Editorial:
Technological change, which appears to be moving forward at ever-increasing speed, is also driving related changes in financial, regulatory, and policy arenas. The impacts are more significant than many people realize. Policy makers and energy consumers will need to understand the implications of the current turbulence, and try to ensure that public policies and systems of oversight are keeping pace. A prime example is the way the energy system is responding to shorter and less certain economic lifespans and depreciation periods for energy infrastructure. The rules built into our energy system are based on useful lifespan estimates. These rules and assumptions determine what technology gets installed where, who pays for it, and ultimately how the benefits are distributed. It may be time to ask whether our assumptions or systems need to be updated.
The competition for the latest and greatest energy technology is alive and well. This is entirely positive. The creative interplay, often on a global scale, will likely produce all kinds of innovation in generation, transmission, energy management and delivery. Examples abound: Think of rooftop solar, electric vehicles, smart home controllers, shared storage, and intelligent interfaces of all sorts, vying for market share. In less than a decade the consumer will likely be offered a basket of tools and options to manage energy consumption, storage and production, at a level of sophistication previously available only to utilities. Not everyone will want to be active in the local and regional power markets. However the software will be working away tirelessly, optimizing the variables for the less active customers almost as intensively as it does for the active customers.
Unfortunately, in integrated systems like the power and gas grids, where some functions are highly regulated and others are wide open to new competitive entry, the path to market for viable innovations may be strewn with financial barriers designed for an earlier era or a different system.
While the public in general and consumers in particular stand to benefit from the development and deployment of new technology, the new options that are selected, and the speed at which new equipment is installed, depends on more than their fundamental economic appeal. Well-intentioned checks and balances in the system can delay and condition the process for introducing new technology. For example, laws set minimum standards for new equipment, and regulatory rules normally operate to ensure that publicly-financed investments are efficient, and that costs aren't shifted unfairly between customer classes.
A telling example of the current rules is the timeline allowed for depreciation of regulated assets. For example, if a new apartment block wants to install an internal storage and energy management system, regulatory rules determine who will have to pay for the upgrades the local distribution company may have to build to make sure the operation of the new system doesn’t unreasonably impact the grid or other customers. In some cases the adaptation of the system is a shared cost with benefits for all or virtually all customers. In those cases, the local utility is typically permitted to add the cost to its regulated rate base, spreading the cost amongst all customers and depreciating it over a lengthy period of time. In other cases the costs may be private responsibility of the project’s customers. Either way, these innovative initiatives could be assisted or impeded depending on what regulators and investors believe the appropriate depreciation timelines are for the new installations, and for the more centralized alternatives to them. Of course, regulators rely heavily on the expertise brought to bear by depreciation studies, which are usually done by external parties commissioned by the utility. No doubt the experts have been revising their spreadsheets lately, given that current development proposals are likely perceived as being at risk of being outmoded more quickly than before. Even in cases where upgrade costs are not rate-based, changing expectations about depreciation timelines will have an impact.
Is it a race against time for new energy technology? Who will get financial and regulatory approvals first, before the next wave of change displaces the latest installed assets? Perhaps the advantage goes to those with the shortest financing cycle, the best adaptation abilities, or both.
To be clear, a little known factor is at work, underwriting our collective energy systems: The depreciation period approved by regulators for major shared infrastructure like transmission lines and pipelines. Sometimes as long as 40 years, extensive depreciation periods help to make new infrastructure affordable today, and greatly assist the original developers’ ability to raise and borrow funds to finance the investment. This is good for the proponents of major infrastructure and their customers – a pretty broad group. But there’s a fly in the ointment: It may become more difficult to justify comfortable 40-year depreciation time frames if the pace of technology change is more rapid than it has been in the past.
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Sometimes as long as 40 years, extensive depreciation periods help to make new infrastructure affordable today, and greatly assist the original developers’ ability to raise and borrow funds to finance the investment.
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Regulators typically assess the reasonableness of an application for new infrastructure by looking at third party studies of how long a new asset is likely to be in service. In the past, a transmission line or a pipeline could be treated as a 40-year asset because the physical equipment lasts that long - and the economic demand for that kind of infrastructure could be assumed to be just as long. Those assumptions may face more questions as competing technology enters the market using relatively short timelines. How do you value a new 40-year investment proposal if the prevailing assumption is that much of today’s technology will be outmoded in 20 years?
What might shorter timelines mean for the energy sector?
Shorter depreciation timelines for the energy sector could have a range of impacts on the energy sector. To be clear, because regulators are unlikely to radically change depreciation timelines on existing projects, the impacts are primarily on which new investments are most likely to be added to the rate base. If new shorter term thinking on depreciation schedules finds its way into regulatory proceedings, it will impact the kinds of new common infrastructure that are likely to be approved and how much time they will have to recover their costs from consumers. Some of the new infrastructure could be of great value to local distributors, helping them to manage their systems, improving service, reliability and efficiency. At the same time there may be fixed costs for installing the new capabilities, and less willingness to stretch out the defeasement of those fixed costs over long time frames.
One of the potential outcomes of shorter depreciation timelines could be a shift in the balance between the bulk system and local systems. At the same time as Distributed Energy Resources appear to be gaining market share because of their inherent economics, their shorter development timelines could mean that the relative appeal of incremental investments in large scale and long term bulk infrastructure softens from the perspective of the overall energy market. In other words, relatively modest expansion of bulk infrastructure could become the general pattern while development and reinforcement of local infrastructure moves forward quickly.
The difficulty here is that there will be definite winners and losers as depreciation timelines for rate based investments are reconsidered. This is familiar territory for those in regulatory professions, if almost unknown outside the field. The key difference is that the discussions which have usually taken place gradually over the course of many years, may need to develop relatively soon and prepare to make some choices more quickly than has been the case in the past. Both regulators and the industry participants in regulatory proceedings may need to gear up their activities in analyzing depreciation timelines.
Promoting innovation is top of mind these days. However the readiness to adopt innovations might be dampened if concrete information were available on the cost impact of so much infrastructure being turned over more quickly thanks to continual technology updating. That kind of cost information might not force a complete rethinking of our technology choices, but at least we’d be better informed about why costs are rising.
What are the likely and possible responses for consumers and policy makers?
There will likely be many examples in which consumers and their distributors have to weigh alternative courses of action. For example, should we invest in new control infrastructure that will improve efficiency and allow for more operational choice on a day-to-day, if not hour-by-hour basis? What kinds of grid integration infrastructure can be justified? EPRI, the Electric Power Research institute, has begun a major initiative to identify tools and techniques for assessing these questions. Several studies available and soon to be released at the Integrated Grid project may hold some answers. (See story in the IPPSO FACTO magazine online at this location.)
It may be necessary to ask, from a consumer perspective, when is it appropriate to accept this kind of acceleration in the pace of infrastructure replacement. It certainly entails costs. One of the opening questions will likely be this: How can consumers determine if the benefits of these types of modernization are truly worth the costs?
The potential options and benefits are likely to be widely varied, provocative, and frequently changing as new options are brought forward by the entrepreneurially minded. Most likely, grid operators, along with regulators and policy makers, will need to create a catalog of new options, with initial assessments of their costs and benefits, for sharing with the public prior to regulatory hearings at which new depreciation timelines are being considered.
One thing is relatively certain: Determining the appropriate timeframes for new investments will become a more active area and affected parties will likely need to inform themselves and prepare for more discussion, both formal and informal. Collecting relevant information and organizing to share it with stakeholders in various kinds of public conversations will likely be increasingly important.
It would be interesting to invite the proponents of micro-grids, storage and distributed generation to make the case to ratepayers prior to future distribution rate proceedings, as to why they think the enabling investments will benefit consumers, if they are allowed to be partly or completely rate-based. This kind of information could prompt more engagement in distribution hearings than has usually been the case in the past. Objective results of such research if widely shared could help to ensure better decisions are made.
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In providing for consumers to have access to newer cost-saving technologies, the financing of certain types of long term assets becomes slightly riskier, raising costs for everyone.
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There is a little irony in the fact that, in providing for consumers to have access to newer cost-saving technologies, the financing of certain types of long term assets becomes slightly riskier, raising costs for everyone. Analogously, although Ontario’s recently announced Fair Hydro Plan is a topic too expansive to address here, one can only wonder if the assets covered by the 30 year refinancing will still be producing competitively priced power in the later parts of their depreciation period.
You never know where the next public policy debate is going to pop up. But if you want to make sure that debate focuses on key aspects of the system that can be consciously anticipated and managed, it could be very useful to prepare for organized discussion on the appropriate ways for dealing with the potential for new approaches to the depreciation timelines for energy infrastructure.
The Canadian Power Conference scheduled for November 20 and 21, 2017 plans to host an open discussion on issues of this nature as they relate to the energy sector. In preparation for that event, the APPrO Conference Committee is inviting concerned parties and everyone interested in these questions to voice their concerns and suggest issues to address at the conference by posting comments on this article or contacting the organization directly.
— Jake Brooks
This editorial also appears on LinkedIn at this location. Comments and further discussion can be posted there.
Note: This posting contains conjecture and opinion and should not be relied upon as definitive or used as a guide for any kind of investment decision. It contains the views of the author and may or may not reflect the views of APPrO or any APPrO members.