Inducing Private Investment for Grids

There is widespread agreement on the need to expand transmission capabilities, especially between areas likely to be active in the generation of electricity from renewable sources and population centers, as well as the need to make the transmission capability as efficient and secure as possible. It is also clear that accomplishing these goals will cost a lot of money. Starting with these assumptions, let's define some basic terms.

First of all, the "smart grid" does not replace the "real" or "traditional grid." The real grid is made up of hard assets that constitute traditional infrastructure, that is, wires, substations and the like. Reference to the smart grid encompasses the application of advanced technologies that will enhance the operation of the real grid, bringing greater efficiency, reliability and security.

How can these relatively uncontroversial goals be realized, and why, despite consensus on need, hasn't progress been made? There are several categories of perceived obstacles standing in the way of the utilities, renewable energy generators, transmission companies and seemingly interested investors. While the categories overlap somewhat, these obstacles include economics, the state of technology, the state of public policy, the need to achieve interconnectivity and standardization, and cost recovery -- or who pays.

The economics of transmission have been adversely affected recently. The costs of repairing existing transmission lines or constructing new ones have been increasing. This is exacerbated by the long time frame needed to complete a significant transmission project. Holding bids has become difficult, while projects are held up by the permitting and approval process. On the revenue side, the recession has resulted in reduced demand. Power purchase agreements have come down in costs, and terms have shortened in the marketplace. As a result, it has become difficult to forecast the cost of projects and difficult to project meaningful returns on investment.

There are several issues related to the state of technology. First, the existing real grid is in need of repair. If this overdue maintenance cannot be accomplished, any gains realized through smart grid technologies will be minimized.

The real grid must be expanded to connect new sources of power generation with population centers and to interconnect the Western, Eastern and Texas grids to increase efficiency, reliability and security. In addition, smart grid technology must be added to the real grid. Many of the technologies needed to realize the full promise of the smart grid are only in the early stages of development and have not yet been commercialized. To date, investors have been reluctant to significantly back new technologies that may not prove to be winners in the ultimate grid. Until new technologies have settled out a bit, it will be difficult to make significant progress in financing and expanding the grid's reach.

The state of public policy is often cited as a large obstacle to advancement with respect to the grid. Currently, there are many stakeholders or constituencies with competing interests. These include the utilities, various states or regions, the federal government as holder of federal lands, and consumers. Each has particular interests, including environmental impact, esthetics, costs, cost recovery and regional impact. As mentioned above, there is general agreement on the need for significant improvement to the grid and there are investors interested in deploying capital to finance the grid improvement, but one of the great questions is whether or not the political machine will take the action necessary to make the investment and the ensuing efforts worthwhile.

Several particular obstacles are part of policy debate. Of particular importance are siting and the use of eminent domain. The location of transmission lines is always subject to the "not in my backyard" argument. Unless some siting override authority is granted, true expansion and improvement of the grid will be extremely difficult.

Similarly, the environmental permitting process varies from state to state in terms of the level of review and timing. Standardization of rules and processes will be crucial in allowing significant transmission progress to be made. Any such rules must address and significantly shorten the timeline for consideration of projects.

Regional differences will need to be addressed. These combine issues involving siting; environmental concerns; and, of course, cost allocation. A region in which cheap energy is already produced will not be excited about transmitting such energy out of the region for the benefit of others. Some accommodation will need to be reached among regions.

Whatever rules that are developed relative to technology and political policy will need to accommodate interconnectivity and standardization. There are physical devices and protocols that are currently being developed that can potentially ensure interconnectivity across systems. Policy will need to be developed in order to share a cohesive, efficient, reliable and safe system.

The issue of who pays for improvement of the real grid in general and implementation of the smart grid in particular must be addressed. FERC and state regulators will need to work together to determine the degree to which investments will be recoverable and on what basis.

Finally, in an environment of tightening financial regulation, care must be given to preserving the ability to effectively hedge economic risks in the energy area. If hedging protection becomes unavailable or more expensive, it could adversely affect the economics of expanding transmission.

Two principal models have emerged for financing transmission projects. The first is a traditional project finance format. The second is financing based upon the balance sheet of the developer and is predicated upon rate recovery.

Currently the project finance format is being hindered by all of the obstacles set forth above. In particular, because of the difficulty in identifying, placing and keeping all of the pieces of the puzzle together during an uncertain timeline for approval, there is great difficulty in obtaining risk capital for these transactions. In contrast, the balance sheet model has access to risk capital, but those with the capital available are reluctant to deploy it unless they understand how they will be able to recover their investment, particularly in the event of an abandoned project.

It would seem that for significant progress to be made, some legislative action will need to be taken to provide more certainty to the process. In order to capitalize the large projects that are seen as necessary, this legislation will need to address siting; permitting; interconnectivity; and, most important, cost recovery. It may well be time for a national energy policy to replace our current balkanized system to ensure more certainty in each of these stages and allow developers and financial players the comfort they need to commence and follow through on projects. Historical models for this exist in the 1950s development of the interstate highway system and the natural gas pipeline. If the political will to address the situation in a similar manner can be summoned, transmission and energy in general can be updated so as to make the U.S. more energy independent, efficient, secure and economically competitive. If such action is not taken, it is likely that only short-range transmission projects, largely contained within single states, will be accomplished in the near term.