Are Utilities Deliberately Ignoring CHP Over Large Centralized Power Plants?
In July this year the American Council for an Energy-Efficient Economy (ACEEE) released a series of three papers (please see end of the article for source) that highlighted the benefits that electric and natural gas utilities can derive, if they invest in new combined heat and power (CHP) projects. However in reality utilities have seldom shown an interest in creating new CHP facilities. This article tries to list some probable reasons for this lack of enthusiasm by utility managers.
Traditionally a CHP project is developed by a facility that intends to meet its electric and heat demand on its own. The host facility anticipates benefits from the cost arbitrage between self-generation of electricity (assuming the facility was anyways meeting thermal energy on its own) versus purchasing electricity from the grid (this is known as “the spark spread” in industry lingo). This cost arbitrage is a result of the higher efficiency that a CHP plant offers as compared to separate centralized power plants and thermal boilers.
One of the ACEEE papers puts forward a case for electric utilities to consider CHP as a strategic business choice and lists several benefits that the utility can monetize, including increased system resiliency, reduced transmission and distribution (T&D) investments, reduced costs for environmental compliance, improved power quality and higher customer retention. Logic and conclusions made in the paper are quiet intriguing and make one wonder why the utilities are not taking advantage of such obvious benefits!
One of the major benefits as quoted in the paper is that CHP can lead to increased system resiliency, especially during severe weather conditions. The paper further notes that utilities who have been hit by severe weather have later come up with expensive system strengthening infrastructure plans. However, the paper misses two points – (a) in reality utilities may not be sufficiently penalized for outages during severe weather conditions (that technically falls under the usual definition of ‘major events’ and are excluded from the calculation of reliability indices such as SAIFI – System Average Interruption Frequency Index and SAIDI – System Average Interruption Duration Index), and that (b) the infrastructure upgrade plans, which usually sprout up after such instances, are ultimately funded by the utility ratepayers, and in fact are a way for utilities to increase their rate base. One of the noted exception is the Massachusetts Department of Public Utilities (DPU), which held the state’s three largest electric utilities accountable for their insufficient responses to local public safety officials during the 2011 tropical storm Irene (and a snowstorm that followed in October) and levied a combined penalty of $18.725 million on National Grid, $4.705 million on NSTAR and $ 2 million on WEMCo. More details about the case and ordered penalties can be found in the DPU Press Release.
A similar argument applies to the other oft-quoted benefit that CHP can defer or avoid transmission and distribution (T&D) investments (and also future T&D maintenance costs). Electric utilities under traditional cost of service regulation have long been suspected of ‘gold plating’ their investments (also referred to as the ‘Averch-Johnson effect’) due to the incentives created by this regulatory model. Utilities often argue that this is not a factor in their decision to favor T&D upgrades over possible CHP investments. Their argument is that even if a facility stops drawing from grid (as a result of CHP installation), they still need to maintain peak demand equivalent capacity which might be required in case an outage of the CHP plant occurs and the facility draws power from the grid. So they’ll still need to make investments in T&D even if the CHP plant is installed, utilities argue.
CHP has also been presented as a means to meet environmental compliance obligations and it is reported that utility investments in CHP can reduce their cost of compliance. Again, a couple of counterarguments: (a) vertically integrated utilities may be able to pass through their cost of compliance on to their consumers, and (b) investing in CHP does not relieve a generation company from its obligations for meeting environmental regulations. This is because if a generation company is running a dirty coal power plant, it has to still install pollution control equipment, even if the company is operating a cleaner CHP at some other location. In addition, utilities in many restructured markets have divested their generation assets and may not be allowed to directly invest in CHP by their regulators.
Yet another counter argument can be that utilities in fact may face bigger CHP project siting issues (than other users, say a waste water treatment plant or a school). Local residents may oppose a utility’s plan with a ‘not in my neighborhood’ argument, whilst such a power plant proposal by a local school may get touted as a cleaner energy investment.
Despite all the possible counter-arguments against the supposed benefits CHP investments hold for utilities, I agree that one of the main benefits discussed above could make CHP attractive to utilities given the kind of direct and indirect competition pressures they face today (Editor’s note: see related stories here and here). CHP investment and the resultant benefits of increased reliability may lead to customer retention. Utilities can in fact even carve out customers who might be willing to pay higher tariffs in return for ‘no outage’ service (even at times of severe weather) and overall improved power quality. If a utility can offer and market other value added benefits, such as steam, it can lead to increased revenues and customer long term lock-in. This can be an example of utility business model innovation, which according to experts are under a threat of dying if they do not evolve (in time).
Utilities can look at CHP investments as a ‘sales revenue loss’ mitigation strategy during events of outage. Though they are generally not penalized for outages, the loss of revenue due to reduced sales is an incentive to spur mitigation investments. Non-utility CHP developers will want to make sure that they are allowed to compete with utilities on a level playing field.
Both federal and state governments provide several incentives to CHP developers to add new capacity. President Obama had issued an Executive Order in August 2012, which called for a nationwide goal of new CHP capacity addition equivalent to 40 GW by 2020. That represents about 4% of the current installed total electric capacity. If utilities don’t come forward then that means they risk losing 4% of their sales in the near future. That is not a small number – in an industry experiencing essentially flat sales growth.
Reference: ACEEE Publications titled “How Natural Gas Utilities Can Find Value in CHP”, “How Electric Utilities Can Find Value in CHP” and “Utilities and the CHP Value Proposition” – all dated July 18, 2013 can be accessed at - http://aceee.org/publications
Suggested further reading on the Averch-Johnson effect: Rate of return regulation and efficiency in production: an empirical test of the Averch-Johnson thesis, by Robert M. Spann, The Bell Journal of Economics and Management Science, 1974
Photo Credit: Centralized Power Plants/shutterstock
Rasika is a Research Manager at CEEEP, Rutgers University. Previously as a consultant, she has advised clients on feasibility studies, entry and growth stratgey and bid process advisory. As a founder of MindCrunch she has assisted clients in developing thought leadership content in the energy industry. She writes for various business magazines on global energy industry issues. She lives in ...
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