks;
  • Consulting with the financial community for project development;
  • Identifying sustainable funding sources with long-term viability; and,
  • Engaging utility partners, ensuring knowledge of available rebates and including on-bill financing mechanisms with state utilities.

When thoughtfully conducted, less taxpayer or ratepayer dollars are utilized and these programs facilitate use of public-private partnerships—“P3” structures and mechanisms in the 36 states with P3 framework legislation.

Financing support must be demanded by vendors, project developers and microgrid leaders. The industry itself will not just happen as a matter of state policy or through utilities without a market-based demand from its customer base.

Related research from a National Institute of Building Sciences (NIBS) task force augments this discussion by looking at resiliency-based mortgage financing for residential and commercial/industrial applications. Resiliency suffers from a lack of commonly-defined terms, similar to the lack of standardization in defining a microgrid, and even P3s. For a microgrid project financed with resiliency considerations in the cash flow and income aspects, determinations will still need to be made about the quantity, additionality and nature of ancillary benefits from the project. These must be guided by the industry and will be based also upon state public service commission determinations. To secure resiliency benefits and additional cash flow, the microgrid must offer:

  • A determination of hazard/risk expressed in probabilistic terms over underwriting scenarios over one or more time periods;
  • Resilience offered by the microgrid, measured against a potential disaster event based on the level of risk and potential added improvement in resilience associated with the microgrid investment;
  • Evaluation of the dollar amount of losses avoided based on the micorgrid project’s resilience to a calculated hazard risk should be developed by the sponsor over the life of the loan and also on an annualized basis;
  • Value and/or net operating income should be reevaluated based on avoided losses created by enhanced resilience from the microgrid; and,
  • Negotiation of loan terms to reflect additional value from building the microgrid and the income streams associated with the project. The lead in both isolation of those streams and calculation methodology should come from the developers and the industry itself working closely with its vendors. Additional revenue streams would facilitate consideration of larger project loans, the inclusion of development phase, down payment reductions for private lenders or interest rate reductions in return.

Despite differences across international and domestic U.S. markets, access to market-based financing will facilitate the rapid growth of the microgrid industry in the coming decade. Some in the electric industry see microgrids as the next market iteration of solar, which has grown 800% in the period from 2010-2015. Solar expanded another 119% in 2016 alone. Financing is the primary growth factor and will serve as an essential catalyst for future growth of microgrids with energy storage.

CE3 Blog by Michael J. Zimmer, Executive in Residence and Senior Fellow, Ohio University Voinovich School of Leadership and Public Affairs & Russ College of Engineering and Technology. Edited by Elissa Welch, CE3 Project Manager, Ohio University. June 2017.

 

Key Policy Objectives for a Smarter Grid in Ohio

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Today’s electricity markets were developed in the preceding decades using prices set by the marginal cost of generation. These markets are not determined by physical laws, but by human constructs and economic principles. As such, we need to question established orthodoxies and design more effective market alternatives by embracing the proactive, innovative nature of programs like the Public Utilities Commission of Ohio’s (PUCO) PowerForward initiative. Market principles have a continuing role to play in these alternative regimes through large-scale procurement of competitive output from renewable energy plants, as well as through energy efficiency, demand-side management, and energy storage. The PJM Interconnection, Ohio’s regional transmission organization, has shown national leadership in this direction, but we need to ensure proper and accurate price signals—that provide the ability to finance and access capital—are part of the alternative delivery package.

A new market model is needed because the current system is flawed. Our current system does not guarantee sufficient price signals to maintain the high availability and capacity required for reliable electric service that we historically have been provided in PJM. It also does not achieve the deep levels of decarbonization required to sustain existing operations, nor maintain competitive market positions in public health, safety and welfare in Ohio. The default position has been the utility rate base choice, but that must change for the state to compete, attract business and foreign investment, maintain its talent base, and participate in the industries of the future.

New market frameworks are central to support projected customer demands and changes from advances in manufacturing, internet technologies, transportation, sales, etc. New markets with stronger and more accurate carbon price signals will incentivize clean energy investment rather than continuing subsidies that promote polluting historical fuels and dated equipment. New market models will also require spending to enhance and digitalize electricity networks to manage localized, multidirectional power flows and ensure resilient, reliable and stable electricity supplies. Electric utilities have generally ignored this opportunity for over a decade. Thus, transmission and distribution (T&D) modernization in Ohio will require increased investment by third parties, better capital access, and joint ventures and alliances with electric utilities to complete the necessary market reforms. While some utilities are selectively adapting operations, regulators must also increase the pace of modernization and provide more room for pilots and demonstration projects that foster third-party innovation.

Escalating shadow costs such as the cost of coal externalities, nuclear plant decommissioning, water and other public health impacts, are not calculated for continued fossil fuel use.  Other shadow costs that remain unaddressed in Ohio’s policy discussions include renewables intensity, coal health impacts (air emissions and waste toxics), methane releases, energy-water uses, and nuclear O&M and decommissioning expenses. Moreover, costs of providing system backup power storage are not reflected in the wind and solar levelized cost of energy or in their ultimate market price. There is no free ride ahead and not accounting for shadow costs does the system and the consumer a disservice.

Energy policies are increasingly geared towards expanding renewable energy as an end in itself. Yet the research literature indicates a low-carbon grid with a manageable level of costs will require the blending of nuclear, natural gas with carbon capture, combined heat and power (CHP), or other zero-carbon on-demand sources integrated with more energy storage. Redesigning markets solely to facilitate a very large uptake of renewable energy for its own sake will increasingly become economically challenging and requires more balance to succeed. These efforts could be strengthened by coupling them with goals in carbon reduction, resiliency, system modernization and maintenance of reliability. A stronger system benefits the state’s citizenry and the customers served by its utilities.

The term “smart grid” itself refers to a range of electric grid modernization efforts over the past several years. End-users and vendors seem to focus strongly on issues related to customer choice while electric utilities highlight increased reliability and resilience based upon new transmission investments. The development of a smart grid was established as a national energy policy more than a decade ago by the U.S. Congress in Title XIII of the Energy Independence and Security Act of 2007. State smart grid initiatives must utilize this federal framework that establishes several key criteria:

Increased use of digital information and control technology

  • Dynamic optimization of grid operations and resources with “cyber security”
  • Deployment and integration of distributed generation, including renewables
  • Demand response, demand-side resources, and energy efficiency deployment
  • Deployment of smarter technologies for metering, communications and distribution automation based on two-way interactions through technologies
  • Integration of smart appliances with consumer devices
  • Use and integration of advanced electricity storage, peak shaving technologies including plug-in electric hybrid vehicles and thermal storage air-conditioning
  • Timely information and control options to consumers
  • Standards for communication, interoperability of appliances and equipment connected to the electricity grid, and
  • Identification and reduction of unreasonable and unnecessary barriers to the adoption of smart grid technologies, practices and services.

The federal mandate to the states is clear, but has often been ignored over the past decade. Clearly, Congress has demanded an electric grid future that is more resilient, secure, efficient and reliable to foster new and desirable services through technologies. The corresponding state guidance should focus on removing barriers and impediments to fully achieve these Congressional goals. Any contrary state actions, or inactions, may risk preemption under existing law. Subsequent guidance on standardization has been developed from Engineering Laboratory at the Department of Commerce’s National Institute of Standards and Technology (NIST). NIST seeks a solid framework and roadmap for smart grid interoperability standards and additional R&D support. The Federal Energy Regulatory Commission (FERC) has also provided guidance on such issues as interconnection policies, integration of renewables, demand-side management and energy storage. States ignoring this clear-cut guidance to date operate at continuing peril and are not necessarily regulating in the public interest consistent with existing federal law.

The State of New York has attempted to offer leadership by allowing utilities to earn returns for their shareholders by advancing clean energy solutions rather than only by investing increased capital in the expansion of the greatest T&D capacity. This renders the utility more neutral and a more competitive and balanced player in the marketplace to improve the energy and financial efficiency of the state energy grid. By using more transparent price signals in retail energy markets, utilities will be able to deploy more renewable generation, demand-side management and energy-efficiency projects where they can address grid congestion in high-use areas. All users will benefit as the utility shifts to providing customers with the electric services and characteristics they seek to achieve instead of superimposing what regulators and utilities think they should want. The ratepayers will no longer be merely price takers, but increasingly drive the markets and quality of service through customer choice. Similar regulatory programs are being pursued in Hawaii, California, Massachusetts, Maryland, Texas and Connecticut. New reviews are being launched in Colorado and Illinois.

Ohio also needs an increased focus on measures to prevent blackouts, clear rules on cyber security and improved smart power grids. The role of providers and innovation is indispensable for enabling active consumers and providing them with a new slate of high technology options and increased levels of customer service. This will open up the market to move beyond the inherent limitations of a utility monopoly and the regulatory protections of those monopoly franchises set for markets in the 1930s. Already, generation has been deregulated, stranded costs have been paid, and non-bypassable charges should be deemed anticompetitive. Similar deregulated results have been achieved for independent third-party services by unregulated entities, distribution is increasingly facing deregulation because of the advent of technology choice, and the only vestige of continual need for monopoly services appears at the transmission level within the state.

In conclusion, this market transformation will be alleged to foster a death spiral and reduce profitability. However, such scare tactics are often advanced as a foil to maintain the status quo. Increased choices, diversification and fuel supply focused on the long-term goals of decarbonization offer an opportunity for new business services based on energy solutions: energy storage, electric vehicles and service, energy customer services, steam capture and waste heat service, demand-side management, on-bill cost recovery, new loan financing, water services, enhanced broadband,  and more centralized energy management of customer services, equipment and energy controls. Rural solutions will require flexibility to accommodate differences and scale from their urban counterparts.

With such a transformation, communities will be empowered to more closely manage their energy needs, provide better customer service for their citizens, and move to more benign energy choices. Demonstrative pilot program can show the opportunities of the future for enhanced quality of life.  Consumption and profits will rise based upon better suites of service choices and smarter operations in an increasingly digitalized world. Energy can become the tool driving urban and rural economic development for all customers.

The competitive future of Ohio, its manufacturing base in the clean tech industry, robust supply chain, retention of its STEM student talents, and human resource attraction hang in the balance for better future energy jobs. A 19th-century fuel orientation will not satisfy the market requirements of the 21st century. Only a smarter grid which fosters the new industry sectors for product design and energy solutions grounded in sustainability will secure our competitive advantage in energy.

CE3 Blog by Michael J. Zimmer, Executive in Residence, Ohio University Voinovich School of Leadership and Public Affairs & Russ College of Engineering and Technology. Edited by Elissa Welch, CE3 Project Manager, Ohio University. May 2017.

The Future of Energy Policy in 2017

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The economics worldview grounded in supply and demand for shale development is tempered by the salient question: Can we keep the current global financial system operating as we reach limits that are economic, geopolitical and price-driven in nature? This is a central question that the Trump Administration will face come January 20, 2017.

Also on the table:

  • Can the price of oil and other commodities be kept high enough?
  • Can the price of renewables provided by solar and wind trend low enough to replace or supplement the fossil fuel status quo?
  • Can we still keep the return on investment high enough to attract capital?
  • Can workers earn adequate wages to support higher energy prices and still buy necessary goods?
  • Will rising interest rates constrain debt access?
  • How will increasing inflation impact purchasing power and reconstruction of economic demand?

Often critical linkages are missed. Unless markets and companies remove barriers and offer near-term substitutes that replace energy products that are cheaper than currently available—without requiring a huge transition in machinery or infrastructure—the country is at risk for deep financial problems. Unbridled markets without socioeconomic balance or conscious and sustainable capitalism creatively destroy jobs via such innovations, increase debt burdens, and stretch the consumer’s ability to pay. This may also be part of the U.S. economic inequality and productivity decline in the past decade.

Global affluence seems to slow growth in OECD countries. Demographics and regulation fuel a lack of productivity (and increase costs) as more complexity with costs are shifted to the citizenry. Workers have less time to be productive in their jobs as shown since 2000. Monopoly and oligarchy concentrations in many U.S. industries foster suboptimal outcomes and inefficient rent transfers. These are reflected in predatory consumer pricing and price responses that exacerbate inflation and stranglehold economic principles.

Affluence can only be maintained with cheap energy—and it will likely not be from oil due to escalating production costs. And it will likely not be from coal because of environmental costs and other externalities. Nuclear is vulnerable to cost overruns of monumental risk and cost exposure. But time has shown that a strategy of cheap energy is short lived, and not based on values that endure.

Energy affluence can only be achieved with permanent value by efficiency, waste heat recovery, combined heat and power, demand-side management, building design efficiency, and/or increased supply diversity with renewables coexisting with nuclear. The role of natural gas will be to shape demand with an immediate supply of fuel for electricity. Government policy in the long-term is better served to cover the initial cost hurdles to facilitate the required energy transition.

Technology including energy storage, materials science, electrochemistry and IT solutions will optimize the end game and make a difference.

New business models and access to capital will be required to support this transition. This can only occur with regulatory reform and modernization that fuels market access to innovation and creative solutions that advance markets beyond the limits of the entrenched status quo.

The business opportunity is too great to not foster an all-of-the-above portfolio energy strategy that promotes innovation, technology, efficiency, and the value-added information delivered by it. These energy products and services have national value and export value that are not limited to the fuels themselves.

Otherwise, we will be stuck with 19th-century fuels, used in 20th-century infrastructure, wondering why we cannot compete and meet the escalating global challenges of the 21st century.

CE3 Blog by Michael J. Zimmer, Executive in Residence, Ohio University Russ College of Engineering and Voinovich School of Leadership and Public Affairs. Edited by Elissa E. Welch, CE3 Project Manager, Ohio University. January 2017.

The Clean Power Plan’s Legal Path

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Background

The Clean Power Plan (CPP) issued by the U.S. EPA in August 2015 represents a hallmark in regulatory and judicial actions.  However, on February 9, 2016, the U.S. Supreme Court stayed implementation of the CPP by a 5-4 vote pending judicial review at the lower court level.  This decision in no way reflects a decision on EPA’s rule itself.  Rather, the Supreme Court ruling—made before the death of Associate Justice Antonin Scalia—has simply delayed implementation of the EPA rule pending review at the U.S. Court of Appeals for the District of Columbia (DC Circuit).  The DC Circuit is scheduled to hear the case on June 2, 2016 with a decision to be rendered later in the year.  The DC Circuit is likely to be favorably disposed to EPA’s plan as our analysis below shows.  Their ultimate ruling is critical because if the Supreme Court is later deadlocked at 4-4 on an appeal of the DC Circuit’s ruling, then the DC Circuit decision will stand (although it could be reviewed again later once a full complement of nine justices is empaneled).

The CPP issued by EPA is based on Section 111 of the Clean Air Act (CAA) authorizing performance standards for both new and existing sources.  The plan seeks to reduce power plant emissions through state compliance plans (SCPs) to be implemented by 2022.  More detail on the CPP can be found here: https://www.epa.gov/cleanpowerplan.  However, despite flexible compliance mechanisms, 27 states and other manufacturing groups filed to appeal the CPP rule.

Prior legal challenges to block EPA from finalizing CPP rules had failed up until the Supreme Court stay in February.  Generally, CPP opponents claim EPA is overstepping its authority under Section 111(d) of CAA, and since EPA’s plan extends deeply into unchartered legal territory, the Supreme Court decided to stay further actions.  While EPA cannot compel the states to take additional action on the CPP right now, it can still advance understanding of emissions trading and benefits of greenhouse gas (GHG) regulation.  Almost 20 states are still moving forward with development of their SCPs.

Legal Issues

When the Clean Air Act was enacted and later amended in 1990, there were two different versions of Section 111(d) in the final statue from the House and Senate.  These differences were never reconciled in Conference Committee before being signed by the President.  Indeed, EPA chose to follow the Senate version of this section in the CPP because it prohibits the agency from writing a second rule controlling a pollutant that is already regulated.  Since GHGs are not regulated from power plants elsewhere in Section 112, the EPA would be free to regulate them under Section 111. In fact, EPA believes it is simply upholding current law following its 2009 Endangerment Finding that GHGs (including CO2) meet the necessary guidelines to be regulated under the existing Clean Air Act, and thus the CPP is not intended to foster conflict but merely adhere to existing law.

The CPP’s definition of the “best system of emission reduction” is also being challenged. EPA believes this system can be applied to entire power sector on a statewide basis.  In contrast, opponents believe the system is limited to individual emitting sources, since all emission sources within a state are not equally integrated into the power sector.  CPP proponents favor EPA’s expertise and flexibility in determining the scope of the rule.

Additionally, federalism is being advanced as an issue by some states that do not wish to implement a national policy that runs counter to state authority.  This same issue has arisen related to water and healthcare with the states as well.

Timing is also a challenge. While the DC Circuit plans to rule on this case later in 2016, because of the annual rotation of law clerks in the DC Circuit every August, appellate justices could lose research continuity and support soon after the hearing thereby impeding progress.  Separately, if the Supreme Court elects to hear an appeal of the DC Circuit decision in early 2017, a final decision is likely not until 2018 from the Supreme Court on the merits of the case.  Regardless, the final outcome could hinge on the 2016 elections, as the party that wins the White House will likely appoint the next justice to the Supreme Court (replacing Justice Scalia).

Precedent and Conclusion

History shows a judicial deference to EPA decisions.  The authors reviewed all judicial rulings at the DC Circuit since President Obama took office (2009-present) in cases where EPA was the Appellee and an Appellant was challenging an EPA policy (or ruling) previously upheld at a lower court.  Out of the 289 cases reviewed, EPA’s record at the DC Circuit was 239 wins, 30 losses, and 20 mixed results.  Only slightly more than 10 percent of the time did EPA lose outright on cases decided before the DC Circuit, evidence of deference to EPA at the Appellate Court level.  Recall the DC Circuit’s ruling might prove to be pivotal because lower court rulings stand when the Supreme Court has a tied vote (e.g. 4-4).

The international Paris Agreement in December 2015 adds broader interest and pressures for GHG regulations.  The Paris commitments may need additional policies in the U.S. beyond the CPP and tax incentives to succeed—an opportunity for tools under existing law to be used for the first time to reduce emissions.  For example, Section 115 of the Clean Air Act could support GHG action beyond the power sector in the U.S. by offering broad country reciprocity over any air pollutant anticipated to harm or threaten public health or welfare in a foreign country.  The U.S. already treats GHG emissions as pollutants and the United Nations Framework Convention on Climate Change offers the U.S. the reciprocity required to pursue Section 115.

The CPP is a part of an ongoing public debate in the U.S. regarding energy and environmental policy.  Pivotal to that public debate will be the judicial rulings on the CPP likely to arrive in early 2017 by the DC Circuit.  With the prospect of Congressional action on climate policy unlikely, all eyes are on the courts to decide if the first, nationwide policy limiting GHG emissions in the U.S. will take effect or not.

Addendum: On May 16, the DC Circuit announced that oral arguments will be delayed until September 27, 2016.  Furthermore, the case will be heard en banc by the full panel of DC Circuit judges, rather than the usual, smaller three-judge panel.  Experts believe that the en banc review at this step of the judicial review will expedite final resolution of the legal issues surrounding the Clean Power Plan.

CE3 Blog by Daniel H. Karney, Department of Economics and Michael J. Zimmer, Executive in Residence & Senior Fellow, Ohio University; Edited by Elissa E. Welch, Project Manager, CE3. May 2016.

 

What is at Stake? Assessing the Real Impact of the Clean Power Plan

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On February 9th, 2016, the U.S. Supreme Court issued a stay on the implementation of the U.S. EPA’s Clean Power Plan (CPP).  Hearings on the case will be held during the summer with a potential decision likely by end of the year.  Future blog entries will discuss the political and legal aspects of the case.  The purpose here is to discuss the impact of the CPP nationwide if it were ultimately implemented.

The EPA’s website says the CPP is “a historic and important step in reducing carbon pollution from power plants that takes real action [emphasis added] on climate change.”[1]  The key step in determining the veracity of this claim is figuring out what “real action” means.  Appealing to the logic of the scientific method is the best way to generate fact-based conclusions.

Scientists like experiments, and scientific progress often comes from experimental results.  For instance, start with two petri dishes: one labeled “control” and the other labeled “treatment”.  Add bacteria to the treatment dish and watch the bacteria colony grow, while the control dish remains dormant.  This simple experiment demonstrates the basic logic of the scientific method; keeping all else equal, observe the effect of changing one variable between the control and treatment scenarios.  The same logic can be applied to determining the CPP’s real effect.

To start, EPA summarizes the CPP’s impact as follows: “When the Clean Power Plan is fully in place in 2030, carbon pollution from the power sector will be 32 percent below 2005 levels, securing progress and making sure it continues.”[2]  The problem with this characterization is that it only presents the “treatment” scenario; that is, EPA states what would happen with CPP implementation.  Indeed, the logic of the scientific method requires us to look at the difference between the treatment (“with CPP”) and control (“without CPP”) scenarios when determining the impact.  Therefore, what would be the emission levels in the “control” scenario without CPP implementation?

Fortunately, EPA conducted a Regulatory Impact Analysis (RIA) that provides the information necessary to implement our “scientific method”-based analysis.[3]  Below is Table ES-4 from the RIA that provides CO2 emission projections for a base case without CPP implementation and two policies cases under CPP implementation.  The two policy cases are labeled “rate-based” and “mass-based”, respectively, but for this analysis the distinction is not important.  Consider the base case the “control” scenario and the policy cases the “treatment” scenario.

CPP Table ES-4

The Table ES-4 reports projections emission projections out to 2030 for the base case (or business as usual) and policy cases.  By 2030, the policy cases both achieve a 32 percent reduction from the 2005, just as EPA claims (see the last column of the table).  However, the base case without CPP implementation projects an emissions reduction of 17 percent by 2030 relative to the 2005 baseline.  This is mainly due to the falling price of natural gas generation relative to coal generation, where the former is significantly less carbon intensive than the latter.  But, importantly, this change in the generation mix is independent of CPP implementation and thus included in the control scenario (i.e., base case).  Therefore, the difference between the control and treatment scenarios is only 15 percent, not 32 percent!  That is, implementing the CPP, all else equal, leads to a 15 percent difference between in the emission level from existing power plants by 2030.[4]

As litigation surrounding the CPP proceeds during the summer, it is important to remember what is really at stake: 15 percent.  While that 15 percent reduction in U.S. power plant emissions might seem small, it actually represents over 400 million short tons of CO2 reductions, which is equivalent to all 2011 carbon emissions from Spain.[5]

CE3 Blog by Daniel H. Karney, Department of Economics, Ohio University.

[1] https://www.epa.gov/cleanpowerplan/clean-power-plan-existing-power-plants
[2] https://www.epa.gov/cleanpowerplan/fact-sheet-overview-clean-power-plan
[3] https://www.epa.gov/cleanpowerplan/clean-power-plan-final-rule-regulatory-impact-analysis
[4] This analysis relies on the results from EPA’s model of the U.S. electric power sector given a set of assumptions.  Different assumptions – for instance, a higher economic growth rate – change the model results.  Furthermore, a different model with a different model structure might yield different results and therefore different conclusions.
[5] http://www.ucsusa.org/global_warming/science_and_impacts/science/each-countrys-share-of-co2.html#.VvP8uHDeMgs

Sustainability Emerges as Central to Global Corporate and Social Innovation

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Proactive global companies are moving the concept of sustainability beyond an intangible vision and aspirational goals in support of concrete actions, visible metrics and public reporting and disclosure. These companies value innovation, conscious capitalism, and a new model for business that is more accountable to a global citizenry than to crony capitalism or PAC activism. They also realize they must offer a responsibility-based “service” to others for their products and services to differentiate themselves and compete successfully in a dysfunctional society with consumer options too numerous to count. Economic performance still must be achieved, but more C-suite executives are balancing their bottom line with a more sophisticated complexity grounded in scientific, systems-based thinking.

Companies and global enterprises cannot succeed nor profit in a society that is failing with little regard for the integrity of workers, consumers, natural resource use or environmental resilience. Ignoring the trend towards sustainability principles will leave the laggards at a perilous high risk of failure because of exposure to the creative destruction of capitalism in normal business cycles.  Here are the top ten reasons not to ignore this trend:

  1. Companies with sustainable business models have lower costs of capital, better capital expenditure levels in their industry peer groups, and enjoy quality training for their workforce, better management, succession strategies and industry respect.
  2. Commitments to sustainability and their implementation appeal to millennial human capital with relevant skill sets encouraging this market transformation and values-based capitalism. Companies in heavy metals, minerals extraction, utilities and energy-intensive manufacturing are realizing that with senior staff retirements they face a “brain drain” and human capital shortfall.
  3. Sustainability-minded companies enjoy wider networks of stakeholder support and respect—especially from millennials—which are reinforced and validated through social media efforts, thereby providing communications, marketing, sales and public affairs benefits on proactive and defensive corporate issues. A company must always manage with trust as we saw recently with Volkswagen’s emissions scandal.
  4. A company’s leadership on sustainability thrives through its supply chain by fostering quality communications, productivity, modernization and execution support for sustainable results through thoughtful partnering and not rote supplier mandates.
  5. Sustainability becomes the centerpiece of innovation, encouraging improvements in the R&D process and methods, and quality and productivity metrics, throughout the company’s supply chain. Improvements to existing products, methods or processes already in the mix are more likely to appear than just sole reliance on new products.
  6. Resource, materials, energy and water impacts are accounted for, with decreases in waste materials and negative community and ecosystem impacts. Stakeholders’ concerns are better managed and enhanced corporate-community partnering can be sustained with improved risk management and more economical results.
  7. Financial and non-financial compliance and goal-oriented outcomes are fostered with increased levels of cross-team respect, allowing teaming and innovative solutions to be undertaken with less confrontation or adversarial hurdles within companies, and across stakeholders and their external markets.
  8. Product development, design and process improvements occur that are focused on durability, efficiency, minimal waste creation and maximum resource recovery and reuse. Life-cycle cost analyses for products improve, contributing to positive company and socioeconomic outcomes beginning at product inception instead of at product disposal.
  9. Product branding, loyalty and cost benefits accrue to support better teaming with customers and the media for future market share retention and growth. Sales and marketing initiatives can become more effective and productive—the gains of which can be reinvested into customer service, O&M support, social media, revenue sourcing and feedback for new product development.
  10. Improved performance within peer industry groups of sustainable companies promotes better economic outcomes for products and motivation for senior management to achieve performance incentives that benefit the customers served. As noted above, companies who differentiate themselves on sustainability principles are also able to attract relevant millennial talent that is drawn to a comprehensive value stream that is not merely financial, but reflective of wider values, integrity and character.

Historical growth with its cyclical patterns and consequences has fostered a false sense of consumer capitalism security, marked with concentrations of capital and power. Yet status quo capitalism without sustainability-focused improvements does not support the global capacity to bear a doubling of the Western-lifestyle expectant population in 15 years as related propaganda might purport. At this current resource consumption trajectory, what level of growth can really be achieved? Capital availability, mergers and acquisitions and technological innovation create complexity in this growth thesis. These growth tensions were already appearing in global markets as of 2014 and are spreading.

New Metrics

Leaders as diverse as product designers GE, Eaton Industries, Apple and Ford Motor Co. to leaders in cities, counties and local governments are demonstrating how to create a new structural framework for growth that is sustainable. In places across the U.S. from Seattle to New York and Austin, Texas to Arlington County, Virginia, locally-led initiatives center on buildings, “Smart Cities” growth, efficiencies in energy, water, solid wastes, transport, and more.

These trends may focus less on economic growth measured by GDP, and more on human health, well-being and quality of life outcomes. Broader views and definitions of capital will arise, with new sources and metrics of value. The current monetary system and model for capital delivery must improve and extend the reach of public funding with more public-private partnering and matching funding to decrease a reliance on grants. Sustainability measures advance collaboration which is in turn replacing mindless competition. The subsequent financial overhaul of businesses and industries will likely be less Darwinian and more strategically service-oriented. In the short term, bubble speculation must be terminated in deference to investments that create a lasting multiplier benefit to stakeholders. Accountability, responsibility, long-term durability, innovation and stewardship are the real values created by corporate sustainability.

A greater incorporation of system-focused management principles will create a closed loop system where traditional law of commons thinking erodes in favor of longitudinal externality accounting. Shared ownership models like those already seen in hotels, ride sharing and health care will further expand with a heightened focus on product resilience and durability in new ownership and delivery models. The entrepreneurial, startup companies entering the market with this new business model are likely to model sustainable practices as well because of their relatively high investment in capital equipment (compared with mature companies) and because of their unique managerial incentives.

The past decade has set the table and transformed companies, industries and global markets. The process has been marked with confusion, setbacks, and achievements by corporate shareholders, NGOs and stakeholder leadership. Consequently, the Congressional Budget Office now forecasts a reduction in U.S. economic growth by 1% to 2025, compared with the 1980-2007 period. The results of structural, corporate dysfunction are validated by senior executive, boards, market, and customer action and impact growth priorities, competitiveness, and income equality in U.S. society. The trends can no longer be ignored because of the governance, market and financial operating risks that are created.  Moreover, Pope Francis has encouraged renewed moral and ethical dimensions to business practices and societal growth decisions which would apply equally to sovereign governments, companies and NGOs together.

Thinking Long with Durability in Mind

Until recently, markets generally were built on voluntary outcomes for capital investment, loans, product selection, and consumer choice. Yet markets are human enterprises formed by business, political and cultural choices. A corporate failure to address more sustainable outcomes in the upcoming decade could place at risk whether 50-70% of current companies listed in the Dow Jones will survive or not in the listing index over the next decade. For these companies to survive, they must ensure they are participating and contributing to thriving societies and global markets, and not just to their boards and shareholders. The affected communities, skilled employees and stakeholders already realize that their public success and well-being are on the line.

This awareness on both sides will be the center of a new value proposition that offers genuine value that is affordable and sustainable for people, communities, businesses and societies. That new value cannot be measured solely by GDP. Government spending must generate better returns beyond entitlements spending focused on physical and social infrastructure, R&D, innovation, entrepreneurial startups and healthcare and defense efficiencies through informed information technology. Technology solutions focused on processes, without asking why and what for, are only half truths. Companies must focus on doing no harm as they pursue their strategic business objectives; their raison d’etre will be held accountable, feet to the fire, through social media and global communications in our on-demand world. Case in point again, Volkswagen. That leadership will come from the engineering, communications, scientific and IT systems and functions with less reliance on the corporate, legal and financial functionaries of the past.

The evolution has begun, but at what pace, which industries and for how long? Who will lead and how? How should progress and outcomes be measured? And is there a moral and ethical obligation to do no harm as we consider our collective future imperatives? You, the leaders of tomorrow, will be answering those difficult questions to advance the transformation towards a sustainable future marked by success and measured to foster new and wider outcomes than mere profit ahead.

CE3 Blog by Michael J. Zimmer, Executive in Residence & Senior Fellow, Ohio University; Edited by Elissa E. Welch, Project Manager, CE3; Originally published Feb. 2015, Revised Feb. 2016.

 

The Prospect for Alternative Energy in a Fossil-Fueled World

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In the month of July 2014 (an “average” month with peak summer electricity demand), the U.S. Energy Information Administration (EIA) estimated that the U.S. used 6.65 quadrillion BTUs of fossil fuel-generated energy (i.e., coal, gas and petroleum), 0.75 quads of nuclear, and 0.81 quads of renewables (i.e., photovoltaics, wind, geothermal, biomass and hydropower). That’s a total of 8.2 quads. That means 9.1% of the total energy consumption that month was from renewables and 80.5% was from fossil fuels. Compare this to five years ago: in July 2009, 8.3% of total energy consumption was from renewables and 81.9% was from fossil fuels.

Continued phasing-in of renewables is required as part of an overall supply mix. In spite of the fact that over the past several years, the cost of renewables has been declining faster than other fuel sources, renewables will not likely surpass fossil fuel resources until post-2050. A more plausible supply strategy goal is to strive for increases of 10% more renewables each decade coupled with the increased use of demand-side management, transmission & distribution (T&D) investment, energy efficiency and waste heat recovery. The challenges are numerous, but the rewards will be long-lasting. Here’s why.

  • We have the technology to increase renewables, but it won’t be easy, quick or cheap. An inordinate focus on supply ignores the necessary infrastructure investment required to support renewables within the current investment framework for fossil fuel development.
  • Renewables cannot replace fossil fuels in the near term because the cost of capital, rate shocks and costs to end users. Energy investment will continue to compete with similar investments in new technology, water infrastructure, urban growth in our cities, housing stock upgrades, railroads, highways and tunnels and bridges. But renewables cannot be ignored or postponed because of their lower operating costs, efficiencies, reduced emissions and sustainability benefits.
  • Increasing renewables capacity will require huge amounts of capital outlay and technical expertise which could consequently boost business development, workforce training and infrastructure upgrades. These investments will create a 21st-century power grid that is distributed, diverse and more resistant to the effects of a changing climate and/or security attacks.
  • The status quo, consisting of resource extraction, fuels, transportation infrastructure, generation, T&D, manufacturing, etc., has taken countless investment dollars and more than a century to build. It will not be radically altered but will be modernized for the future with competitive manufacturing, global trade and tax reform pressures incentivizing more accelerated decisions than regulatory fiats or mandates.
  • The sheer magnitude of energy required to be generated on a 24/7/365 basis is impossible to recreate using existing technology, land transfers, materials (i.e., rare-earth minerals) and infrastructure. New technologies such as those being developed by our colleagues at Ohio University related to algae- based fuels, waste-to-energy and electrochemical technologies are the way of the future. Bringing them to market on a commercial scale is the next order of business.
  • The intermittency, lack of storage, and relatively high up-front costs of renewables make them less attractive for energy-intensive and trade-exposed (i.e., “EITE” and internationally competitive) industries such as steel, aluminum, paper and cement. These challenges will need to be addressed with reliable solutions so that these industries—the building blocks for infrastructure, manufacturing and product development necessary for competition in future global markets—can continue to grow.
  • The resurgence of oil and gas has led to a quiet revival of manufacturing, supply and logistics, and associated industries in and around the Ohio River Valley that has become a major driver in the post-recession economic recovery. North Dakota led the nation in job retention and growth over the last five years due solely to the growth in the unconventional oil and gas from the Bakken shale play.
  • The shale resources appear driven for global export value rather than indigenous national use. Similar development and trade incentives for clean technology and renewables for export value are equally important for advancing U.S. manufacturing and export product goals.
  • Experience in coal emissions controls has shown that the costs of mitigation are so high using existing technology, that it is not currently economically feasible. If mitigation follows a scheduled phase-in over a reasonable time frame and is coupled with significant legislative action (e.g., cap and trade, carbon tax, etc.), the adoption of low-carbon strategies such as renewables, nuclear, and carbon sequestration can be incentivized.
  • Electric generation technology, policy and market factors have reduced the cost to install renewables to the point that they are at parity with the cost of installing electricity from fossil fuel sources in many applications such as rural/remote areas, military installations and microgrids. Over the next five years, grid parity will escalate and could be accelerated by a market clearing price for carbon, a fuller inclusion of the negative externalities of fossil fuels, and the game-changing issue of electricity storage.

Fossil fuels enjoy 400-500% more national benefits and incentives than renewables—better balance in this mix is required moving forward. This necessary balance is already recognized by our military, intelligence and international energy agencies. Cities and countries where 70% plus of future global populations will reside also endorse a more balanced approach. Recognition is similarly advancing in global financial communities as investments in non-fossil projects are advancing rapidly. Aside from supply, the focus on network modernization, efficiency, materials science, and energy storage will impact the timing and depth of a global market acceptance of non-fossil alternatives.

CE3 Blog by Michael J. Zimmer, Executive in Residence & Senior Fellow, Ohio University with Scott Miller, Director, CE3; Edited by Elissa E. Welch, Project Manager, CE3