California on edge
What does the PG&E bankruptcy suggest for the utility business model? Some banks have stepped back from financing new projects in California for fear that future wildfires may threaten other utilities. As much as 85% of the electricity load is expected to have shifted from investor-owned utilities to community choice aggregators by the mid-2020s. State regulators are still wrestling with exit fees to pay for stranded utility assets and are worried about the challenge a fickle customer base presents for CCAs. Is the road ahead one of opportunity or challenge?
Five key participants in the California market discussed these and other questions at our 30th annual global energy and finance conference near Laguna Niguel in June. The panelists are Michael Picker, president of the California Public Utilities Commission, Kevin Sagara, chairman and CEO of San Diego Gas & Electric, Tom Buttgenbach, CEO of 8minute Solar Energy, Tom Werner, chairman and CEO of SunPower Corporation, and Jan Smutny-Jones, CEO of the Independent Energy Producers Association in California. The moderator is Todd Alexander with Norton Rose Fulbright in New York.
MR. ALEXANDER: Michael Picker, would you agree that the current market structure in California is unsustainable?
It is not just the wildfire liability that has driven PG&E into bankruptcy. You have investor-owned utilities that are losing some of their best customers to distributed energy. They lose revenue streams while retaining the full cost of maintaining the grid. Then you have less regulated community choice aggregators entering into long-term contracts to buy electricity, but not under the same rules as the IOUs. The whole independent power business is built around having long-term contracts with credit-worthy entities.
Is this sustainable? Do we need major reforms in how the California market works?
MR. PICKER: I want to take a second to notice the passing of Ron Nichols, who has been a longstanding colleague and a major player here in California, with Navigant, then with the Los Angeles Department of Water and Power, and recently with Southern California Edison. He was a person of extreme kindness and grace; we all miss him.
The last time I was here, I think the panel I sat on was asked whether the utilities were in a death spiral at the hands of SunEdison and SolarCity. I have the same reaction to this question. Our customers in California can get electricity from a variety of technologies and suppliers. The incumbent utilities are becoming transmission and distribution companies.
We think we have the business model of the future, but we have the rate structure of the 1950s.
Regardless of the degree to which customers are procuring their own electricity, all of the fixed infrastructure that the utilities will continue to provide is being funded based on the volumetric sales of electricity. Recent legislation has started to correct that by allowing utilities to charge customers who install rooftop solar a $10 flat charge, but that amount is capped. The challenge will be, as we continue to see evolution in customer choice, to provide the utilities with a predictable source of revenue for the utilities so that they can maintain the grid. The grid is a natural monopoly. It is the equivalent of a public highway.
MR. ALEXANDER: Kevin Sagara, SDG&E has said publicly that it wants to become a poles and wires company and get out of electricity generation. How do you see the future?
MR. SAGARA: Well, we have our principal regulator sitting right next to us, so . . . [Laughter] I totally agree with everything that President Picker just said. [Laughter]
I actually do. Obviously there is an issue around sustainability of the utilities in the state given their exposure to wildfire liabilities. I am confident it will be addressed. Once we get past that, we need to move to a modern rate structure. The current rate structure does not work in an era of customer choice. We are going to have more electric vehicles, more direct access, more rooftop solar and more CCAs. The rate structure is not designed for that.
In our service territory alone, rooftop solar is a $450 million-a-year rate subsidy going from one class of customers to customers who have rooftop solar. That is the share of grid costs that is shed by those installing rooftop solar on their homes to customers who continue to buy all their power from the utility.
That is a failure of rate design and is not sustainable. It is the same thing with the CCAs. You have customers exiting to take their electricity from local CCAs. You cannot have this and, at the same time, expect the utilities to bear the full costs of legacy power contracts they entered into in the past to comply with state policies to serve customers who have now moved to CCAs. The CCAs must take their fair share of those legacy costs along with the customers. More than 45% of the electricity that SDG&E supplies today is from renewables. We support customer choice. We just want to make sure that there are not unfair rate shifts among customer groups.
A modern rate structure is essential to serve other policy goals. You are not going to get lots of people buying electric vehicles if they have to pay 40¢ to 50¢ a kilowatt hour to do so. Yet under our volumetric rate structure, that is what we have today in California at the upper volume levels.
I came from the solar and wind development side of Sempra. Prices for wholesale solar and wind electricity are very low. You will sell a lot of electric vehicles if the electricity costs 4¢, 6¢ or 7¢ to charge a car. The same is true for electric water heaters and a lot of other places where electrification wants to go. We need a more modern rate structure.
MR. ALEXANDER: Tom Werner, your take? Do you agree that the remaining utility customers are bearing an unfair share of the cost to maintain the grid?
MR. WERNER: I agree that customer choice has moved faster than policy. As the cost of storage comes down, it will just compound the effects. The model is not sustainable. However, I struggle with the idea of imposing a fixed charge on solar rooftop customers. It is not a good solution because it does not encourage the right behavior for energy use. There are probably better rate structures.
MR. ALEXANDER: Do you think distributed energy will continue to take a larger and larger market share?
MR. WERNER: The payback period for a commercial solar customer to recover its investment in a solar-plus-storage system is nearing two to three years. At such rapid paybacks, installing solar is a fairly easy decision. The equipment is warranted for 25 years. If the market evolves in such a way that ancillary services get compensated, then the payback period improves even more and this trend, I think, is inevitable.
MR. ALEXANDER: Tom Buttgenbach, you have built one of the most successful utility-scale solar developers in the country. Do you think the current market structure is sustainable, and do you see distributed energy continuing to gain market share?
MR. BUTTGENBACH: I do not think the current market is sustainable. I think that California is headed towards a potential disaster unless we fix it. I do also think that the PG&E bankruptcy is a good thing. Sorry to say that, Kevin, but . . . .
MR. SAGARA: We had a renewables business that had PG&E as an offtaker, but we sold it last year.
MR. BUTTGENBACH: We didn't buy it.
The PG&E bankruptcy is forcing all of us to take a hard look at the future in California. The wildfire liability is a totally different problem. What Michael Picker just discussed is the grid design, and I think we all agree that it is due for a major overhaul.
The CCAs are a big problem. They were created without an adult in the room. The largest CCA, Team Power Alliance in Los Angeles County, had something like 30 cities sign on. Someone said we will give you 12 chairs and one office, and now go run a multi-billion dollar business.
It has no balance sheet. There are now two financeable CCAs. That reminds me of 2006 or 2007 when I drove through LA and there were posters hanging on the light posts saying, "No job? No problem. We'll finance you to get a house." Those people were financeable in 2006 and 2007. Not much longer. I think the CCAs are in a similar stage. We are thinking about entering into PPAs with CCAs, and the bankers tell us, "There is a lock box that will lock up six months of cash." The PPA is 20 years. What good does it do me to have a six-month lock box? I have no idea.
Maybe my perspective is colored by our situation. I own the company. When I sign a PPA, it is my personal funds on the line. I am struggling with the idea of signing a large, 20-year PPA with someone who has a credit rating suggesting he may be able to pay his bills for the next two years. The CCAs have no assets. So what is that credit rating based on? I have no idea. Mortgage-backed securities were also credit-rated until suddenly they were not.
I am really concerned about the future of the market, mostly driven by CCAs going bust. First, they drive the IOUs into bankruptcy, because it is impossible to run a business when half your customers are walking away. Then some of the CCAs are going to screw up. I am not saying all of them, just some, but that will be enough to take the whole ship down because the guys in New York will stop answering the phone.
At some point the music will stop, and all of these projects that are signing contracts with CCAs will not be financeable. To my mind, that is a huge problem. We have to tackle that. It probably requires a legislative solution.
The funny thing is the ratepayer is in good shape. Joe, in his home, will pay his bill. I, as an independent power producer, am okay. I am happy to sell. It is the people in the middle who are a mess right now. It is the IOUs and CCAs. The only stable ones are the municipal utilities.
We have to figure out how to stabilize that market going forward. The PG&E bankruptcy is an opportunity to force a redesign of the way the IOUs and CCAs interact.
Provider of Last Resort
MR. PICKER: I have a slightly different perspective. I think part of the reason why we see such anxiety about this is not just the fact that there is a new player that is moving into a field traditionally served by the electric utilities. It is also that the independent power producers on this panel did too good a job. Too many contracts were signed, and too many projects are still being built, leading to a flattening of wholesale prices.
The fact that we are returning to a disaggregated procurement system is not new.
There are similarities between what is happening today and what happened during the California energy crisis in 2000 and 2001. We know what mistakes we can make. And yes, we are making them again. We spent two years conducting workshops and hearings and writing two reports to examine whether we are drifting back into the same set of patterns as in 2000 and 2001. I think we have learned a lot, but clearly not enough.
The California legislature read the reports, and there are competing bills to create a backstop procurement system in California. I expect something will pass. I think it will help to stabilize the market. I am not so alarmed about those challenges. There will be failures, so we need to create a provider of last resort that we do not have currently and that will be the ultimate backstop.
The good news is how easy it has become to buy renewable energy and the degree to which such energy has become a commodity.
MR. ALEXANDER: One proposal is to make the IOUs the electricity provider of last resort.
MR. PICKER: That is the current situation. Our experience in 2000 and 2001 was that when all of a sudden an undercapitalized third-party provider fails — in that case, it was an electricity service provider or a direct access provider, people use those terms interchangeably here — in a really turbulent market, it dumps back on the incumbent utility an obligation to procure a lot of power in the spot market at peak prices.
That doesn't work. The costs are passed along to all the ratepayers, and there is a cascading effect. We are going to guard against that by creating a central POLAR, a provider of last resort. Some utilities may decide they want to participate in providing that service, but everybody else will have to fund that insurance. It will force us to focus on the different risks that third-party providers impose on the system. They are going to have to contribute toward the insurance in proportion to risk.
MR. ALEXANDER: Tom, do you think it will work?
MR. BUTTGENBACH: I think, yes, but it needs also to include the contract. It is not enough just to have a provider of last resort.
MR. PICKER: You guys are commodity providers. You are at the point where it is so cheap that it is truly a commodity. Will you continue to operate in this bilateral system? Will you be competitive on that level? Will we see the renewables industry go truly merchant?
MR. BUTTGENBACH: I wish. It is not a reality right now. I can't finance a plant based on merchant sales. I wish I could. Today we are relying on long-term power purchase agreements, but long-term has changed. It used to be 20 to 25 years, and now it is 15 to 20 years.
MR. PICKER: So then the statewide central procurement vehicle becomes very important.
MR. BUTTGENBACH: Right. The problem with central procurement is that the CCAs absolutely hate it and will fight it tooth and nail. They happen to be the political darlings right now.
MR. PICKER: No, they're not. They are losing that fight.
MR. BUTTGENBACH: Good. I am all for it.
What we have to provide is a financing environment where California is not seen as the next Venezuela. I can tell you we have a project in the market and about 50% of potential buyers have said, "California, we're not looking at it right now. I don't care who the project is with, doesn't matter."
MR. PICKER: We do not have growing demand for such projects, so why would they look at us?
MR. BUTTGENBACH: There is quite a bit of demand.
Seen a Thing or Two
MR. SMUTNY-JONES: This brings to mind an old Jim Morrison line about the future is uncertain, and the end is always near. Welcome to California. [Laughter]
I think it is a good time for a walk down memory lane. In 2008, there were 300 megawatts of utility-scale solar in California, primarily parabolic mirrors out in Kramer Junction. The price of utility-scale floatable tags was something like 50¢ or 60¢ a kilowatt hour. There are now 12,000 megawatts of utility-scale solar in California, and the price is now less than 3¢.
Ten years ago, rooftop solar was pretty much non-existent. Today, there are another 6,000 megawatts of rooftop solar. We have not built a new conventional power plant in California in a very long time. We built 16,000 megawatts of gas generation in the 15-year period leading up to the California energy crisis. That is all there is backstopping all this.
Then the CCAs roll in. In 2002, no one talked about 80% of the load shifting to CCAs. That was what they were going to do in Davis, in Berkeley and in a few other places, but that was going to be about it.
All of the post-energy crisis policy initiatives were successful in reaching their individual goals, but as these policies now converge, they are creating issues. They are part of our infrastructure. They cost money. We are going to be paying for them in the future. You put on top of that the wildfire liability and the bankruptcy, and it leads to a significant amount of uncertainty.
I represent a broad range of both renewable and gas generators, all of which have PPAs in California. We are a PPA-based system here. No one has built a merchant power plant here in a very long time. What we do in the future is a big concern.
I find it ironic that after 25 or 30 years of promoting deregulation and having multiple buyers and multiple sellers, the solution to this is to create a state entity that will buy power.
We have been able to work our way through things in the past. That will happen here again.
There will be some rough sledding for a while. Tom Buttgenbach and Michael Picker have accurately described some of the challenges with the CCAs. It is not a given that all of them will succeed. I can't think of any human endeavor where everybody is 100% successful.
We will have to spend time trying to figure out how to bolster the existing CCAs to address the issues around creditworthiness and long-term viability and to provide some place to go for customers of any CCAs that fail.
The bottom line is that there are a whole lot of people in this state who don't want to think about electricity. They want to hit the light switch, and they want the lights to come on. They are not interested in being prosumers. They are not interested in anything except reliable electricity that they can afford, and preferably clean. That's our market, and we have to keep that in mind.
MR. WERNER: It occurs to me that we want the audience to finance us, so we probably ought to pull back a little bit. [Laughter] Life isn't that bad. There will be a lot of good stuff mixed in.
That said, to pile on the CCAs, it is not good to have asymmetrical risk. You sign long-term PPAs, and you have short-term buyers. On the flip side, some of the capital that would have been invested in the past in traditional IPPs is moving to C&I. Things are getting very complex, but that's the beauty of software. In time, we will solve everything.
There is too much complexity in the near-term, but it creates opportunity for companies like us. And, by the way, the shift to C&I is to a form of project that is very financeable. [Laughter]
MR. SMUTNY-JONES: On the positive side, because you're right — I was just joking about that Jim Morrison line, by the way [Laughter] — you are in a state where we adopted a 100% clean energy policy, whatever in the world that means, but we are working on that. It is a huge market: the fifth largest economy. There is a lot of work to be done between now and 2045, so we need to get over this rough spot in the road to get on with it. We do not want to be spending our time on more bankruptcies.
MR. ALEXANDER: Kevin Sagara, the investor-owned utilities seem trapped in a political struggle. They face strict liability for wildfires. Their only source of money to pay the cost is to pass through the liability to their ratepayers. It is not exactly clear when they will be allowed to do so. This has led the rating agencies to downgrade the IOUs. Where does this lead?
MR. SAGARA: The inverse condemnation law imposes strict liability on the IOUs for wildfire damage. We have less-than-clear rules about when that cost can be passed through to ratepayers. The destructive wildfires are a product of climate change. We spent $1.5 billion over the last 10 years on hardening our system and putting 170 weather stations and 100 digital cameras into the field.
The costs of climate change mitigation will fall of necessity on ratepayers or on taxpayers generally. The investors will not bear the full costs in the end because they can simply pack up and invest somewhere else. We are going to have to decide whether cost recovery comes in the form of passing through directly in rates or we pre-collect and put the money into some kind of insurance fund, for example, through a securitization or other form of financing.
MR. ALEXANDER: President Picker, what is achievable politically?
MR. PICKER: I absolutely agree that we are seeing the effects of climate change. I spent a number of years thinking we were being successful in averting the impacts of climate change in California by helping to green up the electricity supply. We have done a good job. The electricity grid here in California accounts for only 17% of all the carbon emissions in the state. Transportation is 40%.
But we were practicing a form of climate denial when we assumed that this was enough. Last year, there were 8,000 wildfires in California, consuming about two million square miles. That's a lot. It is also abnormal, never having been experienced before in the meteorological records. Only one in 10 of the wildfires was related to electric utility infrastructure.
So we have a much larger problem, and we have to look at larger mitigation strategies. The utilities are now the largest forestry operation in the western United States, charged with removing trees on narrow corridors around their infrastructure. They are becoming the most granular weather system in the state of California. SDG&E has digitized most of the landscape behind the city of San Diego, and it provides better weather reporting on a more granular level than you can get from the National Weather Service.
Our utilities are the vehicle by which we transform the infrastructure in California. That infrastructure is increasingly focused on adaptation to the effects of climate change.
MR. SMUTNY-JONES: Last summer, we had a fire in Redding that started by hauling a trailer uphill with a flat tire. It destroyed half the town.
The utilities have become very serious about trying to address wildfires, and it will take money to do so. This is not just an investor-owned utility problem. I am a SMUD customer in Sacramento, and the SMUD general manager made it clear that if they burn down Placerville this summer, I, as a ratepayer, will be strictly liable for the cost. There is a small public utility district in Trinity County that is being sued for more than $32 million. Its annual budget is $12 million, okay? It is a small little PUD.
There is a lot of marketing going on that if we would just switch to micro-grids, no problem. The Tubbs fire, which you all know as the "wine country fire," got started by a privately owned electrical set up — a micro-grid, basically — of, I think, four poles and a bunch of wires going to pumps and wine cellars. If you learn nothing else listening today, the point is that a hot wire and dry brush cause fire, and if you put wind behind it, you have real problems.
This is a big problem that is taking up a lot of the legislature's time this year. There are something like 700,000 homes in what they call the "urban wild land interface."
MR. PICKER: Fifty percent of all new housing in California built since 2010 is in areas that now we consider to have extreme fire hazard risk. We make the utilities build wires and poles to all those new homes.
MR. ALEXANDER: Changing topics, what will happen to the power purchase agreements that independent generators have signed with PG&E?
MR. BUTTGENBACH: Nothing. Twenty years ago, the same judge preserved the utility's non-executory contracts. I am not worried about the contracts with PG&E. I am much more worried about the state being viewed as an area where future projects are unfinanceable. If PG&E were to decide to cancel some of its PPAs, the independent generators will sue. The costs of the litigation will be borne by its shareholders, if it loses. The upside, if contracts are cancelled, would benefit the ratepayers. So if I am PG&E, why would I cancel a contract when I don't capture the upside and I only capture downside?
MR. SMUTNY-JONES: Tom is one of my board members, and he is one of the calm ones. [Laughter] He may be the only calm one, as a matter of fact.
We are spending a lot of time on this issue, and I have to say that the CPUC, President Picker in particular, as well as our governor have been very clear about their expectation that PG&E will continue to honor the contracts. These contracts were executed as part of our climate change policy and for resource adequacy. They are fundamental to the integrity of how we operate our electric system.
If the utility starts rejecting contracts, there are liquidated damages provisions in those contracts that will still have to be paid by the utility.
The elephant in the room is that if California moves from one wildfire season to the next facing the same issues, I am not sure how many people in this room are going to be interested in investing capital in California to do all the wonderful things — the batteries, the electrification of the transportation fleet —that we will need to achieve our longer-term goals. Honoring contracts is fundamental.
MR. PICKER: The challenge is that, early on, there were many expensive contracts because nobody had built a large-scale renewable project in recent memory in California. You had to go back to Kramer Junction to see such a project. So investors wanted a premium. It is the older expensive contracts that people tend to focus on in terms of trying to do cost reduction. PG&E does not own those generating facilities. We made it divest most of its generating assets years ago. It is basically wheeling a commodity from a contract from a third party to consumers, and it gets to collect a little money on this. It is not a good business proposition. You can ask Kevin Sagara about that.
MR. SAGARA: We don't want to be in it. [Laughter]
MR. PICKER: It is an increasingly thinly priced commodity. There are some who would like to see those contracts renegotiated. There are some probable owners of those contracts who may be willing to do that. The CPUC does not break contracts. However, we will consider whether it is in the ratepayers' interest if two willing parties — as happens on a regular basis — have decided to renegotiate a contract. It is our position, and has always been our position, that we have to approve things that come out of bankruptcy.
MR. WERNER: We built around 1,500 megawatts of projects in California. The risk we were taking when we built one of the projects, called Solar Star, north of LA, were as big as the company. It was a massive bet, so we needed a reasonable return. Does the utility get a do-over? Of course, we are all brilliant in hindsight, but the risk at the time is unchanged. I don't think you get a do-over. I just wonder what the impact will be on our ability to reach our 100% renewables goal if we start to change legacy contracts. It will increase financing risk and make renewable energy projects more expensive to build. We have seen what happens in other countries, like Spain, when this happens.
MR. BUTTGENBACH: Let's be clear. The reason why those contracts were high-priced is not because the risk was so high back then. It is because the technology was so expensive. We paid $3 a watt in capital costs back then to build a large solar project. Today, the cost is 35¢. These contracts were signed to meet the state renewable portfolio standard. That was the cost at the time for such contracts.
Today, we are signing contracts to supply electricity for around 2¢ a kilowatt hour, from solar projects like our project in Nevada, and we will be announcing a very large project that is between 3¢ and 4¢ that includes massive amounts of storage at the gigawatt hour level.
These very large power plants have capacity factors that allow them to provide reliable power. They are not intermittent any more from seven in the morning until 11 o'clock at night. They can match exactly the load profile of the utility. That's what the utilities are looking for, and it is now cheaper than a new gas plant. We are below 4¢ a kilowatt hour, including storage.
We can design a system that is 100% reliable because the sun is highly predictable, which is different from wind where the storage is actually more expensive for a wind plant because you have a lot longer periods of potentially no wind. Solar plus storage creates a more reliable, more cost-effective system in the future, and I think a lot of the distributed generation will start going away because its appeal is going away. There is a better, cheaper and faster solution that the market will adopt.
MR. PICKER: I think that all this is focused simply on the generation side, and I'm sitting next to three people who've excelled at that. The reality is SB 100 is probably unnecessary, not harmful, but also absolutely insufficient to the task. The legislation that we should all think about is not SB 100 — the renewable portfolio standard was intended to direct investment to technologies that were not present in the marketplace — but rather another bill, SB 350, that requires us to meet a declining greenhouse gas standard.
We will not get to our 2030 carbon reduction goal, much less our 2045 goal, on 100% renewable electricity. We have to electrify the transportation sector, we have to de-carbonize buildings, and we have to figure out what we are going to do about those large industries that are much more difficult to de-carbonize.
One significant tool that we have always used in California is on the demand side. The heavy expenditures in energy efficiency, in appliances and building standards have made a significant difference in terms of demand in California.
If you are looking at California as primarily a place to invest in projects, there will be some business here. We will start procuring again shortly. But I think that looking at all these other needs is probably where the real opportunities will be in the future, and I encourage people not to remain so narrowly focused because the underlying structure of policy is going to move away from RPS to de-carbonization.
MR. ALEXANDER: Tom Werner, we are just about out of time, but I will give you the last word.
MR. WERNER: Changes create opportunity. As a businessperson, if you don't have change, then it is just a commodity business. So how do we capitalize on the changes? How do we electrify? How do we bring software? How do we make the power plant more flexible? I think there is lots of business to be had here.
I wouldn't be so extreme to say that solar power plants win. Consumers have a choice. They may want to produce themselves. I think storage is inevitable. The wholesale markets are going to change so that there will be more value for ancillary services. The utilities will become transmission and distribution companies.
The question is pace. There is lots of opportunity.