Record Changes and Uncertainty Reshape the U.S. Utility Industry

Wind production in the U.S. hit record highs in October 2015, natural gas prices hit record lows, and solar photovoltaic (PV) adoption is continuing to grow to unprecedented levels. Energy storage prices are projected to drop, several states are proactively targeting alternative resources such as demand response and distributed generation, and the Clean Power Plan has yet to be implemented.

Not surprisingly, the need for new business models is a pressing issue on the minds of utility industry stakeholders. This concern is echoed in DNV GL’s second annual Utility of the Future Survey. A third of respondents cited the need to find new business models as the most significant challenge facing the industry over the next five years.

Clean Energy Drivers Are Prompting Diversification

Power generators are particularly prone to business challenges stemming from lower market prices, the rise of renewable energy generation, and evolving policies on emissions regulations. According to DNV GL’s Pulse Survey, 44% of respondents believe generators will face the greatest challenge with the rise of renewables.

Early indicators reveal owners of generation assets looking to change their business through diversifying their investments toward clean energy and energy storage. For example, in 2015, AEP announced plans to increase renewable generation capacity by roughly 8,500 MW and natural gas capacity by 3,000 MW, dropping its share of coal production from 50% to 45% by 2026. In addition, the company recently invested $5 million in Greensmith, a grid-scale storage software and integration offering provider. NextEra plans to invest $100 million in energy storage over the next 12 months and is continuing to grow its renewables fleet. Southern Company recently announced the issuance of $1 billion in bonds, with the funds planned for renewable energy projects. Energy storage procurement targets in California and Oregon also will require utilities to invest in storage.

More broadly than the examples noted above, we are already seeing a sizeable shift across the U.S. in changes to fuel use. According to the U.S. Energy Information Administration, generation from natural gas has been increasing, with July last year seeing monthly natural gas–based generation surpassing coal-based generation and the share of coal dropping compared to natural gas across the country.

The Financial Outlook

The financial community more or less agrees that significant challenges lie ahead. Moody’s recently revised its industry outlook for the U.S. unregulated power and utilities sector, giving it a negative outlook for fundamental business conditions in 2016. However, the ratings agency stipulated that the industry outlook for U.S. regulated utilities in 2016 was likely to be stable due to expectations of a supportive regulatory environment.

Moody’s cited falling market prices and weaker demand prompted by energy conservation and slow economic growth and noted a widespread shift to renewable energy. Separately, it stipulated that New York’s Reforming the Energy Vision (REV) initiative would have negative credit implications for unregulated generators, particularly should peaking plants see revenue declines from REV-induced peak demand reduction.

More Forces of Change

Pressure will continue. State renewable energy standards, for the most part, remain intact or are even growing. Price drops in PV and storage fuel expectations for these alternatives, and many customers have plans for continued adoption. Wal-Mart, for example, has installed 105 MW of PV on roughly 6% of its locations, making it the single largest commercial solar generator in the country. The retailer is targeting a doubling of its PV investments by 2020. Even if natural gas prices rise again and renewable incentives decline, there’s a strong likelihood that the technologies prompting reduced volumes in demand, thereby affecting the demand for traditional generation, will continue.

Apart from falling demand and increased regulation of emissions, another phenomenon likely to affect generation portfolios is ramping capability. As variable resources take a greater share of portfolios (and if loads become less predictable due to end-user investments in distributed energy resources), ramping capability will likely become more valuable. System operators such as CAISO and MISO are beginning to explicitly account for ramping needs. Demand for ramping capability will potentially shift market demand toward flexible assets. Natural gas turbines and energy storage are technologies poised to take advantage.

Apart from diversifying the bulk generation portfolio, an additional question is whether we will see more movement toward non-generation technologies, such as storage, demand response, and distributed energy resources. As noted above, many utilities are investing in energy storage. Furthermore, customers and activists are calling for alternatives to coal and natural gas plants. Duke recently modified its plan to convert a coal plant to natural gas and add transmission, deciding instead to build smaller natural gas units and work with customers to reduce peak demand through energy efficiency and renewable energy. Southern California Edison (SCE) (SCE) recently faced criticism for plans to invest in new natural gas generating capacity. Critics said SCE had not focused enough on clean energy resources. Activists in Oregon have a ballot initiative under way to require utilities to eliminate coal generation by 2030. It may be too soon to see diversification across the full value chain as a standard option, but it is a feasible, potentially long-term approach for many. Existing pressures could make that a reality.

Diversifying is likely the best hedge at this moment where the market is in flux. However, the overall trend is clear: New energy resources and generation sources are here to stay. While utilities are starting to shift their investment and generation portfolios, the question of which business model will succeed is still working its way out in the market. ■

Jessica Harrison (Jessica.Harrison@DNVGL.com) is head of section for Energy Strategy, Markets & Policy Development at DNV GL.