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Death to Power
By Yardi Blog Staff on Nov 13, 2016 in News
Editor’s note: This piece originally appeared in the fall issue of NAREIM Dialogues.
Electrification is perhaps the greatest technological advancement of the 20th century. The ele
ctric power grid, the system that delivers electrification, is considered by many to be the largest and most successful machine ever built. But it may be about to die.
The power grid “machine” is an interconnected system of long distance transmission lines, local distribution systems, transformers, substations, generating power plants, and the computers and control systems that manage it. In the United States, it delivers $400 billion in electricity annually over 7 million miles of power lines and through the efforts of 3,200 utility companies. The infrastructure in the system is valued at over $850 billion. Uptime is an astonishingly high 99.97% (I certainly wish my laptop could approach that level of reliability) and growth in the system is delivered relatively reliably by simply calling your utility. All this is delivered at price that is slightly below where it was in 1960 in real terms. This is an incredible success story; it seems like there is little here to concern real estate investors and owners…right?
If only it were so simple. We have entered a period of incredibly rapid change in energy technologies, and the future of the utilities that deliver power to our buildings, and even the future of the electric grid itself, is in considerable flux. The forces threatening to disrupt the power grid include distributed solar systems, fuel cells, demand response technologies, battery storage, energy efficiency, electric vehicles, and various micro grid technologies. We can sum these up with the phrase: be your own power plant. Or to be cheeky, “adios, utility company.” Even if you think your particular investments, assets, buildings or properties won’t mess around with something like that, you may find that your access to cheap and reliable power could be seriously at risk if you don’t adopt the new paradigm.
It’s important to note that “climate change” has not yet appeared in this narrative and nor will it again beyond this paragraph. While the threat of climate change has been a driver behind various incentives that support new energy technologies, many are now growing at a rate that will disrupt the utility system regardless of future government incentives. A U.S. government that chooses to support clean energy technologies in a substantial way will only further hasten these trends.
The Rise of Cheap Solar Power
The story starts with photovoltaic solar energy. Photovoltaics are the energy generating cells that you’ve seen on calculators for years, and are increasingly showing up on residential and commercial rooftops across the U.S. and the world. Since the mid-1970s the cost of solar panels has fallen 99% as installed solar energy capacity has grown 115,000x. This cost decline continues at a rapid pace, and has now made solar the cheapest form of new generation in some markets around the U.S. and the world. In fact, in 2015 the price of solar energy fell below $0.05 per kWh in 4 of 5 U.S. regions. Several contracts signed in 2016 have fallen under $0.04 per kWh, within the range of average U.S. wholesale power prices of $0.03 to $0.05. Bloomberg New Energy Finance predicts that a staggering 3.7 terrawatts (roughly equivalent to 4,000 nuclear power plants), or 43% of all new energy generation capacity built over the next 20 years, will be solar.
The Utility Death Spiral
The U.S. utility industry spends roughly $95 billion per year upgrading and maintaining the grid. Many observers suggest this is far too little to maintain an effective system and at some point the level of investment will need to increase substantially to maintain service levels. Despite that massive, and potentially increasing, investment retail prices remain low due in part to the huge number of customers served. Utilities can amortize costs across so many customers because essentially every single consumer and business is a customer. Not a bad business model! But what if some of those customers start to find a better deal somewhere else? Customers fleeing the grid could lead to what industry observers call the utility death spiral.
Here’s how the death spiral works. Solar and other technologies become so cheap that power users with the most expensive prices will be economically better off to cut ties with the grid and generate their own power. As those utility customers defect, the cost of maintaining the grid must be absorbed by fewer remaining customers so electricity prices rise to compensate. Meanwhile, solar costs have continued to decline. Now the next group of electricity users find it economic to defect leaving even fewer customers to pay for the grid so prices rise again. This continues until utilities are left with the worst customers and are forced into bankruptcy as they can no longer afford to maintain a massive portfolio of stranded assets. The Edison Electric Institute (EEI), a utility trade group, said in a 2013 report that “the longer-term threat of fully exiting from the grid (or customers solely using the electric grid for backup purposes) raises the potential for irreparable damages to revenues and growth prospects.”
Other forces are also working against utilities. Investment continues to pour into energy efficiency technologies such as intelligence HVAC optimization software and LED lighting. This is leading utility industry revenues to fall as a percent of GDP. The EEI described the march of energy efficiency as “a meaningful impact on utility load…that will create significant additional lost revenue.” As with grid defections, this will lead to increases in per unit electricity costs which will make efficiency upgrades that much more attractive. Other technologies that may enable large scale grid defections are improving at rates similar to solar. Battery storage is a key example. Just a few years ago lithium ion batteries were deemed impossibly expensive for large scale energy storage. But batteries are gadgets and the price of gadgets tends to go down fast; batteries have plunged in price, and are being deployed for large scale energy storage at a rate more than 100x greater than just two years ago. Finally, the U.S. is likely to begin exporting large volumes of natural gas which could lead to large price increases in the most important input for electricity generation.
Impact on Real Estate
What does this mean for the real estate industry? The first takeaway is that there is a big opportunity available to increase NOI due to the maturity of various technologies. Is it profitable for many buildings to install solar today? Yes. Are there NPV positive (and under 3-year payback) projects in energy efficiency software, batteries, demand response, variable speed chillers, LEDs and the like in your portfolio today? In greater than 80% of the buildings in North America the answer is a resounding “yes.”
But what about the utility death spiral? What do you need to do about that? First, keep in mind that with new technology the world seems to change only very slowly or not at all until suddenly it’s clear that nothing will ever be the same again. Think of television, smartphones, laptops, automobiles, email, nuclear power, air travel…and of course the electric grid. That’s happening now with energy. Will you be prepared for a world of suddenly spiraling energy prices? What will happen if several major utilities declare bankruptcy? What if your competitors are completely insulated from energy cost increases? What if the best tenants all demand backup energy under any conditions and an ENERGY STAR score of 90 to boot? On topics such as these, I can only assure you of one thing: expect change, and a lot of it.
