94 Investment in DG

The comparative economics of self-generation and utility supplied power have been calculated and recalculated for well over 100 years. At the dawn of the electric age and continuing for about fifty years, it was commonplace for factories to self-generate. Gradually over time, the utilities' economies of scope and scale made grid-supplied power more attractive to large customers. Only the largest customers found it to be more economical to continue to self-generate. State laws typically provide complete freedom for companies to self-generate "within their fence." Most states have generally defined a public utility as any entity that provides electricity to others. States also often assign a certain geographic area as a legally enforceable exclusive franchised service territory granted to a utility in exchange for accepting public regulatory control over the rates charged. Under traditional electric regulatory law, this has confined industrial generation to within the fence.

The 1980s witnessed the combined impact of higher utility costs, PURPA incentives, and development and improvements of combustion turbine engines. These and other factors have caused more large loads to continually consider whether to self-generate or continue to buy power from the grid. With the advent of EUIR, there is pressure to remove laws permitting monopoly franchised service territories and prohibitions on selling outside the fence. All of this bodes well for DG, but how well is a function of the comparative economics of utility-supplied power and DG.

DG may develop more slowly in low-cost states than in high-cost states. Industrial and commercial facilities owners and managers typically prefer not to have to assume the burdens of buying equipment, procuring fuel in an uncertain fuel market, as well as maintaining and operating their own plants. Since there is a role here for third party providers, energy service companies (ESCOs)* are determining new ways to integrate traditional demand-side management energy services with DG. The ESCOs see the winners in this market to be those companies that position distributed generation not as a new device, but as a solution that gives customers more choice and control over their energy use, quality, and costs.

* See National Association of Energy Service Companies.

As a necessary reality check, it is interesting to note the relative lack of venture capital interest in DG compared to the other sectors of the economy.* The cause of this could be the unfortunate history of premature and exaggerated claims by energy technology developers. Another cause could be that there are less risky opportunities for venture capitalists. Developers have a vision of DG playing a highly productive role in the $250 billion per year U.S. electricity market, and that will always attract investors.

However, to date, DG suppliers may not have cost-effective technology, so cautious investors may hedge their bets until they see a clear answer to cost effectiveness and a signal as to where the utilities are going to go with DG. Private investors know that there is plenty of domestic and foreign** utility money eventually available to invest, through utility affiliates' structures, in DG. Could the serious money be holding back until they see which utilities are moving into DG, determine how successful they fare (given utilities' spotty record on affiliated interests), and then decide whether to invest? It is a classic chicken-or-egg situation, because a significant DG industry is unlikely to exist without venture capital.

Utility investment in DG will be competing with utility investment in traditional generation, transmission, and traditional distribution. Utilities have formed generation affiliates financing merchant plants, and the capacity additions announced have been extraordinary.*** As utilities invest in central generation, they are acutely aware of the painful lessons learned from excess capacity, coupled with knowing they are arriving at a point when they may not be able to ask regulators for recovery for their generation investments. Utility investment in transmission will continue to be problematic due to the underlying changed economics favoring the long-distance movement of energy through gas pipelines rather than across transmission lines,1" the questionable profitability of transmission in the wake of open access, and siting problems. So, for the Disco aspect of the de-integrated utility, the question is whether they will invest in DG. Again, the answer depends on how cost-effective the technology is and how well the regulatory structure can incorporate DG into the new pricing paradigm.

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