The stranded assets problem

If you wanted to point to a single year as the source of the current challenges facing the California electricity market and the major choices it’s leaders are confronting, it would be 2002.  This was the year of AB 117, the bill authorized community choice aggregation; the year of SB 1078 that established the original Renewable Portfolio Standard;  the first year the major generation capacity contracted in response to the 2000-01 electricity crisis came online; and the year the CPUC started allowing utilities to negotiate long-term PPA contracts with independent power producers (IPPs / generators).  No single one of these policies is the cause of the current turmoil but their convergence has given rise to a core problem in the changing California market: stranded assets.

The stranded asset problem is not new – it shows up in any basic investment risk assessment of any business.  Even in the California utility market, the stranded asset problem arose in the early 90s when the legislature and the Public Utility Commission (CPUC) were mapping out how to deregulate the electricity market – forcing the IOUs to sell all but a few of their physical generating assets. But unlike Finance 101 or mid-90s California, this time stranded assets are not physical (or technical) investments – they are contracts. Specifically, long-term Production Procurement Agreements (PPAs) with IPPs.

These contracts establish a set $/kwh price (plus additional prices for frequency and other ancillary services) and a minimum purchase amount by the utility annually for the life of the contract (usually 25-30 years).   These prices are then passed directly through to the customers on the “energy” line item of their bill.   In response to the RPS, several of these new contracts over the next 10 years were for renewable power – solar and wind – at prices that reflected the cost of these technologies before the significant drop in $/W in the early 2010s.  Hence the bid price of a solar plant into the CAISO wholesale market is exponentially lower now than the contracted price the utility (and thus customers) end up paying.   These contracts also assumed a load growth over that 25 year period that has, in reality, flatlined after the 2008 economic crash and doesn’t look like it’s coming back any time soon, if at all.

Many point to the rise of CCAs in California, starting in 2010, as reflective of the public belief that utilities are not moving fast enough to run the entire electric grid on 100% renewable energy.  However, while that is a strong local selling point, the state could reach that goal with the simple act of passing SB 100 and moving (and redefining) the RPS to 100% renewable. What makes the CCA case so strong is the economics – the opportunity to deliver cheaper power to communities because renewable power in California is significantly cheaper than what we’re paying for it.

The stranded asset problem, as it manifests in the CCA challenge, is embodied in the Power Charge Indifference Adjustment (PCIA).  The PCIA is intended to balance the contracted payments the IOU owes generators for the remaining life of a PPA for power customers are now buying from their CCA at lower rates.  It’s wrong to have customers staying with the IOU make up the difference in cost, and the utilities just not paying the bills would send them into bankruptcy (not a good idea).  The argument then – as seen in the current CPUC docket – is what and how should the PCIA be calculated.  Not surprisingly, CCAs argue that its current calculation is too high and the IOUs argue that it’s too low.  The Utility Dive article here gives a good overview of the changes each side is proposing.

But there is a larger structural challenge that this decision – depending on its result – will either inform or avoid.  The issue of stranded assets and the incentive structure of the cost-of-service utility revenue model.  Both Moody’s and the Rocky Mountain Institute have released reports in the last week pointing to the risks to major utilities in further investment in natural gas generation.  Not coal. Natural Gas.  What they both highlight is that with the increasing growth and decreasing price of renewable generation – utility-scale, corporate direct access contracts, and distributed energy resources – significant investment is more natural gas generation, utilities and energy companies are risking a serious stranded asset problem not just in California but across the country.

In 2002, California was already exerting significant political effort to transition the electric grid onto cleaner natural gas as a “bridging fuel” to renewable energy.  The general market and investment expectation was that that bridge would be necessary for about 30-40 years until renewables could really take over the majority of power production in the country.  It turns out renewables are running 15 years ahead of schedule and both the political and financial worlds have been caught off guard.  The stranded asset problem is rolling down the tracks and picking up speed.  It is imperative we come to a solution – one that will likely leave everyone a little pissed off but hopefully no one completely screwed over – before we get run over by the oncoming train.

You keep using that acronym…it may not mean what you think it means

There’s a vote today/tomorrow at the California Energy Commission (CEC) that has thrust “ZNE” back into the headlines. “ZNE” in this case stands for “Zero Net Energy” – the goal for a building to have onsite (or nearby) renewable generation and building efficiency investments such that it generates as much electricity as it consumes over the course of a month or a year.  But there is a new trend occurring in California policy language that is replacing “energy” with “emissions” in the ZNE calculation.  A shift that has major implications for the energy landscape.

While energy is a broad category, in policy, zero net energy is almost exclusively used in reference to electricity. This is best illustrated by the progression of building standards from the California Energy Commission from basic efficiency increases to upcoming ZNE requirements in new residential construction.  Yet even before these new standards go into effect in 2020, there is now a new bill (AB 3232) which directs the CEC to open a new proceeding to determine how to get energy use to zero emissions.

The primary source of this language adjustment can be traced to the three major utilities (IOUs).  As California policy makers and clean energy advocates pushed to decarbonize the grid, the IOUs started countering that the overarching goal should be a decrease of emissions and therefore policy should focus more on transportation – now responsible for a greater percentage of GHG emissions than electricity – instead of continuing the push toward a 100% renewable grid. A shift in focus to transportation could also drive incentive dollars toward greater EV deployment and lead to bills like AB 1745 that seeks to eliminate the sales of internal combustion engine cars and trucks by 2040. (Originally I’d qualify 1745 as a moonshot bill this session, but with Trump and Pruitt’s recent shot across the bow on emissions standards, movement on this bill may reveal just how ornery the CA legislature is feeling this election year).

While an increase in EVs may help the IOUs electricity business, success in changing the policy language and scope of from power to emissions may end up a pyrrhic victory. Advanced energy industries in the electricity sector lose nothing by changing measurements from clean generation to decreased or avoided emissions. The recent headlines from Portugal on what can best be described as a “zero net emissions” month on their electricity grid shows why. Broadening the focus to emissions will still incentivize new clean technologies but instead of moving the electricity sector out of frame, it could put a target on the other half of the IOUs business – natural gas.

If we clean up electricity and use it to power transportation, our remaining emissions are driven by the demand for heat.  Natural gas demand in the US is relatively evenly split between heat demand for building temperature and for industrial processes.  In the residential and commercial sector, electrifying heat demand is technically possible. However, as a recent GTM article illustrated, it’s not an easy, or economic, process – revealing a lot of low-hanging fruit in this space. Policies originally designed to drive fuel switching from dirty coal electricity to cleaner natural gas 20 years ago are now disincentivizing switching from GHG-producing gas back to a now 65-75% zero-emissions* grid. In a ZE policy environment, these will be first on the block.

This risk to utilities natural gas business was clearly seen recently in Sempra’s Very Bad Week™.  In addition to new natural gas plant denials in place of DER aggregation and storage, the CPUC looks like it will deny the SDG&E petition to build a new gas pipeline through San Diego, and SoCalGas was caught out working against efficiency programs that would drive down demand. Sempra’s recent 10-k filing specifically calls out the inherent risk of zero emissions policies to its shareholder returns.

The question remains on how quickly this transition from energy-ZNE to emissions-ZE will take. There are components of emissions-oriented measurements already in effect such as California’s cap and trade mechanism – another example of a “zero net emissions” approach – or 2015’s AB 802 requiring any >50,000 sqft building to submit energy and efficiency data to the CEC for benchmarking.  But the real political signal flare will be if and when a California governor stops talking about cleaning up specific market sectors and throws down the ZE gauntlet – publicly setting the long-term goal of a zero emissions economy.

*All renewables, hydro, and nuclear

Happy (Belated) Birthday to Us!

I just realized that Semper Varia turned a year old last week (April 17th to be precise)!  I’m really proud of the work and support this company has provided clients over the last year and look forward to new adventures in this ever-shifting market of ours. Thank you to everyone who supported and cheered me on over the last year.  Onward!

ITC Section 201 Decision

The next 24 hours are going to be filled with hot takes and calculations regarding the ITC announcement of tariffs on solar cells. I have three.

1) No, it’s not as bad as it could have been, but SEIA is projecting up to 23,000 solar jobs at risk in the US because of the tariffs. So it still sucks.
2) Anticipate increased logistics costs to cover warehousing as outside solar companies stay competitive by front-loading & warehousing 2.5GW cumulative each year and selling to spec when they’re gone.
3) Combined w/ the changes in the tax code, we’re likely going to see a shift in the timing of commissioning systems from Q4 to Q3 (maybe Q2) which are going to screw up companies’ QFY1/QFY2 numbers for a little while. Don’t panic.

You can read the decision here.

CA Legislature 2018 – 4 Trends to Track

As we move into the second of the CA Legislature’s two-year term, there are a number of carry-over bills and a few new ones popping up on the docket that will be interesting to watch over the year, some of which we’ll cover here.  However, there are four big areas that will drive this years trends and will have the biggest effect on the sector.

The Timing: Election 2018 – While 2018 is a midterm election nationally, it’s the equivalent of a general election in state politics, and two of the major powerhouses that have pushed the California clean economy are moving on. As Governor Jerry Brown heads into his legacy year, there is little left on his personal energy agenda beyond regionalization (more on that below) and his swan song, the Global Climate Action Summit in September.  And former Senate leader, Kevin de Leon, is challenging Diane Feinstein from within the Democratic Party for her seat in the US Senate.  With California’s jungle primary system, it’s quite possible that de Leon will be running against DiFi twice – once in the June primary and again head-to-head in general. The governor’s desire for any final crown jewels to be set before GCAS, and de Leon’s need to focus solely on his campaign heading into November, makes it extremely likely that any and all 2018 energy legislation will be pushed over the line before the June recess.

The Crown Jewel: SB100 – SB100 – a requirement for all California utilities to procure 100% of electricity for the state from  renewable sources – got caught up in some last minute (rather ugly) politics in the Assembly just before the end of of the session last September, revolving around bills ostensibly around CASIO expansion and largely stuffed with pork, political payouts, and bad politics.  It is extremely likely that this will happen again this year.  Climate and clean energy advocates who want SB100 will need to fight hard to both push SB100 as a requirement for passage of any regionalization legislation, but simultaneously decouple them enough that SB100 moves to the governors desk even if CAISO expansion negotiations fail. It’s a thin needle to thread, but de Leon and Brown have a lot to gain and much less to lose this time around.

The White Whale: CAISO Regionalization – If there were a state policy equivalent to the complexity and competing stakeholders of the comprehensive immigration national debate, it would be merging the California ISO (CAISO) with the balancing authorities of other western grid states into a cohesive western Regional Transmission Operator (RTO). From labor, utilities, climate change warriors, consumer advocates, financiers, and energy developers, CAISO regionalization involves tradeoffs in multiple areas of the economy, starting with California giving up some of it’s autonomy and authority over its intrastate grid management.  And thus, the debate and legislation is going to be filled with pork, passive-aggressive soundbites, and other standard features of zero-sum politics.  However, over the 4 years the legislature has been grappling with this, there have sprung up competing interests outside of California – the mountain west transmission group (MWT) is looking to join the southwest power pool (SPP) and the need for CAISO to become a reliability coordinator after leaving Peak Reliability next spring –  that make 2018 a fish or cut bait year for this initiative.

The Silent Tsunami: CCAs – Community Choice Aggregation (also known as Community Choice Energy) was enabled in 2002 passage of AB117 as a (politically brilliant) way for the legislature to leave the door open to electricity market deregulation after the electricity crisis of 2000-2001 without ever saying the words “deregulation” again.  It would be over 8 years before the CPUC certified the first CCA implementation plan for Marin Clean Energy in 2010.  However, in the following 8 years, CCAs have started forming at a rapid clip and CPUC staff found that they could be serving 85% of the total load within the next eight. While the CPUC is concerned about this from a regulatory perspective, the politics are getting ugly between the utilities and CCA advocates due to the Power Charge Indifference Adjustment (PCIA). Utilities contract capacity (generation) to serve their expected load from power producers through PPAs that are typically 25 or 30 years long. If half that load departs to purchase power from a CCA, the utilities are still on the hook for the contracted capacity and payments.  The PCIA is the charge to former utility customers to cover the cost of the contracted payments.  That’s all fine from a financing perspective, but politically, the utilities are well aware that the more CCAs expand, the greater pressure there will be from constituents to not have to pay extra for power they aren’t using. This is why the addition of a 400MW capacity requirement for the IOUs in the regionalization bills was seen as a direct threat to CCAs – those contracts would have been included in the PCIA calculation of new CCAs, making them less competitive or even viable. Capacity requirements, renewable requirements, and the PCIA are all part and parcel to the underlying debate over the future of the state’s electricity market and the role of utilities in it.  This debate isn’t politically public on it’s own (yet), but the battles and skirmishes will be seen in multiple areas of multiple bills over the next few months.

Now What? Reading Trump Tea Leaves on ITC Section 201 Solar Case

The International Trade Commission has filed its remedy recommendations for the Section 201 case filed by Suniva & SolarWorld. These recommendations will be submitted to President Trump no later than November 13 and the President will make a final decision within 60 days whether to apply, ignore, or change the remedies before committing them to policy. While Trump is the most…erratic…decision maker we’ve had in the White House in recent decades, there are personality tendencies and external factors that can inform us of likely outcomes.

Whether attributed to core psychology or the result of growing up in the cutthroat world of NYC real estate, it is no great secret that Trump indulges the strongman tendencies inherent in his zero-sum, us vs them paradigm of the world. It’s well-documented that he’s not big on details, has a short attention span, and is known to change his mind or statements based on the last conversation he had.

Beyond his own personal tendencies, President Trump has a mix of advisors around him pulling in different directions. Advocating the pro-tariff argument will be the “economic nationalist” folks like Steve Bannon and his protege Steve Miller (don’t make the mistake of thinking that Bannon doesn’t have influence just because he’s left the White House). On the other side, you have free trade “globalists” like NEC Director, Gary Cohn and Treasury Secretary, Steve Mnuchin. While Cohn and Mnuchin will be making strong arguments aligned with the Heritage coalition in the ITC hearings, Bannon and Miller’s cohort have the direct line to Trump’s die-hard base.

It’s also worth mentioning that – given his appointments of climate deniers to scientific positions – health, environmental, and other quality of life arguments aren’t going to have much weight with this President. Throw into the mix a Secretary of Energy who seems to be ignoring even his own oil & gas posse to push FERC toward subsidizing coal and nuclear power in the name of “baseload reliability,” and it’s unclear how much detail or explanation of the energy economy will resonate with the President either.

On top of all of this, there’s the real wildcard – the President is traveling to Asia November 3-14 including two days of bilateral meetings with Chinese Premiere Xi Jinping. This comes after Xi just successfully executed a power consolidation that significantly strengthened his own position juxtaposed with a progressively weakening US President roiled in scandal and without any moral authority to challenge the Chinese leader’s own strongman maneuvers. Xi has some previous experience with Trump after his earlier visit to the US, which included an explanation of the complicated nature of China’s relationship and influence on North Korea. It’s a safe bet that Xi is going to bring this issue up in his meeting with Trump. The question is how he presents the issue. Unlike the NYC real estate market where cutthroat competition is predicated on the inherent scarcity of the market, the global demand for solar panels is only increasing. China’s domestic demand alone is projected to be 4x that of the US in 2017. Suffice it to say, we need them more than they need us.

So what does this all add up to? Trump has three likely courses of action.

Option 1: Accept the ITC recommendations – This is most likely if (1) the President listens to the Bannon-ites around him and wants to stick it to the Asian manufacturers, (2) finds the nuance, arguments, and multiple upstream and downstream variables of the energy market too complicated and detailed, and (3) on his desk when he returns from Asia, it will be the most recent message in front of him before making a decision. There’s a 40% chance of this decision.

Option 2: Ignore the recommendations – This will be the argument from Cohn and Mnuchin in addition to SEIA and others. As climate, health, and even jobs are likely to have little impact, it’s going to be important to have the “if it ain’t broke, don’t fix it” case made not just from solar advocates or free trade think tanks but also major industries that matter to Trump such as tech, manufacturing, and real estate. It would also be extremely useful to get Secretary Perry to vocally support this option. How Xi manages ‘face’ regarding Trump on his visit could also have a major impact on this result. There’s a 20% chance of this decision.

Option 3: Target China – This option is where the Asia trip wildcard and Trump’s strongman tendencies combine. If the President leaves China feeling weak or losing face to Xi, it’s quite possible he’ll lash out and use solar tariffs to do it. Trade penalties on Chinese solar panels play into his us vs them paradigm; responds with ‘economic nationalism’ language that resonates with his base; allows him to ignore the details of the larger energy economy; and, in some circles, will prove a nice headline distraction for a day or so to the Mueller investigation. Will it also embroil us in an unfair trade case at the WTO? Highly likely. Does the President care? Almost certainly not. The probability of this outcome is 30%, but is heavily dependent on how Xi handles the meeting with Trump and his ego – and one should never underestimate the Chinese sensitivity to ‘face’ in getting what they want.

Burying the Lede

A  PV-Tech article highlighting a decision by SunPower to sell their stake in yieldco 8point3 Energy added a quick note in the final paragraph on what may be another domino falling in residential solar financing.  It seems in addition to the yieldco sale, SunPower is also looking to sell its portfolio of residential solar leases.  It’s unclear if this signals the end of SunPower’s financing program entirely, but with the aim of returning to profitability by next year, it wouldn’t be surprising to see the company jettison the capital intensive product to return to its core solar manufacturing business. With scuttlebutt of troubles for Spruce Financial remaining solvent, OneRoof Energy closing its doors, and the recent bankruptcy of Sungevity, an exit by SunPower would further shrink residential third-party owned solar financing down to four: Tesla, Sunrun, Sunnova, and Vivint Solar.

The Customer Gets a Vote

There’s a common phrase in military strategy that every industry should adopt if they are selling to people…in other words, everyone. “The enemy gets a vote.” Regardless of how well planned, well executed, and well meaning an operation may be, it can all go pear-shaped if the enemy doesn’t react in the way(s) all the brilliant planning anticipated.

While one should never see the customer as an enemy, the same concept applies in just about any situation where a great idea or an amazing opportunity runs into the wall of consumer expectations or, more commonly, customer ambivalence. How many startups, regardless of industry, can one name that had a truly innovative, amazing idea that died due to bad timing, lack of interest, or a customer pool too small to monetize?

In the realm of energy, especially distributed energy, it’s important to remember that from the customer perspective, electricity has always been extremely simple and thus extremely easy to ignore. There is an amazing opportunity over the next decade to take advantage of new technology and data platforms to shift the electricity sector from a supply-driven model to a load-driven market – a shift that will affect industries across the entire economy, not just energy. But while those of us in the industry can see the numerous possibilities of DER aggregation, transactive energy, peer-to-peer power supply, and realtime power rates, none of them will manifest if they aren’t packaged in a way that provides customers with a sense of direct control without requiring a change in their lifestyle. Rooftop solar makes enormous sense for just about anyone in a position to install it (and often for those that aren’t), but in most cases and in most markets even something as simple as solar is still an educational sale – not because solar is particularly complex but because salespeople are fighting something much more powerful than confusion: complacency.

For an industry that hasn’t changed in 100 years, the power of inertia in engaging customers to perceive and act differently about electricity, in the face of extremely entrenched interests, is a pretty large Sisyphus stone. It will take more than marketing, lead generation, and soaring rhetoric. And most importantly, it will take more than grand ideas and shiny objects as products. As the distributed grid goes beyond solar and starts adding storage and platforms and energy management systems, each new widget may increase the capability of the end user but that doesn’t mean they’ll see the value of any of them in isolation or be willing to invest in each piece as part of a larger system.

If distributed energy is truly going to change how electricity is bought, sold, generated, and consumed, it’s going to have to have to guard against drinking it’s own kool-aid of shiny objects and focus heavily on building an entirely new system that saves homeowners money, decreases their carbon footprint, while staying extremely simple and extremely easy to ignore.

Lithium & the “Resource Curse”

I had an interesting exchange w/ Mike Gatto on Twitter this morning regarding the likelihood of the dangers and damage current ‘petro-states’ do to both their own economic development and the international security space writ large, would only be transferred to and repeated by states with significant sources of lithium and other rare-earth elements based on this FT article.  I pointed out that the US and other nations dedicated to international development have lessons learned and influence to help structure and/or direct policies on the extractives industry and those countries internally in order to avoid the “resource curse” – it was just a question of whether or not we would leverage them.  Mike doubted that such leverage would be used.  I didn’t disagree.

The resource curse, for those playing along at home, is an umbrella term for the numerous ways that building a national economy around a single high-demand resource (usually finite and labor intensive) damages the countries economy and civil institutions by flooding a limited group of individuals and companies with an exorbitant amount of money as compared to any other industry in the country.  This often opens the door to massive corruption, vast amounts of income inequality, and autocratic government dedicated to keeping the money flowing from that resource with little interest or investment in diversifying any other economic sector.  Examples of this are not just major oil countries such as Saudi Arabia, pre-2003 Iraq, and Venezuela, but also African nations mining coltan (used in electronics) and other conflict minerals, and, of course, Russia.

Thinking on it later, however, it did occur to me that there is one major distinction to be drawn between oil and lithium – the first is consumed, the other simply utilized.  This may seem to be splitting hairs, but it means there is a much easier path forward that avoids the worst outcomes of a resource curse for any country: recycling.  An economy that runs on oil (or coal or gas) is consuming that resource and must always replace it.  There is always a need for more production.  But a resource that is simply utilized can be re-utilized in another form – such as stacking worn out car batteries into a static battery bank on the electric grid – or recycled and re-processed to be used again – which Europe does with spent nuclear fuel as opposed to shoving it under a mountain like we do in the US.

Of course, as long as there is an ample supply of anything, the likelihood of major investment into recycling and reuse is small. We know this is still true for plastics and paper worldwide. Nor does this possibility negate the need to continue R&D into storage technology that use more common elements to avoid geographic and national dependencies.   However, if we keep avoiding the resource curse in mind, and push storage businesses to develop cradle-to-cradle supply chains from the outset, we’ll have a much easier time avoiding the exchange of one resource curse for another.