The Energy Industry Update – February 2011

The ScottMadden Energy Industry Updategy y pHighlights of Recent Significant Events and Emerging Trends

February 2011

Copyright © 2011 by ScottMadden, Inc. All rights reserved.

Vol. 12, Issue 1

Table of Contents

E ti S /Vi f th E ti S it 2Executive Summary/View from the Executive Suite 2

Executive SummaryEconomic Outlook: Turning the CornerEnergy Industry Stock Prices—Electrics, Diversifieds Continue to LanguishTrends in Dividends, Earnings, and Valuations Among Selected Energy SectorsMergers and Acquisitions—Speeding Up?Behind-the-Meter Products and Services: New Opportunity or Dot-Com Redux?Residential Utility Customer Satisfaction: A Mixed Bag

Energy Supply, Demand, and Markets 10gy pp y, ,

Natural Gas: A New Normal or About to Make the Turn?Two Views of the Impact of EPA Regulations on Power System Reliability in the U.S.

Infrastructure 13

Smart Grid 2.0: Integrating Smart Grid Into Utility System-Wide Business PlanningNERC Reliability Standards and Compliance Violations: A Roundup

Rates and Regulatory Issues 16

Electricity Cost Trends, Fuel Mix, and Regulatory and Market ModelsEnergy Costs and “Share of Wallet”: A Pushback Coming?

Climate Change, Environment, and Sustainability 19

Renewable Portfolio Standards: Comparing Resources with GoalsEnergy and Environmental Policy: A Grand Bargain or Guerilla War on the Piece Parts?Solar Development Remains on a Roll, But It Still Requires Subsidies

Copyright © 2011 by ScottMadden, Inc. All rights reserved.1

Executive Summary/View from the Executive Suite

2 Copyright © 2011 by ScottMadden, Inc. All rights reserved.

Executive Summary

Enhancing Value The economy is brightening, as the world continues to dig out of the “Great Recession.” Energy consumption has begun to recover, but only modestly

Electric utility valuations have lagged the broader indexes; for some companies, this presents t ti l t iti f bl i d i itipotential opportunities for reasonably priced acquisitions

In this slow-growth environment, utility companies are looking for growth opportunities. Some options include both corporate mergers and acquisitions or asset acquisitions. Also, utilities are pondering behind-the-meter products and services opportunities as growth vehicles, enhanced by smart grid capabilities (if and when those capabilities come to fruition)

Diverging Trends in Costs

Natural gas continues to be cheap and plentiful, with continued modest demand combined with plentiful resources, including shale gas

These plentiful supplies, and the slow economic rebound, helped keep end-user gas and power costs tame in 2010. However, the broader trend is that energy is taking a larger p , gy g gproportion of the consumer “wallet”

In the renewables sector, solar photovoltaic module costs continue to fall, little by little. However, the overall installed cost of solar remains high. Solar development, which had a strong 2010, continues to require significant subsidies to achieve grid parity

The Beat Goes On...in Regulation

Regulatory activity continues in both the environmental and energy arenas The U.S. EPA continues to push tightening emissions requirements for power generators, with

unknown impacts on reliability and price of energy. The Administration’s rapprochement with business and concern about economic growth might lead EPA to delay implementation. However various interest groups may use the courts to keep the regulatory “train” goingHowever, various interest groups may use the courts to keep the regulatory “train” going

FERC is engaged as well, focusing on more aggressive enforcement of reliability standards and also trying to resolve years-old issues regarding transmission cost allocation


Economic Outlook: Turning the Corner

E i G th I Pi ki g U U S E i G th A l t I t 2011Economic Growth Is Picking Up Economic growth is expected to continue into 2011, aided

by compromise over extension of tax credits and extended unemployment insurance benefits

While some forecasts are quite bullish (4% to 5%), the median among economists is 3% for 2011

U.S. Economic Growth Accelerates Into 2011

2%

4%

Year

R

ate

U.S. Real GDP Growth – Actual and Selected Forecasts (%)

median among economists is 3% for 2011

CFOs Are Optimistic but Cautious CFOs expect increased growth in both revenues and profits,

but have a slightly negative view of business conditions Biggest concerns: healthcare costs revenue growth cash

-4%

-2%

0%2007 2008 2009 2010 2011 2012

Year

-Ove

r-Y

Gro

wth

R

Actual OECDConference Board Wells FargoBofAML WSJ Median

Biggest concerns: healthcare costs, revenue growth, cash flow, consumer confidence, and corporate taxes

There are fewer downside risks in the near term, as most believe a “double dip” has been avoided

A key near-term risk to the world economy: a significant economic deceleration in China

Interest Rates May Increase Sooner Than Expected

Ten-Year Treasury Yield (2000–Early 2011) (%)

8 2011 Forecast

Blackstone ~5%BofAML 4%

Capital Spending Expected to Increase Continued growth in capital investment is expected as credit

loosened, especially for large firms, as well as tax incentives. This may bring forward some capex from 2012 into 2011

-

2

4

6

Yiel

d (%

)

o %Northern Trust 3.7%Wells Fargo 2.98%

into 2011 M&A activity is expected to continue as well

Interest Rates Are a Worry, Inflation Less So Increasingly, analysts are expecting interest rates to

increase especially as 60% of U S federal debt matures in

Commodity Prices Are on the Rise

Iron and Steel Scrap and Copper Prices (Jan. 2009–Aug. 2010)

2000 2002 2004 2006 2008 2010

increase, especially as 60% of U.S. federal debt matures in the next three years and must be rolled over

Rising rates are expected longer term: By 2020, OECD expects a large gap between savings and investment needs, especially as investment in developing countries accelerates

$0

$100

$200

$300

$400

$0

$1

$2

$3

$4

$/Ton

$/Po

und

Copper (COMEX) ($/lb.)Steel Scrap (Am. Metal Mkt.) ($/ton)


Core inflation has faded as a concern, but some key raw materials and food prices are rising, as developing countries post strong economic growth

$0$0

Sources: OECD; IMF; Kiplinger’s; Wall Street Journal; Wells Fargo; The Blackstone Group; Bloomberg; Northern Trust; Bank of America Merrill Lynch; The Conference Board; U.S. Geological Survey

Energy Industry Stock Prices—Electrics, Diversifieds Continue to Languish

Small Diversified Gas Companies Ahead of the Dow Since CrashDiversified and Electric Utilities Tracking The Dow Since 2005

3-Year Sector PerformanceNormalized Daily Index Values (Dec. 2007–Dec. 2010)

175%

200%

Peaked at 206%

5-Year Sector PerformanceNormalized Daily Index Values (Dec. 2005–Dec. 2010)

175%

200%DJ Industrial Avg. SNL Energy Large Diversified

SNL Energy Small Diversified S&P Gas Utilities

Small Diversified, Gas Companies Ahead of the Dow Since CrashDiversified and Electric Utilities Tracking The Dow Since 2005

100%

125%

150%

175% Peaked at 206% In May 2007

100%

125%

150%

SNL Merchant Generator S&P Electric Utilities

DJ Utility Index Citigroup MLP

0%

25%

50%

75% DJ Industrial Avg.

SNL Energy Large Diversified

SNL Energy Small Diversified

S&P Gas Utilities

SNL Merchant Generator

S&P Electric Utilities

DJ Utility Index

0%

25%

50%

75%

18-Month Sector PerformanceNormalized Daily Index Values (Jun. 2009–Dec. 2010)

Ending Index Value (Start of Period = 100%)Since

Mid‐2009Since

End‐2007Since

End‐2005

SNL Energy Large Diversified 116% 75% 95%

0%Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10

Gas Upstream and LDCs Continue to Outpace DJIA, Electrics Trail

gy gSNL Energy Small Diversified 132% 103% 115%S&P Gas Utilities 142% 95% 134%S&P Electric Utilities 105% 68% 95%SNL Merchant Generator 88% 40% 70%Citigroup MLP 161% 117% *125%

150%

175%

200%

DJ Industrial Avg. 134% 86% 105%DJ Utility Index 114% 74% 96%

Despite low natural gas prices, gas LDC and gas MLP stocks have done well. Moreover, electric and

50%

75%

100%

DJ Industrial Avg.

SNL Energy Large Diversified

SNL Energy Small Diversified

S&P Gas Utilities

S&P Electric Utilities

SNLM h G

Copyright © 2011 by ScottMadden, Inc. All rights reserved.5Note: All index values are 100% at beginning of relevant period. * means not available.Sources: SNL Financial; ScottMadden analysis

diversified utility stock prices continue to lag the Dow, despite improving economic numbers.0%

25%

Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10

SNL Merchant Generator

Citigroup MLP

DJ Utility Index

Trends in Dividends, Earnings, and Valuations Among Selected Energy Sectors

S ll Di ifi d B ki g E i g G th D liP i t B k V l ti E ilib ti g P t R i

600%

Year-End* Price-to-Book Value(Capitalization-Weighted) (%)

Large DiversifiedS ll Di ifi d

250%

Year-over-Year Net Income Growth Rate (Capitalization-Weighted) (%)

Large Diversified

Small Diversifieds Bucking Earnings Growth DeclinePrice-to-Book Valuations Equilibrating Post-Recession

200%

300%

400%

500% Small DiversifiedElectricMerchantGas Utility

50%

100%

150%

200% Small DiversifiedElectricMerchantGas Utility

0%

100%

200%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 3Q 2010 -100%

-50%

0%

50%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Year-over-Year* Dividend Growth(Capitalization-Weighted) (%)

Dividend Growth Down but Still Positive Utility valuations, as measured by multiples of book value, are down from the mid-2000s— A key question is whether these valuations are a return to

normal or some inflection point that signals a bottom or b i t it

5%

10%

15%

20%Large DiversifiedSmall DiversifiedElectricGas Utility

buying opportunity

Dividend growth declined in response to the “Great Recession”— Another driver is the desire to retain funds for the next wave

of capital investment

As one might expect, net income growth has trended downward

-15%

-10%

-5%

0%

g p , g— While slightly negative for most sectors in 2009, it was not

as negative as many had feared— Early returns for 2010 show improved sales, especially

among industrial classes— Small diversified utilities, however, seem to have been able

i i i i h d i h d


%1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 3Q

2010Notes: *3Q 2010 is for quarter end. Sectors are derived by SNL Financial: SNL Large Diversified (electric &

gas utilities > $4 billion capitalization); SNL Small Diversified (< $4 billion); SNL Electric (electric only); SNL Merchant; and gas utility components of the SNL Energy index.

Sources: SNL Financial; KeyBanc Capital Markets; ScottMadden analysis

to sustain positive earnings growth during the downturn

Mergers and Acquisitions—Speeding Up?

The first half of 2010 saw continued merger activity with large transactions like A t D l C i g B k Sl l F b t L g The first half of 2010 saw continued merger activity with large transactions like PPL/E.ON, FirstEnergy/Allegheny, and Exxon/XTO. The second half continued this trend, with both asset and corporate acquisition activity continuing

Some large transactions were announced at valuations that, for the most part, represented very modest premiums. This could reduce the need for huge synergies and perhaps lessen the risk of regulatory “claw back”

147 143

117 140160$25

ons)

Power Generation Asset Deals (Announced and Pending 2008–2010)

Asset Deals Coming Back Slowly: Fewer but Larger

Deal drivers were often related to scale:— Increase balance sheet size to support infrastructure investment (NU/NSTAR,

for example, expect $6 billion in combined spending over the next several years)

— Acquire assets or reserves in pursuit of growth (renewables, shale gas) or while valuations are depressed (merchant generation)

$21.8

$9 5

117

6080100120140

$10

$15

$20 No. of D

ealson Value

($ Billio

shale gas) or while valuations are depressed (merchant generation)— Expand base across which to spread fixed and corporate costs

The weak economy requires savings without layoffs and could pressure public service commissions— Despite synergy potential, many acquirers are relying on attrition, not politically

unpalatable layoffsWith ratepayers strapped for cash regulators may require compelling savings

$8.5 $9.5

02040

$0

$5

2008 2009 2010

s

Tran

sactio

Major Corporate Merger & Acquisition Announcements—Energy Companies

Share Deal

— With ratepayers strapped for cash, regulators may require compelling savings passed along in rates, even absent large synergies Total Transaction Value No. of Transactions

M&A Announced Transactions (Corporate)

Companies Deal Value PricePremium

Announced Sector Size Value/Book Value

Exelon Corp./John Deere Renewables

$0.9B NA Aug. 2010 Renewablegeneration

1.5 GW in various development stages NA

34

37

23

26

11

20052004200320022001

Northeast Utilities/NSTAR

$4.2B(plus $3.4B in debt) ~1.9% Oct. 2010 Electric

utilities3.5 million customers combined NM

Chevron Corp./Atlas Energy

$3.2B (plus $1.1B in debt) 37% Nov. 2010 Upstream

gas9 TCF (incl. shale gas reserves) 2.2x

AGL Resources/Nicor Inc

$2.4B(plus $0 7B in debt) 13% Dec. 2010 Gas

utilities4.5 millioncustomers combined 2.22X

33

36

69

37

34

201020092008200720062005


Nicor, Inc. (plus $0.7B in debt) utilities customers combined

Duke Energy/Progress Energy

$13.6B(plus $12.1B in debt) 3.9% Jan. 2011 Electric

utilities7 millioncustomers combined 1.36x

Sources: SNL Financial; The Wall Street Journal; Bloomberg.com; company websites; ScottMadden analysis

47

0 50 100

2010

Behind-the-Meter Products and Services: New Opportunity or Dot-Com Redux?

Relative Technology Maturity of Behind the Meter Products Companies in our sector and outside it are trying to determine whether the smartRelative Technology Maturity of Behind-the-Meter Products

Ado

ptio

n

Demandresponse

aggregation

Distributedresources(traditional)

DistributedEnergy

monitoring/d

ESCOservices

Companies, in our sector and outside it, are trying to determine whether the smart grid will create a new era of business opportunity for behind-the-meter (BTM) products and services. Some questions they have: When will smart grid be capable of creating BTM opportunities? What is different now from prior retail “waves” in energy? How much integration is needed across value chain stages?

Maturity

Gro

wth

in

Distributedresources(emerging)

meter datamanagementSmart

appliances

How will the revenue and profits of this BTM “renaissance” be divided among segments and players? What operating and business models will emerge?

How will customers respond? Which segments can, or will, participate? What are the scale and scope requirements to profitably offer BTM products?

Segment Description Example Players Some Drivers/Issues

Demand response aggregation

Intermediators between customers and utilities/regional ISOs to pool demand response capabilities and provide peak load management and curtailment services, capacity bidding, and other services to reduce firm energy costs

EnerNOC cPower Comverge

Energy market expansion, restructuring; ISO roles

Transparent price signals; supportive rate structures

Public policyother services to reduce firm energy costs p y

Distributed resources (incl. renewables)

Distributed generation and storage for primary and stand-by power, heating and cooling applications, and grid ancillary services/renewables support

Capstone Turbine

Caterpillar Siemens

GE Energy FuelCell

Energy SunEdison

Installed cost (improving) Resistance to net metering

buybacks and FIT structures Grid-parity costs (esp. renewables)

Energy monitoring Software, hardware, analytics, and customer OPower eMeter Improved technologygy gand management/ meter data management

yinterfaces that provide signals, information on real-time consumption

GridPoint Smart Synch Google EnerNOC

Comverge Tendril Itron

Clear interoperability standards Privacy concerns “Performance contractor” stigma;

customer investment required (also applies to ESCOs below)

ESCO services Energy audits and consulting; energy equipment Utility affiliates National ESCO

Subsidies and financinggy g gy q pand installation, including energy efficiency retrofits, controls, HVAC, and building automation

Global equipment providers

ESCOs Local HVAC,

electric cos.

Agency issues Pricing of efficiency Payback time, return

Smart appliances/ hardware (incl facility/

Facility appliances and devices with modernized electricity usage systems that monitor, protect, and automatically adjust operations to the needs of its

Whirlpool Honeywell Carrier/

I E

Johnson Controls

General Electric

Clear interoperability standards Technology maturity/lifecycles Customer and equipment service


(incl. facility/ premise area networking)

y j powner, including in response to price, utility signals, and emergency power situations

Ice Energy Microsoft

Electric “New normal” frugality Transparent price signals;

supportive rate structures

Sources: Company websites; investment analyst reports; industry news; Cleantech Group, 2010 U.S. Smart Grid Vendor Ecosystem (Sept. 2010); DOE Berkeley National Laboratory; ScottMadden analysis

Residential Utility Customer Satisfaction:A Mixed Bag

W t d S th L d R id ti l El t i Utilit S ti f ti Customer Communication Helps ElectricsWest and South Lead Residential Electric Utility Satisfaction

750

king

Residential Electric Utility Average J.D. Power Rating* by Region and Utility Size (2010)

Median Score High Low

Customer Communication Helps Electrics According to J.D. Power, satisfaction levels have increased

year-over-year as customer bills have decreased and reliability has improved

J.D. Power also found that managing customer expectations around outages and restoration mitigates

550

600

650

700

r Sat

. Ind

ex R

ank expectations around outages and restoration mitigates declines in or even improves satisfaction

To improve satisfaction, a mix of proactive and event communiqués is required. For example:─ More scheduled outage notifications with the rising

number and frequency of grid upgrade projects

500West:

MidsizeWest: Large

South: Midsize

South: Large

Midwest: Midsize

Midwest: Large

East: Midsize

East: LargeC

usto

mer

number and frequency of grid upgrade projects─ Announcements of reliability and operational

response investments and their results (benefits)─ More frequent status updates, even with limited

information, during storm outages (e.g., radio or mobile devices—texting, Facebook, Twitter, etc.)

Residential Gas Utility Average J.D. Power Rating* by Region and Utility Size (2010)

Gas Utility Satisfaction Has a Narrower Range Than for Electrics

Helping customers with their overdue bills, as one might expect, substantially improves customer satisfaction; utility education and energy efficiency/management programs are additional, helpful high bill resolution options

Customer awareness of their local utility’s implementation of smart grid and smart meter technology remains low

600

650

700

750

ndex

Ran

king Median Score High Low

of smart grid and smart meter technology remains low

Satisfaction Improves for Gas Utilities Lower bills, more frequent communication, and improved

perceptions of corporate citizenship have led to higher satisfaction levels

500

550

600

West: Large

West: Midsize

South: Large

South: Midsize

Midwest: Midsize

East: Midsize

Midwest: Large

East: LargeC

usto

mer

Sat

. In satisfaction levels

Gas customers are also more familiar with energy savings programs and want more communication on how to reduce bills and conserve energy

J.D. Power opines that emphasizing the value of service provided by gas utilities lifts overall satisfaction


g g g g

Notes: *Scores are out of a possible 1,000 points

Source: J.D. Power and Associates, 2010 Gas Utility Residential Customer Satisfaction Survey (Sept. 22, 2010) and 2010 Electric Utility Residential Customer Satisfaction Survey (July 14, 2010); ScottMadden analysis

provided by gas utilities lifts overall satisfaction

Energy Supply, Demand, and Markets


Natural Gas:A New Normal or About to Make the Turn?

“D ill B b D ill” P d i C i G G P i P j t d t R i i th Mid $4 t Mid $5 Th gh 2013“Drill, Baby, Drill”: Production Continues to Grow Onshore gas production continues to grow despite

low gas prices and regulatory setbacks in Marcellus

Rig count is expected by some to level off and ltimatel decline to a tipping point of abo t 800 $8

$10Natural Gas Week Scoreboard (Median)

Actual Wellhead Gas Prices vs. Henry Hub Price Projections by Selected Analysts (in $/MMBTU)

Gas Prices Projected to Remain in the Mid-$4s to Mid-$5s Through 2013

ultimately decline to a tipping point of about 800 rigs (U.S.) to stabilize gas prices

However, horizontal gas drilling operations are more efficient and productive, yielding more gas per rig, so supply should be plentiful through 2012 $4.36 $4.45 $4.45

$4.72$5.35 $5.35

$2

$4

$6

$8

$/M

MB

TU

NGW Scoreboard (High Forecast)

Wellhead actual prices(average) EIA Forecast:

2011: $4.02

For Producers, First the Bad News, Then…? Enhanced revenues from rising natural gas liquids

prices have lowered the breakeven dry gas production cost in some plays

Some producers looking to migrate from dry gas-

$02005 2006 2007 2008 2009 Jan.-Oct.

2010 (Avg.)

2010 2011 2012

2011: $4.022012: $4.50

Some producers looking to migrate from dry gasonly plays like Haynesville and Barnett to places like Eagle Ford and Marcellus

Some analysts project that gas prices will firm after 2012, buoyed by:

— Coal power plant retirements 100%1,200

Horizontal Rigs in January 2011 at 967, Up from Under 400 in Spring 2009

North American Rig Count by Type vs.U.S. Gas Rigs as % of Total Rigs

— Carbon constraints— Step-down in drilling activity as wells mature— Hedges (i.e., forward sales) roll off— Possible export (LNG) demand

20%

40%

60%

80%

200

400

600

800

1,000 U.S. G

as Rigs

as % of Total R

igNor

th A

mer

ican

Rig

Cou

nt

Demand and New Large Players Demand remains suppressed, but is expected to

begin to firm with continued economic growth Oil and gas majors are entering the market,

acquiring shale players who need a larger balance

0%

20%

0

200

2006 2007 2008 2009 2010 2011

sgsN

% Gas Rigs Directional Horizontal Vertical

Rig Count% of Total Rigs


acquiring shale players who need a larger balance sheet and gaining experience to apply in shale fields inside and outside North America

Sources: Energy Intelligence Natural Gas Week; Energy Information Administration; SNL Financial; Baker Hughes; Deutsche Bank; American Gas Association; industry publications; ScottMadden analysis

Rig Count% of Total Rigs

Two Views of the Impact of EPA Regulationson Power System Reliability in the U.S.

Much attention has been paid to the potential retirement of power generation in the U S as a result of various pending Much attention has been paid to the potential retirement of power generation in the U.S. as a result of various pending EPA regulations covering air, water, and ash. Two recent studies looked at possible consequences for reliability.

A Comparison of Two Analyses of EPA Regulation

NERC (Oct. 2010) Charles River Associates (Dec. 2010)( ) ( )

Key Points of Alignment

A significant portion of coal-fired generation is currently slated for retirement, even without tighter environmental regulations Certain reliability sub-regions will be affected much more than others The impact of greenhouse gas regulation is not included Assessments did not project expected power cost, only retrofit vs. retire economics

Key Differences in Looks at all EPA regulations – MACT, coal combustion Looks only at MACT and CATRKey Differences in Assumptions and Approach

residuals, cooling water (thermal) constraints, and Clean Air Transport Rule (CATR)

Analysis was national in scope

Limited its analysis to the Eastern Interconnection

Regulations impact 33 GW to 70 GW (retire or retrofit) MACT alone could trigger retirement of 2 GW to 15 GW Cooling water intake has the greatest impact on reserve

Under an aggressive MACT policy, CRA projects 35 GW of coal capacity in the Eastern Interconnection to be retired by 2015— Retirements are small compared with historical net

Conclusions

Cooling water intake has the greatest impact on reserve margins, as it impacts nuclear and could force derates

By 2015, combined EPA regulations could cause 32+ GWs in retirements and derates (over 77 GWs under a strict case with no compliance extensions)

Under a moderate case and assuming only deliverable (i.e., existing plus planned) capacity:

Retirements are small compared with historical net capacity additions

— Average age of those units is 55 years With retirements, 2015 reserve margins fall below required

margins in some sub-regions, but are adequate on a regional level— Permitted projects development can reduce the shortfall

— ERCOT, ReliabilityFirst, and SERC-Delta, are most affected by retirements (in total GWs)

— ERCOT, the Midwest, New England, and many of the Southeastern subregions fall below target reserve margins

— New gas-fired capacity, above that currently permitted, can “easily address” the shortfall (about 11.5 GWs)

Other methods can be used to manage shortfall, including:— Load management— Coal-to-gas conversion

Key issues and uncertainties: How long cheap gas will last Impact of better than expected electric demand Availability and cost of gas pipeline extensions,

expansions to support new or repowered generationR i d t d ti i f t i i h t

Leadership in the Republican-controlled 112th Congress has announced strategies (or intent) to slow or moderate EPA regulation via: Appropriations: Limiting EPA funding on selected initiatives Oversight: Conducting hearings on EPA activities before

Energy & Environment other Congressional committees


Required cost and timing of transmission enhancements Realistic timing of new capacity resources “in the wings” Cost of power with shift in resource mix

Sources: NERC, 2010 Special Reliability Scenario Assessment: Resource Adequacy Impacts of Potential U.S. Environmental Regulations (Oct. 2010); Charles River Associates, A Reliability Assessment of EPA’s Proposed Transport Rule and Forthcoming Utility MACT (Dec. 16, 2010)

Energy & Environment, other Congressional committees Legislation: Mandating delay on some EPA actions (esp.

greenhouse gas regulation)

Infrastructure


Ad d E C bili i E bl d b S G id Industry leaders believe smart grid and the advanced

Smart Grid 2.0: Integrating Smart Grid Into Utility System-Wide Business Planning

Utility scale renewables Extended storage Customer energy

efficiency/management

Current Applications Value– Process / workforce efficiencies– Operating savings– Targeted event response

f (

GridReliability

SmartEnergy

Applications

Advanced Energy Capabilities Enabled by Smart Grid Industry leaders believe smart grid and the advanced energy capabilities it enables can significantly benefit core utility value—reliability, efficiency/cost savings, compliance, and customer service

Many utilities have developed business cases valuing individual smart grid-enabled technologies (e.g., AMI,

UtilityValue

Billing accuracy Faster issue resolution

Substation and DAI GIS management Advanced sensors

and system monitoring Advanced conductors

Event detectionand response

Demand response Ancillary services Voltage mgt. Condition-based

maintenance Fast response

storage for regulation

efficiency/management Dynamic rates “Load as Capacity” Distributed energy (DER)

and CHP Small-scale renewables Smart appliances and

EVs

Future Application Value

– Reduced field service trips (truck rolls)

– Higher customer satisfaction– Improved issues resolution– Improved load planning

CustomerServices

Grid Management

g g ( gdemand response, etc.)

To date, this narrow scope has limited utility planning, acceptance, and investment in smart grid capability

Focus has been on engineering “proof of concept” pilots. However, pilots do not clearly demonstrate the value of

Smart Grid Functionality

SCADA AMR Mobile dispatch

AMI (2-way) Remote operations

(connect/disconnect) OMS / system restoration

Faster issue resolution Energy information, IHDs,

web analysis portals Power quality services Load profiling and

forecasting

Future Application Value– Higher reliability– Operate grid closer to “true” limits– Early event detection and condition-

based response– Grid congestion management– T&D planning and IRP optimization– Renewables integration– Digital power quality– Distributed resources/micro-grids– Reduced cost/carbon footprint

Distribution Operations

EventManagement

p ylarger (full) system deployments to the market

Utilities are now seeking a broader, comprehensive value framework and planning approach to cohesively guide this multi-year, multi-billion dollar, industry-wide system capability investment, both on the utility and customer sides of the meterSmart Grid Functionality

Advanced System Capabilities Enabled by

Key Utility System Business Models

Smart Enterprise “Value” Framework and Planning Approach

sides of the meter

Aligning Smart Grid Functionality With System Business Needs in the Context of a Utility’s Market and Operations

Key QuestionsEnabled bySmart Grid

MarketModel

OperatingModel

CustomerModel

RegulatoryModel


ye

Smart Grid Functionality


EventManagement

CustomerServices

Grid Management

GridReliability

SCADA AMR Mobile dispatch

AMI (2-way) Remote operations

(connect/disconnect) OMS / system restoration

Billing accuracy Faster issue resolution Energy information, IHDs,

web analysis portals Power quality services Load profiling and

forecasting

Substation and DAI GIS management Advanced sensors and

system monitoring Advanced conductors

Event detection and management

Demand responseand ancillary services

Voltage management Condition-based maint. Fast response storage

for regulation

SmartEnergy

Applications

Utility scale renewables Extended storage Customer energy

efficiency/management Dynamic rates “Load as Capacity” Distributed energy/CHP Small-scale renewables Smart appliances

Future Application Value– Higher reliability– Operate grid closer to “true” lim its– Early event detection and condition-

based response– Grid congestion management– T&D planning and IRP optim ization– Renewables integration– Digital power quality– Reduced cost/carbon footprint for

supply

Current Applications Value– Process / workforce efficiencies– Operating savings– Targeted event response– Reduced field service trips (truck

rolls)– Higher customer satisfaction– Improved issues resolution– Improved load planning

Related Regulatory

Key Questions

What are key market, operating, and customer value drivers or “sign posts” to monitor?

How do drivers impact a utility’s key business models and metrics (e.g., market, operating, customer, regulatory)?

EventManagement

CustomerServices

GridManagement

G id

Reliability

Com

pliance

Cos

ts Identify• Business model impacts?• “Core” value benefits?

g yCompact Impacts

• ”Used and useful” criteria

• Ratebaserequirements

• Ratemaking and cost-of-service methodologies

• New rate

What are achievable opportunities to “operationalize” smart grid’s value today and in the future?

Are clear, long-term system core values demonstrated to ratepayers, regulators, and stakeholders?

What are our business plans—market, operating, customer, and


GridReliability

Smart Energy

CustomerService

mechanisms• Regulatory

engagement• Other

p , p g, ,regulatory—and supporting smart grid strategy/infrastructure “roadmap” for moving ahead, managing related enterprise risk, and gaining regulatory, community, and stakeholder support?

Source: ScottMadden analysis

NERC Reliability Standards and Compliance Violations: A Roundup

C iti l I f t t P t ti Th W t U S L d Oth R gi i C li P lti

Cumulative NERC Compliance Penalties (No. of Assessments)* by Topic Area

(June 2008–December 2010)

Cumulative NERC Violations and Monetary Penalties* by NERC Region

(June 2008–December 2010)

Critical Infrastructure Protection Has Been Oft-Cited

The Western U.S. Leads Other Regions in Compliance Penaltiesin Part Due to the Number of Registered Entities

104107107

267381

428

Transmission Planning

Transmission Operations

Emergency Preparedness and Ops.

Facilities Design, Connections, and Maint.

Critical Infrastructure Protection

Protection and Control

600

700

800

900

1000

$1 500 000

$2,000,000

$2,500,000 No. of A

ssessm

nalti

es ($

)

Penalties ($)

Penalties (No. of Assessments)

15344144

99104

Communications

Resource and Demand Balancing

Interconn. Reliability Ops. and Coord.

Personnel Perf., Training, and Quals.

Voltage and Reactive

Transmission Planning

200

300

400

500

600

$500 000

$1,000,000

$1,500,000

ments (vs. R

equiremTota

l Mon

etar

y Pe

n

111215

0 100 200 300 400 500

Interchange Scheduling and Coord.

Modeling, Data, and Analysis

0

100

200

$0

$500,000

WECC SERC RFC NPCC FRCC MRO TRE SPP

ments)

T

Note: Includes violations that did not include financial penalties

NERC and FERC have been trying to address friction as FERC seeks more timely standards development and aggressive enforcement (i.e., more significant penalties) of key focus areas like critical infrastructure protection

FERC, in reviewing NERC’s self-assessment of performance, had specific concerns about NERC’s reliability standards development process, specifically improving certain standards and their pace of development

A FERC’ i i NERC h d f h d d d l At FERC’s insistence, NERC has now proposed a revamp of the standards development process

Only time will tell how these changes will affect registered entities and the regional reliability organizations

In addition to evolving standards, the industry is contending with alerts from NERC that may require swift and costly modifications to equipment and operating processes


Notes: *Excludes FP&L’s $25 million settlement in October 2009. NERC violation count based upon each requirement violation.

Sources: NERC (as of Jan. 15, 2011); SNL Financial; ScottMadden analysis

Rates and Regulatory Issues


Electricity Cost Trends, Fuel Mix, and Regulatory and Market Models

C d A l G th R t i T t l R t il R kWh (1994 2009)

10

15

20

25

2%

3%

4%

5%

Avg. R

evenue h R

ate

(%)

Chart TitleGrowth Rate Median Growth Rate 2009 Avg. Revenue (¢/kWh)

Compound Annual Growth Rate in Total Retail Revenues per kWh (1994–2009)and 2009 Average Revenues per kWh

0

5

10

0%

1%

2%

AK AL

AR AZ

CA

CO CT

DC

DE FL GA HI

IA ID IL IN KS

KY LA MA

MD

ME MI

MN

MO

MS

MT

NC

ND

NE

NH NJ

NM NV

NY

OH

OK

OR PA RI

SC

SD TN TX UT

VA VT

WA WI

WV

WY

(Cents/kW

h)G

row

th

AK AL AR AZ CA CO CT DC DE FL GA HI IA ID IL IN KS KY LA MAMD ME MI MNMOMS MT NC ND NE NH NJ NM NV NY OH OK OR PA RI SC SD TN TX UT VA VT WA WI WVWY

Part

of RTO

100%

pe

of RTO

Restructured Retail

RRA PUC Ranking

25%

50%

75%

ener

atio

n by

Fue

l Typ

0%

25%

Net

Ge

Coal Hydro Natural Gas Nuclear Renewable Other

The link between growth in revenues per kWh of electricity andLegend

Part of RTO: Full or most | Part | None or insubstantial Restructured Retail: Full choice | Partial choice RRA PUC Ranking: Above average (constructive)| Average | Below Average

The link between growth in revenues per kWh of electricity and regulatory model is uncertain at best

Fuel mix has a bearing, especially where coal (historically cheaper) or gas (historically more expensive) is a significant part of the mix

Interestingly, while revenues per kWh (rates) predominantly coal-fired jurisdictions remain relatively low for many their growth hasS E I f ti Ad i i t ti ISO/RTO C il C t C liti


fired jurisdictions remain relatively low, for many their growth has been above median

Some lower cost jurisdictions—Alabama, Tennessee, Oregon, and Washington—have increased the most over the past 15 years

Sources: Energy Information Administration; ISO/RTO Council; Compete Coalition; SNL Financial/Regulatory Research Associates; Distributed Energy Financial Group, Annual Baseline Assessment of Choice in Canada and the United States: An Assessment of Restructured Electricity Markets (Dec. 2010); ScottMadden analysis

Energy Costs and “Share of Wallet”: A Pushback Coming?

E C t P t f I A Ri i N Th T t Y T d f H h ld E

Share of Wallet: Median Energy Costs as a % of Median Household Income (Nominal $)*

4%500( )

Average Annual Electricity Rates vs. Other Cost Measures (1990–2009) (Index: 1990=100)

Energy Costs as a Percentage of Income Are Rising Now, a Trend Exacerbated by a Decline in Household Income in 2009

The Twenty-Year Trend for Household EnergyIs in Keeping With Key Price Indexes

.0%

% % % % 2.3% 2.

6%

% % % %.0%

% 2.1%

2.2% 2.

6%

3.1% 3.2%

2%300

400

x Va

lue

Electric Rates (All Classes Avg.)Natural Gas Prices (Henry Hub Avg.)Producer Price Index (Less Food and Energy)Consumer Price Index

2.

1.8

1.7%

1.7%

1.7%

1.3%

1.2% 1.

6%

1.4% 1.

7%

1.6% 1.82

1.7% 2 2

0%1997 1999 2001 2003 2005 2007 2009

Electricity Piped Gas Fuel Oil0

100

200

0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9

Inde

y p

Energy Costs Take a Larger Bite Out of Households While household energy costs have kept pace with

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Share of Wallet: 2009 Median Energy Costs as a % of

Regional Variations for Energy Costs In Comparisonwith Median Income Levels Can Be Significant

gy p pkey inflation indices over the last two decades, “share of wallet” is increasing now

— Piped natural gas expenses, as a percent of income, have increased since the late 1990s

— Electricity costs, which fell in the early 2000s, have increased rapidly since mid decade rising

Median Household Income (Nominal $)*

3.6%

3.5%

%

4%

have increased rapidly since mid-decade, rising from 1.7% of income to 2.6% in four years

There are differences by region in household energy “share of wallet”

A tipping point is possible as stagnant incomes, coupled with increasing costs squeeze households

2.1% 2.3%

1.9%2.

4%

2.2%

1.8%

1.2%

2.5% 2.6 %

2.2%

0%

2%

Copyright © 2011 by ScottMadden, Inc. All rights reserved.18Notes: *Energy costs are for those households consuming this fuel type; median income is for all householdsSources: U.S. Census Bureau, Annual Household Survey; U.S. Bureau of Labor Statistics;

Energy Information Administration; ScottMadden analysis

coupled with increasing costs, squeeze households This could mean lower consumption, fewer rate case

filings and less favorable ratemaking mechanisms

Northeast Midwest South WestElectricity Piped Gas Fuel Oil

Climate Change, Environment, and Sustainability


Renewable Portfolio Standards: Comparing Resources with Goals

50%

60%

Renewable Portfolio Standards for 2012 and 2020 (% of MWhs) vs.2008 Renewable Generation as % of Total Generation (% of MWhs) by State

ID: 84.5% OR: 63.4% WA: 74.5%Renewable Generation as % of Total Net Generation

40%

50%TX Renewable Target:• 2013: 5,256 MW• 2025: 10,000 MW• 2008 (Actual): 8,380 MW

2020 RPS target (small square indicatesno 2012 target)

2012 RPS target

20%

30%

0%

10%

AL

AK AZ

AR

CA

CO CT

DC

DE FL GA HI

ID IL IN IA KS

KY LA ME

MD

MA MI

MN

MS

MO

MT

NE

NV

NH NJ

NM NY

NC

ND

OH

OK

OR PA RI

SC

SD TN TX UT

VT

VA

WA

WV WI

WY

As the first target dates under various state renewable portfolio standards approach, states are positioned differently States with a large portion of their energy mix from large hydro (e.g., the Pacific Northwest, New York, Maine, Vermont) are well

positioned However dependence upon these resources make hydrologic conditions a crucial variable in whether the standardspositioned. However, dependence upon these resources make hydrologic conditions a crucial variable in whether the standards can be consistently met

Some states—Delaware, DC, Illinois, and Pennsylvania, for example—have a significant gap to overcome to achieve their 2012 renewable generation targets

Others with 2020 time frame targets have a similar gap but some time to put resources into place


Sources: U.S. Energy Information Administration (EIA), State Renewable Electricity Profiles 2008 (Aug. 2010), at http://www.eia.gov/cneaf/solar.renewables/page/state_profiles/r_profiles_sum.html; EIA, State Electricity Profiles 2008 (Mar. 2010), accessed at http://www.eia.doe.gov/cneaf/electricity/st_profiles/e_profiles_sum.html; Database of State Incentives for Renewable Energy

Energy and Environmental Policy:A Grand Bargain or Guerilla War on the Piece Parts?

AnticipatedWhite House/ Agency Approach

New Congressional Environment

PossibleWild Cards

The Bottom Line

Proposed boiler MACT House oversight hearings Results of and reactions to Compliance may

EPA ConventionalEmissions

prules in Q1 2011, finalize by Mar. 2012

Final Transport rule in 2011

Some delays requested (e g biomass MACT)

g glikely

Potential limitation on EPA spending

“listening” meetings Obama regulatory review Judicial action in response

to EPA-sought delays and environmental organization challenges thereto

p ybe deferred out of concerns on impact on U.S. economy

But environmental intervenors may force continued

Regulations (e.g., biomass MACT) challenges theretoEPA action

No reversal of standards in next two years

“Clean” energy standard expanded to include some

Some bipartisan support in Senate for clean energy

Deficit concerns on additional funding

Some R&D funding

Clean Energy

expanded to include some types of non-renewable generation

Continued investment in R&D

Government-driven green t

Senate for clean energy standard (with nuclear)

No strong advocate in House

additional funding Clean or renewable energy standard less likely given opposition to nuclear by the environmental lobbyenergy procurement lobby

Regulation Of G h

No cap-and-trade legislation pushed

EPA pushing tighter standards on new sources and implementation plans,

No cap-and-trade legislation

House oversight hearings, potential limitation on EPA spending on GHG

Carbon tax may be viable with deficit hawks, but industry will oppose increased customer cost

Supreme Court decision

No legislative approach, but EPA pushes on (inventory baseline)

Possible HouseGreenhouse Gas Emissions

and implementation plans, BACT on existing generators

spending on GHG regulation

Supreme Court decision on GHG emissions tort vs. EPA regulatory pre-emption

Outcome of state lawsuits challenging GHG BACT

Possible House inquiry into climate science

U.N. non-binding targets

I d th it f C ll t f t D fi it i A h ll t t


NuclearDevelopment

Increased authority for guarantees for new plants

Call to reform guarantee program, reduce role of OMB

Deficit concerns: increase may not be budget-neutral

A challenge to get additional funding, guarantees

Sources: Van Ness Feldman; K&L Gates; Alston & Bird; SNL Financial; industry news; Senate, House committee websites; ScottMadden analysis

Solar Development Remains on a Roll, But It Still Requires Subsidies Solar development continued to grow in 2010 I ti d T C dit C t N t I t ll d C i l PV C t i H lf

Installed Cost of Commercial PV (>10 kW / All Technologies) Over Time ($/WattDC)

Solar development continued to grow in 2010, well above the 2009 pace

— Solar PV installations totaled 525 MWs through 3rd Quarter 2010, up 1/5 vs. 2009

— One projection has U S solar capacity

Incentives and Tax Credits Cut Net Installed Commercial PV Costs in Half

$12.00$10.59 $9 59 $9 89$12

$16

d DC)

— One projection has U.S. solar capacity reaching 44 GWs by 2020, requiring $100 billion in investment

Solar costs have been decreasing with scale economies and expanded manufacturing capacity

$$8.93 $9.59 $9.89 $8.83 $8.45 $8.02 $7.81 $8.10 $7.95 $7.95

$0

$4

$8

$12

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Inst

alle

dC

ost (

$/W

D

— Global PV panel capacity is projected to grow to 30 GWs by 2013 from 10.1 GWs in 2009

— Producers are mobilizing—e.g., GE is prioritizing solar business growth

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Net Installed Cost with ITC State/Utility Cash Incentive (After‐Tax) ITC (State and/or Federal)

U.S. Utility-Scale ( 100 kW) Solar Projects (in MWs) by Operating Date

— European manufacturers are expected to look abroad as European subsidies (especially feed-in tariffs) are reduced amidst fiscal austerity

The U.S. market is still dependent upon favorable state policy and development is 400s

Solar PV Installations Helped by Grants and Reduced Equipment (Module) Cost

favorable state policy and development is concentrated in a handful of states

— The top five states—CA, FL, NJ, AZ, and PA—account for 76% of large (>100 kW) solar PV installations since 2000 0

100200300

Inst

alle

d M

Ws

— Policy support is still necessary: CA, for example, allows up to 5% aggregate net metering and providing $3 billion for “Go Solar” subsidies

Asian growth will fuel increased activity and

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Solar PV Concentrating Solar


Sources: Solar Industry magazine; Renew Grid magazine; SNL Financial; The New York Times; The Wall Street Journal; Bloomberg New Energy Finance; Energy Acuity; G. Barbose, N. Darghouth & R. Wiser, Lawrence Berkeley National Laboratory, Tracking the Sun III: The Installed Cost of Photovoltaics in the U.S. from 1998-2009 (Dec. 2010); Greentech Media, U.S. Solar Energy Trade Assessment 2010 (Nov. 2010), prepared for Solar Energy Industries Association

pull equipment abroad: China is targeting 20 GWs of installed solar by 2020; India’s goal is 1 GW by 2013

Energy industry landscape: sharpening contrasts and accelerating change

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Recent ScottMadden Insights—Available at ScottMadden.comFossil Generation

Coal Combustion Residuals, by J. Jacobi, http://www.scottmadden.com/insight/410/Coal-Combustion-Residuals.html

Coal Plant Shutdown—A Case Study: Why? How?, by S. Pearman & G. Robinson,http://www.scottmadden.com/insight/409/Coal-Plant-Shutdown-A-Case-Study-Why-How.html

Natural Gas Infrastructure Investment in the Gas Industry, by E. Baker & J. Davis,http://www.scottmadden.com/insight/354/Infrastructure-Investment-in-the-Gas-Industry.html

Renewables Biomass: Electricity Generation and Transportation Fuel, by J. Jacobi, http://www.scottmadden.com/insight/408/Biomass-Electricity-Generation-and-Transportation-Fuel.html

Solar Photovoltaic Plant Operating and Maintenance Costs, by J. Jacobi & R. Starkweather, http://www.scottmadden.com/insight/407/Solar-Photovoltaic-Plant-Operating-and-Maintenance-Costs.html

Resource and Supply Planning

Resource Planning—Confronting Challenges and Managing Uncertainties, by R. McAdams & J. Davis, http://www.scottmadden.com/insight/405/Resource-Planning-Confronting-Challenges-and-Managing-Uncertainties htmlUncertainties.html

EnergyEfficiency

Improvements in Data Center Management, by J. Jacobi, J. Kerner, & Scott Wilson, http://www.scottmadden.com/insight/412/Improvements-in-Data-Center-Management.html

Energy T h l i

Storage Applications: Where Is the Value—Now and in the Future?, by J. Jacobi,& Scott Wilson, http://www scottmadden com/insight/403/Storage Applications Where Is the Value Now and in the Future htmlTechnologies http://www.scottmadden.com/insight/403/Storage-Applications-Where-Is-the-Value-Now-and-in-the-Future.html

NuclearGeneration

Improving Nuclear Maintenance Productivity—Insights from ANS, by C. Vlahoplus, published in Nuclear News,http://www.scottmadden.com/insight/424/Improving-Nuclear-Maintenance-Productivity-Insights-from-ANS.html

Nuclear New Build, by E. Baker, http://www.scottmadden.com/insight/411/Nuclear-New-Build.html

Using Benchmarks in Gap-Based Business Planning, by J. Sequeira, I. Falk, & C. Carmichael, published in Nuclear Power International, http://www.scottmadden.com/insight/425/Using-Benchmarks-in-Gapbased-Business-Planning.html

FinancialShared Services

ScottMadden and APQC Article Series: Financial Shared Services, by B. DeMent & J. Davis, http://www.scottmadden.com/insight/423/ScottMadden-and-APQC-Article-Series-Financial-Shared-Services.html


Energy Practice

The energy industry landscape is one of sharpening

Research

ScottMadden Research provides clients with valuable gy y p p gcontrasts and accelerating change. The shelf life for conventional wisdom seems to grow shorter with each headline. Every day in this challenging and exciting environment, experienced ScottMadden consultants offer our clients deep energy knowledge and practical business

pinsight on developments, trends, and practices in energy and sustainability. Through its semi-annual Energy Industry Update and other occasional publications, our research team helps clients discern and analyze critical issues and inform their business decisions.

acumen, collaborate with them, and help them succeed.

We have done this for more than 25 years, served more than 150 energy organizations, and completed thousands of successful projects. We have helped some of the best in the business in nuclear and fossil generation

We also provide customized, project-based research and analytical support on matters of interest to our clients.

For more information about our research capabilities or content see the Insights section of our website orin the business in nuclear and fossil generation,

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For more information about our Energy Practice, contact:

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The Energy Industry Update – February 2011

Education

economic growth

growth opportunities

continued growth

growth vehicles

increased growth

goals energy

price of energy

energy arenas