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The Dbriefs Energy & Resources series presents:

The Math Does Not Lie: Factoring the Future of the U.S. Electric Power Industry Greg Aliff, Deloitte LLP Marlene Motyka, Deloitte Financial Advisory Services LLP Branko Terzic, Deloitte Services LP January 16, 2013

Copyright © 2013 Deloitte Development LLC. All rights reserved.

Objectives of Paper

Planning for the Near Term

The Math

The Numerator

The Denominator

The Math at Work

Electricity Sector’s Response

Agenda

Objectives of Paper


Objective

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To explore what is changing in the electric industry and introduce a straightforward approach to examine the future through a simple framework using a mathematical equation. Two emerging trends

Moderating electricity consumption

Steeply rising costs


How do you think U.S. electricity consumption will change between 2012 and 2020? It will:

• Increase at an average annual rate of 2% or more • Increase at an average annual rate of less than 2% • Remain essentially the same • Decrease at an average annual rate of less than 2% • Decrease at an average annual rate of 2% or more

Poll question #1


Planning for the Near Term - 2020

7

• Longview Power’s 695 MW (net) supercritical pulverized coal-fired power plant in Maidsville, W.V., completed recently, took 5 years to come online • Georgia Power’s Vogtle and SCANA’s V.C. Summer nuclear

plants are expected to take 9 to 10 years to complete

Eight years is not far away:



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During eight short years, many unknown factors will impact the U.S. electric power industry, such as:

• The global and U.S. economy

• Coal, natural gas and nuclear fuel prices

• Federal and state policy and regulation

• Technological advances

• Changing customer behaviors and demands

Despite uncertainty, if constituents use a simple mathematical equation as the framework, they can focus on the variables and analyze them in relation to each other − The math does not lie.

The Math


The future can be evaluated with a simple mathematical equation

10

Cost per kWh sold

($/kWh)

Cost of electricity sold

($)

Number of kilowatt hours

(kWh) consumed


Variables to Include in the Equation

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The Numerator: Cost of Electricity Sold

The Denominator: kWh Consumed

Capital and Operations Costs Consumption Capital costs

• Generation, transmission and

distribution additions • Environmental regulation compliance • Renewable portfolio standards • Nuclear safety regulations • Cost of capital/interest rates Operations costs • Cost of fuel • Incremental operations costs of

environmental compliance retrofits • New operating technologies

• Changes in weather • Changes in the economy • New sources of electricity

demand • Technological advances in

energy efficiency • Customer attitudes and

behaviors


Which of the following variables do you think will have the greatest impact on the electricity sector’s costs from 2012-2020? • Investment in generation, transmission, and distribution

(associated depreciation and interest costs) • Environmental compliance costs (associated

depreciation, interest, and operating costs) • Compliance with Renewable Portfolio Standards (RPS),

(associated depreciation and interest costs) • Smart Grid Deployment (associated depreciation and

interest costs)

Poll question #2

The Numerator


The Numerator − Capital Costs

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Transmission Investment

Grid reliability and renewables integration • From $100-$120 billion in new

transmission assets between 2012 and 2020.2

Aging fleet and early retirements • Over $150 billion in new generation

capacity from 2012-2020.1

Generation Investment

Changing infrastructure and smart meter installations • $4.4 to $11.6 billion investment in new

smart meters alone through 2015.3

Distribution Investment 1 Estimate based on U.S. Energy Information Administration’s (EIA) forecasts for new additional capacity, overnight capital costs, and lead time for various technologies. 2 Based on The Brattle Group, Employment and Economic Benefits of Transmission Infrastructure Investment in the U.S. and Canada. Johannes P. Pfeifenberger and Delphine Hou, prepared for WIRES - Working Group for Investment in Reliable and Economic Electric Systems, May 2011. 3 Based on $150-$400 per meter deployment cost, MIT, The Future of the Electric Grid. Dec 2011 and estimated 29 million smart meters to be deployed from mid 2012 through 2015 (IEE – Utility-Scale Smart Meter Deployments, Plans& Proposals, May 2012).


The Numerator − Capital Costs

15

Renewables Capacity Investment

Twenty-nine states have set mandatory Renewable Portfolio Standards (RPS) and eight states set voluntary goals • U.S. needs to add 3.62 GW of renewable capacity

annually between 2012 and 2020 to meet RPS2

Evolving federal, state and local environmental regulations • EPA’s Mercury and Air Toxics Standards

(MATS) - estimated incremental compliance cost of nearly $55 billion through 20201 Environmental Compliance

Investment

New safety regulations required by the Nuclear Regulatory Commission (NRC) post-Fukushima will result in new compliance-related investment at nuclear plants

Nuclear Safety Investment

1 U.S. Environmental Protection Agency, Regulatory Impact Analysis for the Final Mercury and Air Toxics Standards, December 2011, p 3-14 2 U.S. Partnership for Renewable Energy Finance “Ramping Up Renewables: Leveraging State RPS Programs and Uncertain Federal Support” 2012.


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The Numerator − Capital Costs Future interest rates remain uncertain but are likely to increase from the current record low

0

1

2

3

4

5

6

Inte

rest

Rat

e (%

)

Interest rate on a 10-year T- Note, 2004-2012 (through August) Average: 4.3 %

Average: 3.1 % Average: 1.8%

Source: U.S. Department of the Treasury


The Numerator − Operations Costs

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1Tim Roberts, Ethylene – Good Today, Better Tomorrow – A Year Later, Goldman Sachs Chemical Intensity Day, Lyondellbasell, March 2012 2 Based on a sample 300 MW coal fired power plant and investment costs converted to $/kWh using a 15 percent fixed charge rate and 60 percent capacity factor. Source: Jim Lazar and David Farnsworth, “Incorporating Environmental Costs in Electric Rates,” Regulatory Assistance Project (RAP), October 2011, p.15

Recent technological advancements such as smart grid and electricity storage could decrease operations costs

New Technologies

Natural gas price needs to rise to ~$4.50/MMBtu1 to make much of U.S. shale production economical

Fuel for Electric Generation

Emissions retrofits’ can increase electric plant operating costs other than fuel by over 50 percent2

Emissions Retrofits

The Denominator

Copyright © 2013 Deloitte Development LLC. All rights reserved. 19

Decreases kWh consumed

Increases kWh consumed

Uncertain Impact on kWh consumed

The Denominator - Kilowatt hours consumed

• Advances in energy efficiency

• Customers will be able to “do the same with less”

• Increased electronics • Computer server

farms • Electric vehicles (EV) • Water management • Resurgence of U.S.

manufacturing

U.S. Economy

Energy Efficiency

Technology

New sources of

demand

Customer Behavior

kWh consumed

• Changing electricity consumption trends by businesses and consumers

• “Permanent demand destruction”?

• Recovery uncertain?


Consumer Resourcefulness Extends to Electricity Findings of Deloitte reSources 2012 Study* of over 2,200 demographically-balanced household decision makers

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• 83 percent of consumers reported they took steps to reduce their electricity consumption – up from 68 percent in the 2011 Study.

• The primary steps taken were behavioral in nature – turning off lights (78 percent), shutting down electronics when not in use (65 percent), adjusting the thermostat in the summer and winter (61 percent), and changing over to compact fluorescent lights (60 percent).

• While interest in purchasing smart energy technologies is relatively low, it is noticeably growing, with younger adults clearly more receptive to making the investment

* Deloitte Development LLC. Deloitte reSources 2012 Studies: Insights into Corporate Energy Management Trends and Insights into Emerging Trends of Energy Customers. May 2012


Businesses’ commitment to energy management practices intensifies Findings of Deloitte’s reSources 2012 Study* of business activities of over 600 companies with greater than 250 employees:

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• 90 percent of U.S. businesses have set goals for managing electricity usage with 49 percent having reported formal goals vs. 45 percent in 2011.

• Of these companies, 85 percent cite reducing electricity costs as essential to staying competitive – up from 76 percent in 2011.

• The average target for reduction in electricity consumption is 23 percent over approximately a 3.5 year period.

• 35 percent of businesses report some level of self-generation of electricity with another 17 percent planning to do so in the future.

* Deloitte Development LLC. Deloitte reSources 2012 Studies: Insights into Corporate Energy Management Trends and Insights into Emerging Trends of Energy Customers. May 2012


Federal Government Impacts on Consumption

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Federal Facilities Energy Reduction Targets: • Annual energy intensity decrease by 2015 using 2003 as a baseline year - 3 percent , i.e. a total of 30% by the end of fiscal year 2015 The Department of Defense (DOD) Energy Reduction Targets Even Greater: • Annual energy intensity decrease in DOD facilities using a baseline year

of 2003 - 21 percent by 2012 - 37.5 percent by 2020 • Renewables as a percentage of energy consumption- - 12 percent in 2012 - 20 percent by 2020

Source: Department of Energy and Department of Defense


As a consumer, have you taken steps to reduce your energy consumption? If so, which one have you taken? • Turning off lights • Shutting down electronics when not in use • Adjusting the thermostat in the summer and winter • Changing over to compact fluorescent lights • More than one of the above

Poll question #3

The Math at Work


The Math in Action:

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The numerator is going up and the denominator may well be going down over time for the first time in the history of the U.S. electric industry


The New Math Suggests a Dilemma

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• Will rising electricity costs and prices lead to further decreases in the denominator and even higher costs per kWh?

• Will the price to individual consumers invoke even greater end-user investment in energy efficiency?

• Will there be a wave of new, economically priced technologies designed to enable greater consumer and business control over their electricity consumption?

Since variables affecting results will vary from company to company, every company must do its own math

The Electricity Sector’s Response


Avenues to Evaluate

Increase electricity demand • Electric vehicles (EV) • Computer servers/data centers Identify new regulated revenue streams • Utility’s value proposition to on-site generation • Opportunities in residential and business

electricity generation or storage • Incremental value for EV beyond electricity? • Opportunities in related areas such a water

scarcity

• Identify and reduce/defer controllable costs

• Consider mergers, acquisitions, or strategic dispositions where significant synergy savings can be achieved

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Reduce numerator

Grow denominator


Poll question #4

Which potential new revenue stream holds the most promise for the electricity sector? • On-site generation • Residential and business electricity generation

or storage • Electric vehicles • Water scarcity (e.g. desalination)


Another Avenue: Change the regulatory paradigm

Evaluate changes to the current regulatory paradigm with policy makers and regulators against the backdrop of the New Math to arrive at mutually acceptable solutions. Examples of recent changes from the traditional model include: • Deregulation of generation • Decoupling of electric rates • Renewable portfolio standards • Demand response programs

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Explore Alternative Business Models

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Invest in new unregulated revenue streams • Diversify the company’s

overall marketplace risk

Evaluate opportunities for new products and services • Bundle electricity services with

other services, regulated or unregulated

Ride the technology wave

• Customer acceptance of new technologies creates new electricity demand, e.g. Best Buy’s Geek Squad Expansion

Re-consider business structures:

• Consider joint ventures and

public-private partnerships

Changing global marketplace and energy landscape suggests a re-evaluation of future business strategies


Navigating the Future

The U.S. electric power industry has weathered previous storms, but it could be navigating uncharted waters in the form of significantly rising costs to produce and deliver a unit of product in the face of consistently flat or declining electricity consumption.

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The time for true innovation in the electricity sector may have arrived

Question and Answer

Join us February 20 at 2 PM ET as our Energy & Resources series presents: ERM Governance – Board Oversight of Risk Management Programs at Energy Companies


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Branko Terzic [email protected] Greg Aliff [email protected] Marlene Motyka [email protected]

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This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

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