lunes, enero 26, 2009

Just as Pogo, IOUs Found the Enemy

Just as everybody else, power industry investors win by changing their IOUs paradigm mental model. Well in agreement with the insights of three DOE’s Electricity Advisory Committee reports, a transformation to the end-state of the power industry, for quite some time, is the EWPC paradigm that allows the application of two crucial socioeconomic insights.

Just as Pogo, IOUs Found the Enemy

By José Antonio Vanderhorst-Silverio, Ph.D.
Systemic Consultant: Electricity

First posted in the GMH Blog, on January 26th, 2009.

Copyright © 2009 José Antonio Vanderhorst-Silverio. All rights reserved. No part of this article may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, without written permission from José Antonio Vanderhorst-Silverio. This article is an unedited, an uncorrected, draft material of The EWPC Textbook. Please write to to contact the author for any kind of engagement.

This paper is a follow up of the EWPC article Will Anyone Pay for the SmartGrid?, which “… is an invitation to readers to comment about the application of two social economists’ insights about the IOUs and EWPC paradigms.” Only two very intelligent and important persons had the courage to respond to the original invitation, and it seems, that for all practical purposes, that was enough to complement all of the others persons whose questions I have responded since the end of 2005. The lessons learned could be readily applied by Dr. Steven Chu to end the debate and get the industry stakeholders agree to open and transform the power markets.

We will also benefit from the use of the timely input of Mark Goldes’ post DOE report paints bleak picture of our electric future, which summarizes John Timmer’s article with the same name. Mr. Timmer’s starts with “There's a long tradition of using Fridays to release reports you'd rather not see attract attention, and the Department of Energy [DOE] has used the last Friday of the Bush Administration to release a big one. Its Electricity Advisory Committee [EAC], composed primarily of power industry executives, has released a series of reports on the future of the US electric grid.”

In what follows, I will be using information from the three reports: 1) “Keeping the Lights On in a New World;” 2) “Smart Grid: Enabler of the New Economy;” and 3) “Bottling Electricity: Storage as a Strategic Tool for Managing Variability and Capacity Concerns in the Modern Grid.” I will refer to them as the first, the second, and the third reports, respectively. It is easy to highlight that in the titles the pairs of words “New World,” New Economy,” and “Modern Grid” suggest an emerging transformation of the whole power industry away from “magnetic forces” of the “Old World,” the “Old Economy,” and the “Not Modern” IOUs paradigm.

The first person to correspond to the invitation was David Katz, who gave us one great input about “Bright” Green Buildings (BGB). Those BGBs are waiting for the needed transformation of the power industry. In my response, I identified a void in what I now say is the presence of an anti-system. The insight is that it is no a system, as the value destruction is rampant, as will be explained soon. In addition, I responded how to take care of the void with EWPC paradigm.

This is well in agreement with the EWPC article The Anti-System Utility, which is summarized as:

Vertically integrated utilities don't operate as a system because of a monopoly mindset of incumbents’ investor owned utilities and political interference. To operate as a system, a paradigm shift to EWPC is required to offer customers competitive services and to neutralize political interference.

The insight about the rampant value destruction is confirmed on page 7 of the first EAC report, that repeats what I quoted in the GMH post U.S Power Service is Regulated as a 3rd World Country, saying that:

According to the Galvin Electricity Initiative, ‘the U.S. electric power system is designed and operated to meet a ‘3 nines’ reliability standard. This means that electric grid power is 99.97% reliable. While this sounds good in theory, in practice it translates to interruptions in the electricity supply that cost American consumers an estimated $150 billion a year.

Missing from that quote is that the Galvin Electricity Initiative also wrote that “… In other words, for every dollar spent on electricity, consumers are spending at least 50 cents on other goods and services to cover the costs of power failures,” which confirms the anti-system conclusion or, better yet, as the late W. Edwards Deming would call it “the destruction of the system.”

The second person that responded to the invitation was Mr. James Carson. I recall that at the end of 2006, he wrote: “My intention is not to convince Professor Banks. My intention is to challenge his assertions with which I disagree. Thousands of people read these forums, and I think it is a bad idea for them to get the impression that Professor Banks reflects the prevailing consensus. Frankly, I expected a more spirited clash. He merely makes pronouncements with little support and fails to respond to my rejoinders.”

While the interchanges between us are different, my respectful intention is also not to convince IOUs or Mr. Carson, but in addition to highlight something completely different. The prevailing consensus, which is the incremental extensions of the IOUs paradigm are destructive.

Even though the above explanations of the need for transformation should be sufficient, I want say that I don’t know everything about the power industry, even as I have been involved in it for more than 40 years. Nevertheless, I like to stress that I know what I am writing about when it relates to the obsolete IOUs and the emergent EWPC paradigms.

It should not, by any means, be apparent that I am writing “out of ignorance of how the North American power markets actually operate,” as Mr. Carson wants to make readers believe. As a self appointed systemic consultant on electricity, I am going further than that. I am writing about how those markets should be structured to operate well. In that light, it is important to learn that this is not the first time that Mr. Carson tries to cast doubts in the minds of readers. Just one example should suffice.

On January 3rd, 2007, after many debate and dialogue interchanges, Mr. Carson tried to show that he knew what he was talking about the power industry, when I had proposed to show how relevant institutional memory was for PJM. That interchange took place under the article Playing with Fire - The 10 Tcf/year Supply Gap -- Part I, by Andrew Weissman, Editor-in-Chief & Publisher, This is part of what he wrote on that day quoting me:

[José Antonio Item #2.] PJM was involved in a large blackout, I believe in 1967. That explains why they played it safe and kept their vertical integration institutional memory quite well.

James: Since New York has had more problems with blackouts than PJM, why did their institutional memory fail? Also, PJM was not a unified control area in 1967. It would not become that for thirty years. PJM as an organization had no such institutional memory.

[José Antonio Item #3.] FERC tried to used them as an institutional memory bridge with SMD, but was unsuccessful.

James: And your basis for making this claim is WHAT? Why was it only PJM that retained that memory? New York, New England and Canada have never experienced blackouts? Why is PJM different?

This is what I wrote on the following day:

Responding your second and third items, the PJM Timeline shows the long institutional history of PJM, which begin in 1927 with PA and NJ, and became PJM Interconnection in 1956. The NYISO is an outgrowth of the New York Power Pool, formed by New York’s eight largest utilities following the Northeast Blackout of 1965. The Power Pool combined the power generation and technical resources of its members to create an organization committed to the reliable, safe and efficient operation of the electric system.

Did Mr. Carson know what he was talking about? Instead of admitting he was wrong, as I would do, and as I have done earlier, he just fled the generative dialogue.

Under the EWPC article about the socioeconomic insights he keeps debating, trying to prove that a transformation of the power industry has already occurred, while I insist that the incremental changes in the industry have the IOUs paradigm alive and well and that a transformation is waiting to happen towards the emergent EWPC paradigm. This is where Mr. Timmer’s conclusion “the basic take-home is that we can't afford another 30 years of talk without a coherent plan of action” Is highly valuable. As the world can not afford it either, there is a high risk of IOUs getting well behind.

The power industry reports are in fact signaling the need for a transformation. Mr. Timmer’s interpretation of the main (first) report also helps infer that transformation has not occurred as he wrote that “overall evaluation that's badly off the administration's message: the government needs to make a significant intervention in the power market, it's completely failed to do so for the past eight years (and longer), and conservation needs to be part of anything we do.” That significant intervention requires shifting from price control regulation to prudential regulation for the end-customers.

Mr. Carson wrote “The energy markets in the United States are regulated by FERC, not the Energy Department. FERC, while administratively functioning inside DOE, Chu has no power to direct FERC to do anything. Again, you really need to learn the ropes.” While his statement may be perfectly right, under some circumstances, in practice this is what is happening. Now, we can see that the letters sent by the chair of EAC, Linda Stuntz, were to DOE from the tree reports and also to Congress only in the third report. None was sent to FERC for the development of new incremental rulemaking. As a matter of fact, I will transcribe the paragraphs of the reports all of which start with “On behalf of the members of the Electricity Advisory Committee (EAC), I am pleased to provide:

1. … the U.S. Department of Energy with this report, Keeping the Lights On in a New World. This report recommends policies that the U.S. Department of Energy should consider enacting as it addresses the substantial challenge of helping to ensure reliable supplies of electricity in the future at reasonable cost and with due regard for the environment.

2. … the U.S. Department of Energy (DOE) with this report, Smart Grid: Enabler of the New Energy Economy. This report recommends policies that the U.S. Department of Energy should adopt to ensure that a successful Smart Grid program is funded and implemented in the months ahead.

3. … Congress and the U.S. Department of Energy (DOE) with this report, Bottling Electricity: Storage as a Strategic Tool for Managing Variability and Capacity Concerns in the Modern Grid. This report recommends policies that the U.S. Department of Energy (DOE) should consider as it develops and implements an energy storage technologies program, as authorized by the Energy Independence and Security Act of 2007.

So, let’s get inside the reports. Page 35 of the second EAC report offers a key insight under the title “Size of the Demand-Side Resources Market,” it says:

Demand-side resources are typically smaller, more diverse, and geographically dispersed compared to supply-side assets. Understanding and organizing effective market-oriented approaches through these demand-side resources poses numerous challenges. A market typically favors larger, more knowledgeable participants, so the electric marketplace has been dominated by the electricity suppliers. This supplier domination leaves residential consumers, commercial businesses, and even most large energy users on the fringes of this over $300 billion market. With a very large and diverse group of constituents, demand-side resources have difficulty establishing a unifying agenda and even getting involved in the often obtuse infrastructure planning process.

The key insight is that the IOUs paradigm is unable handle retail markets as they should. This is Pogo story for IOUs: “I found the enemy and it’s us.” EWPC is the friend to actually consolidate retail markets. This is all about the second social economist’s insights: “In any resource-limited situation, the true value of a given service or product is determined by what one is willing to give up to obtain it.” That is why in the new economy customers go to the “electricity suppliers” to expend the other 50 cents of every dollar.

To establish a unifying agenda and face the challenge, the EWPC paradigm is the friend that opens up the power industry market to enable the development of the resources of the demand side to “organize an effective market-oriented approach.” While “electricity suppliers” are adding a lot of value by positioning themselves in Adrian J. Slywotzky’s (see a book with the same name) “The Profit Zone: how strategic business design will lead you to tomorrow’s profits”, the North American power industry has downgraded itself in the last 40 years to the No Profit Zone, becoming similar to any third world country.

While on page 14 of the second report, the EAC describes IOUs business model, they fail to even hint the emergent business model innovations in the making under EWPC. They ask DOE on page 2 and 17 to provide information on business models. Instead they concede “the lack of a coordinated strategy,” which the EWPC paradigm unifies.

On page 41 of the first report says that EAC:

… recommends that DOE support the following: Development of utility business models and rate-setting approaches that encourage and reward cost-effective energy efficiency and demand response / load management investments while providing a substantial majority of benefits to ratepayers…”

From such recommendation, there is no doubt that the IOUs paradigm is alive and well. That is how Pogo’s mental model needs get us to the key insight to change from Mr. Timmer’s bleak picture into great opportunities to integrate and consolidate retail markets at the federal level.

That insight also confirms Peter Senge’s quote about mental models at the beginning of the EWPC article Think Deming to Enable Much More than Just Freedom, the end of which I paraphrased here: “IOUs investors can now start to see the extraordinary opportunities for innovation that can occur when we abandon fearful, reactive mentalities. They start to realize the deep problems we face today are not a result of bad luck or a greedy few. They are the result of a way of thinking whose time has passed.”

Speaking of a new mental model, on page 39 of the first report the introduction, not the specific recommendations, is right on and says: “The United States has a long tradition of relying on the market to drive results. Often, these results are based on sound economic principles that attract market participants who endeavor to capitalize on market opportunities. It is with this mindset that the EAC provides these specific recommendations to the DOE for improving the use of demand-side resources.

Let’s now review action oriented history. As it happened with PURPA 1989, EPAct 1992 and EPAct 2005, IOUs, DOE and the Obama Administration need to consider the socioeconomic insights to ask the US Congress to invest in the electricity without price controls (EWPC) based Energy Policy Act to accomplish the needed transformation. The IOUs paradigm legislation to mandate competitive power markets that was passed in 1992 is flawed and has led to a very complex regulatory environment, that FERC has implemented with incremental trial and error mandates through a series of Orders (888, 889, 890, 2000 and the SMD White Paper). The incremental extension on “mandatory reliability standards,” enacted as part of the Energy Policy Act of 2005, is not under FERC. Market evolution under EPAct 92 is at a dead-end.

Looking at his bleak picture from a different angle, Mr. Timmer writes that “Incentives for things like fossil fuel exploration and renewable power generation have come and gone from the federal budget with regularity, changing the economic equation for any long-term project on a nearly annual basis. Environmental regulations, such as a carbon tax, have had the air of inevitability for years, but the lack of an definitive structure during that time makes planning for the actual implementation impossible… The lack of a national plan also means any infrastructure work faces a patchwork of federal and local regulations.” That is another way of telling that the U.S. and the world have been changing regulations incrementally. The EWPC paradigm shift has already emerged to change that economic equation.

This means that James Carson’s comment “Over the past ten or twenty years, utilities worldwide have already undergone a massive transformation. Wholesale deregulation is now the norm everywhere in the US and much of Canada. We can now value transmission upgrades under conditions of market discipline. When the SmartGrid has proven its value, it will be built,” has not been a real transformation at all. It has kept the IOUs paradigm alive and well. As seen next, even transmission upgrades are giving a lot of headaches.

On page 50 of the first EAC report, under the heading “Lack of Clear Cost Allocation Policies,” it says:

The difficulty in determining who should pay for transmission that benefits many users across multiple jurisdictions, for a variety of purposes and over a long time, is a serious obstacle to transmission development. As Nicholas Brown, President and Chief Executive Officer of Southwest Power Pool (SPP) said, “our industry desperately needs national leadership on allocating costs for the expansion of the bulk transmission system. We have planned regionally and interregionally for over a decade, but ideas remain on paper due to lack of needed cost allocation.

Now we know that Mr. Carson didn’t know what he was talking about when he wrote:

My point, to put it bluntly, is that the US power markets are already way ahead of you. We already have robust markets. We already have devolved the vertically integrated IOU paradigm towards a competitive one.

The fact is that the power industry has gone to DOE for policy changes and have written on page 56 of the first report that a “key driver of policies in this area and others will be the development of a comprehensive national energy policy for the nation’s electricity future.” On page 67 they add “Continued uncertainty in the energy sector about expected political or regulatory actions has slowed potential new generation projects. Federal legislators have been unable to produce a comprehensive energy plan or establish long-term energy policies.”

As Warren Causey said, on a different context, US Congress and FERC have been “rearranging the deckchairs on the Titanic,” when what’s needed is a high system leverage transformation. Rephrasing the late W. Edward Deming, “the transformation of the power industry, the aim of EWPC is not a job of reconstruction, nor is it revision. It requires a whole new structure, from foundation upward.” EWPC is not about rearranging the deckchairs on the Titanic. That is the true meaning of the EWPC market architecture and paradigm shift transformation, whose foundation is laid in more than 130 articles on the EWPC Blog.