October 2004

Eye of the Hurricane

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2005/01/08)
 

The first winds of a hurricane can be mistaken for a breeze... In May, 2004, Pepco published a study it had commissioned from an independent firm experienced with crisis management, which evaluated its performance in response to Hurricane Isabel, which caused significant  system outages. The frame of reference chosen by that consultant should be a wake-up call to the industry: a review of “the utilities preparation for its response to the event in the larger context of what it takes to rapidly and efficiently restore damaged areas into functional communities, including what others were doing during the restoration process (emphasis added). The major findings of the study struck a new note regarding the interface of public policy with utility management. Its findings:

- There had been an insufficient appreciation that the outage was a community event, not just a utilities event

- There was a need for the emergency management function to have a higher priority, of emphasis on developing operating concepts and support systems that can be scaled to respond to both routine and mass outages

- There was a need, in short, for sharper focus on customer service in a disaster environment

The report was, in effect, a call for the recognition of a new role for public-private partnerships. The idea of “public-private partnerships” has been around for several decades, though not identified with the energy area. There have been various “privatization” proposals, but the emphasis was more on movement of assets to the private sector then on a partnering. Concern with the reliability of the nation’s electric transmission system and more generally with the vulnerability of our electric-powered and power electronics _ controlled economy has been far more recent. Their convergence has been driven by the need for government to create markets for the new technologies to provide system continuity and resiliency, which can respond to our new environment. But aren’t regulated utilities one of the original public-private responses to government requirements? As with many issues in contemporary energy policy, that remains to be seen. Utilities must lead, follow or get out of the way. It’s a much more dramatic remake of the Federal energy conservation story, summarized below, and actually has some of its roots in it.

The blackouts focused attention on the fact that power deregulation, which created multiple new, unrelated users of transmission lines, and less revenue for the generation-de-nuded distribution companies, had provided limited financial incentive to expand and repair the grid which the situation required. Large scale businesses, particularly with cyber-impacted facets which had already begun to install equipment to fend for themselves, began further independent strengthening of their support “critical nodes”. Governments began examining whether civic emergency planning was sufficient and whether, in the event of an emergency, power could be restored and sustained in both private and public critical facilities. It also began to focus on whether there was adequate protection against cyberterrorism; sufficiency of critical “spares” and better technical and economic integration with on-site assets.

In this context, the role of “distributed energy” - which includes not only on-site power supply, but also improved systems controls, power conservation, storage and power management - crossed over from being a subject of interest to a segment of the energy community to being an issue for which it made sense to put public financial muscle behind private engineering initiatives. As this occurred, the issue of whether electrical utilities would become the new constructive public-private interface to address these issues came into focus and question.

What policy makers found were two seemingly intractable and incompatible facts. Focused, as they had been directed, on overall system efficiencies, centered around large central stations, connected by long distance transmission wires, and more recently segmented into discos and transcos, utilities were simply not constituted _ nor compensated by the existing regulation system _ for emergency operation of the several tiered power utilization system for which governments are now called to provide overall protection. Indicia of that fact are the regulators _ skirmishing on issues such as allocation of cost and procedures for interconnection; rights to utility DE ownership; feasibility of aggregation of production from DE owned generation and conservation facilities. These regulatory struggles continue, but their significance is exacerbated by the financial characteristics of DE, which generally smaller cost items (certainly relative to power plants), with cash flow subject to variations beyond their control; and involve risks presented which the project sponsor cannot carry. Aggregation of cash flows, of suppliers warranties and compliance risk would seem basic to providing DE to meet the kind of problems described.

In the Federal buildings shared savings area, Congress simply decided to deal with these problems by creating a financeable market. The government, as customer, stood ready to purchase multiple smaller improvements in multiple units with demonstrated energy savings values.  The supplier market was filled by major equipment providers and innovative financiers also securitized the aggregated obligations. Utility special purpose subsidiaries were significant players, but utilities did not provide the basic market framework for the undertaking. The issues surrounding assurance of electric power security reliability and security are, to be sure, significantly broader and more complex than those surrounding energy savings. But the more sophisticated energy security management tools bear a relationship to those used for energy savings. And if utilities do notinvolve themselves in working with both  the owners of DE at critical nodes and with government security planners, they create a situation where they may have dealt themselves out of one of the key energy games of the next decade. Creative use of DE can deal utilities back into the game.

And it is not a game which utilities are as insulated at playing as in the past. While traditional tariffs established “gross negligence” as the applicable standard, that criterion has been eroded by bilateral contracts and FERC “negligence” standards for transmission. While power has historically been treated as a  service rather than a good or a product, with attendant liability implications,  those protections are eroding. The lawsuits currently faced by First Energy could set new precedents.

Overall, utilities will be facing the consequences of recommendations such as those that emerged from the Hurricane Isabel study:

“(PEPCO”) established service priorities that are logical and defensible from the utility engineering point of view. It may be, however, that different priorities result when health and safety is viewed from a community perspective . . . [R]estoration priorities should result from a collaborative process with the political leadership of the serviced jurisdictions, including the public utility commissions”.

It’s up to the utilities to catch the winds of Isabel-driven change or twist slowly in the winds of bureaucratic envelopments by governments concerned with security.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.