New York is in the midst of a comprehensive, wildly ambitious plan to reform its energy systems, aiming to make them more resilient, cleaner, and more affordable. By 2030, the state aims to reduce its carbon emissions by 40 percent (from 1990 levels) and draw 50 percent of its electricity from renewable sources.
Behind those broad goals is an enormous range of programs, primarily focused on electricity, from research to financing to utility reform. Under the state's Reforming the Energy Vision (REV) program, its electric utilities will be restructured to allow for more market competition and more distributed energy resources like rooftop solar panels, batteries, and home energy management systems. (I wrote about NY REV in some detail in this post.)
The man charged with administering this sprawling effort is Richard Kauffman, New York's first "energy czar," or rather, chair of energy and finance for New York. Kauffman was a partner at Goldman Sachs and head of a renewable energy investment firm before he became a senior adviser to Energy Secretary Steven Chu during Obama's first term. That's where New York Gov. Andrew Cuomo found him.
I recently called Kauffman to geek out over energy, getting his thoughts on the state's energy strategy, the politics around it, and the mechanics of utility reform. What follows is a transcript of our conversation, edited for length and clarity.
David Roberts: How did Gov. Cuomo choose you for this, and what exactly did he charge you with?
Richard Kauffman: Right after [Hurricane] Sandy, the governor was exposed to the suffering of many, many New Yorkers and could see how slow the electric utility sector was to respond to people’s needs. So he said, "The utility sector is in the vinyl record age, and we’ve got to move it into the age of the iPod." His original focus was resiliency, but he knew enough to know that business as usual was not going to work.
I am an energy geek; I worked at the federal government. The governor said, "I want you to come back to New York and take on this challenge." I described for him how I thought all the pieces had to fit together, from market development to innovation policy. And that’s what we’ve been doing in the state since I arrived here.
What the governor did was create this position for me, which has under it the Department of Public Service, NYSERDA [New York State Energy Research and Development Authority], the New York Power Authority, and the Long Island Power Authority.
DR: What's the balance of work that needs to be done on transportation versus electricity in New York?
RK: It’s really about where we get started. The transportation question in a place like New York — it could be an electrified solution over time. But the way we’re going to optimize the value of electric transportation is to have price signals that help with vehicle-to-grid, to help monetize the value of the battery. We wanted to get started with the electricity sector because we felt if we can establish the right economic incentives for utilities and third parties, that would be an enabler for electric transportation.
One of the benefits of an electric vehicle is there are lots of ways to make electricity. The challenge we have with non-electric alternatives for transportation is that then you’re locked into a specific fuel source. Whether you’re talking about hydrogen, biofuels, gasoline, or natural gas, you’re talking about locking in. So there’s something inherently valuable about a means of transportation where the source of propulsion can be made from many different assets.
DR: And EV batteries give you more controllable demand, too.
RK: That’s right. If you can deploy more batteries to help the grid, that’s going to reduce the cost of batteries for transportation. You can see what’s happened already: Just the increased demand for batteries from Tesla is bringing down the cost for the benefit of the grid.
We come from a perspective that the bigger the markets that are created, the bigger the economic prize, the more it's going to draw in innovation and capital.
DR: Oil and transportation politics are terrible out here in the West. Am I missing something, or is New York's energy transformation as orderly as it appears?
RK: I guess geeks rule [laughs]. No, a couple things.
First, we did not start with transportation; we started with the electricity sector, so we haven’t yet taken that on. Beyond that, California is still in the business of producing oil and gas. We’re not in that business in [New York]. So we don’t have that constituent either.
Another thing we have in our favor is that utilities in the state are just in the distribution business. We still think that the rest of [NY REV] should work even in areas where utilities are fully integrated, but I can see how it might be more challenging in areas where utilities also own generation. As the utilities in New York state are just distribution companies, this idea of making them [distributed energy] platforms — it has challenges for them, to be sure, but it doesn’t represent the same issues.
On the politics of this, if we do this right, it should be good for just about everybody in the system. We’re not doing this to the sector, you know; the sector is changing. Not everybody is completely happy the way things are.
Let’s just talk about the different elements. The people in the distributed energy business, sure, their business is growing, but if you look at the solar industry, they’re concerned about net metering battles. The people who are in the fuel cell business, or the battery business, they say, "We’d love to have the same kind of support programs the solar industry got." But is that really possible now? To imagine net metering for fuel cells, CHP [combined heat and power], digesters, and batteries? No, that’s probably not likely.
The customer acquisition costs for some of these new technologies are high. People still feel like they are potentially very large markets, but they are not yet taking off. So the solar companies may be doing pretty well, but there are other companies still trying to still get traction in the market.
Then you look at the utilities in New York. They don’t own generation, so their revenues are protected. Nonetheless, customers can take on distributed solutions. And since we allocate the cost of the system volumetrically [based on how much power customers buy from the utility], it means that over time, if you don’t change things, more and more of the system gets divided over a smaller and smaller number of customers.
That’s okay for a while, but at some point it turns into a zombie business. Utilities are going back and asking for rate increases, but they’re going to get pushback, so service at the margin is going to degrade. And with higher cost, and the declining cost of distributed solutions, other customers leave, so there are more rate increases. Over time, it means the utility can never get the resources it needs to invest in some brighter future, and ultimately we’ll have difficulty attracting people that want to be in the business.
I’m not sure the utilities would use exactly those words, but they’re aware that their core business is not growing. There are other parts of their sector that are growing, and they’re not participating in that, so how can they respond?
And then you look at people who are in the power plant business — not small-scale generation, but larger-scale generation — and I don’t think they’re necessarily all that happy, either. Two-thirds of the generation is upstate and only a third of the load is, so prices are really low. We have transmission bottlenecks, so a number of power plants are barely surviving, on the basis of capacity payments, not from energy that they sell.
So when you roll it all up: Who’s happy?
DR: The New York state renewable energy and efficiency mandates are expiring soon. There's a large-scale renewables track proceeding right now to figure out how to replace them. Where does that stand?
RK: A proposal has been put in front of the [New York Public Service] Commission. It has a few elements we’re calling design principles, things we think are really critical from a policy standpoint.
One is we believe that the market would like to have power purchase agreements, and we’ve had a REC-only approach. Developers, in order to get the most efficient form of financing, need to attract project debt. Given the economics of renewable energy — which is that the costs are very predictable, because the fuel is free — the most efficient capital structure is one that has certainty with respect to revenues.
The challenge with the REC-only model is that the developer has to then try to figure out how to get some certainty on electricity prices, and there’s not a long-dated market for electricity prices. It means we are having to pay more than the theoretical value of the RECs, under our current approach.
The second design element is we want to layer renewables into the context of everything else we’re doing. The wind industry, for example, would like to know that we’re going to have a certain amount of dollars dedicated to wind every year — X amount of dollars or X amount of megawatts. And that’s not really the way we want to do it. We’re sympathetic, we want to give a long-term signal to the renewable energy industry, but the objective isn’t to procure a certain amount of wind per year.
We already have too much generation in the state. It’s not that we want to buy more generation; we want to have renewable energy integrated into the networked grid we’re trying to build. What we’ve been doing up to this point is that we have the traditional [grid] system, and then we’ve been bolting on these other resources, whether solar or wind, but not in an integrated way.
So for large-scale renewables to be integrated, it means, for example, utilities using distributed resources and demand response, things that can actually increase the value of wind resources. Put differently, they can reduce the excess generation you need to deal with intermittency.
So we want to layer in the renewable resources with the rest of the systems. That’s our approach, and it's a little different from perhaps the way the industry would like it to be done.
The third thing is we are very focused on cost, and though we're open to the possibility of some participation and ownership by utilities, for the most part our analysis is that capital market solutions now have a lower cost of capital than utility ownership.
And then the last thing is we want to stimulate voluntary markets. Every customer has, in their electricity bill, a tiny little proration of the amount of renewable energy that’s been procured for them. We want to create a market so that if a company or an individual wants to buy more renewable power, they have an opportunity to do that.
Right now, Microsoft or Google wants to enter into a PPA [power purchase agreement] for renewable power. And sure, there are some companies interested in entering into PPAs for 20 years, and they have good credit with the counterparties, but the number of companies that fit that category is really small. Most companies don't want to make a 20-year commitment for power; they want to make a five-year commitment. And they’re not very creditworthy. So what we want to do — and I hate to use this word — is productize the ability to offer customers whatever [green power] they want.
DR: In states that have undergone retail deregulation, where customers have been given the choice of power providers, some commercial and industrial customers have adopted alternate providers, but the residential uptake has been almost nothing. What's the evidence that customers care enough about electricity to sustain these markets?
RK: Right, [with electricity] you’re talking about what is essentially a commodity, and a commodity that is not a very big percentage of most people’s budgets. So why would we really care?
When we talk about stimulating voluntary markets, it may not be that you and I, household customers, are necessarily going to be active in the market ourselves. It may be that service providers are offering things that aren’t true wholesale electricity price.
With these utility platform providers, what we're trying to set up is relationships with third parties that are going to offer stuff to customers that customers value. We have said that we don’t want utilities to own distributed resources because we need competitive markets — we need the innovation of the markets, not only to find the projects, but to find out what customers are going to care about. What products? How are they going to buy them? What will their motivations be?
So I would contrast, for example, the solar residential lease, an innovation that has revolutionized the market, with what we have done in residential energy efficiency. The programs we have in residential energy efficiency say to customers: You know you should save money, it’s good for you, we’ll pay for an audit, then we’ll pay for some of the retrofit. With the uptake that we have in New York state, where 70 percent of the houses are more than 70 years old, it’s going to take us 500 years to do the housing stuff.
The point about distributed solutions is they have the opportunity to create more value for the electrons. We don’t consume electrons; we use them for comfort, convenience, entertainment, health. So the question is do these distributed solutions enable us to get more out of the electricity system? I think the answer could well be yes.
I’m optimistic, because I think there’s an opportunity to create an energy system that is more valuable to customers, because of the services it provides, and it happens to be energy efficient and cleaner to boot.
DR: Let's get into utility structure. Some grid reformers, like [ex-FERC Chair] Jon Wellinghoff, have advocated for what is essentially the mirror image of the wholesale deregulation model, which is having an independent, third-party nonprofit organization oversee these markets — an IDSO [independent distributed system operator], as it’s called. New York decided instead to give that market oversight responsibility to the utilities themselves. So utilities are going to play a dual role: the traditional, regulated, maintain-the-grid role, and then this second role as distributed service providers and market managers. What was the impetus for that decision? Why not go the IDSO route? [I wrote about this dilemma in this post.]
RK: There are lots of answers to that.
Let’s think about the physical platform that needs to be built. If you think about the iPad as a platform — Apple wants third parties to develop apps, because a share of the revenue from the apps goes to Apple. So there’s a virtuous cycle that takes place, where the more Apple invests in the platform to make it valuable to the app developers, the more Apple gets paid back in revenue. That’s the kind of dynamic we need to create between the utilities and third parties.
The idea of an independent market operator, we get it. But the [wholesale electricity] market we’re talking about, people have to buy. The market has to buy wholesale power. Nobody has to buy retail power. As we talked about, how do we know people are going to care?
The only way people are going to care is through robust creation of these third-party apps, which requires a connection between utility operations and this platform and the market. It requires commercial interest, as opposed to a nonprofit operator.
If the market already existed, then yeah, you can have a nonprofit operator. But the market doesn’t exist. And the kind of market we’re talking about is one that is going to require lots of innovation to get customers to care about it. It’s going to require utilities to engage in a culture of innovation in all kinds of ways.
DR: Let's talk about market-based earnings (MBEs), the alternative revenue streams utilities are supposed to develop through operating these platforms. One thing utilities have stressed is that they want to be able to rely on their traditional revenues as well, because they don’t know how much revenue is going to come out of these MBEs. In your mind, 10 years from now, how big of a role are those MBEs playing relative to traditional, regulated utility revenue? Are they equal? Or are MBEs always going to be a marginal revenue stream?
RK: I don’t know. I can’t tell you where it’s going to be in 10 years. This is where I would like the utilities to open their minds in some ways. Utilities are worried about their investors wanting safety and security. I’d make two points in response to that.
One is that we’re not doing this to the utilities; the world has changed, for utilities and utility investors.
The other point is that some of the revenues we’re talking about, alternative revenues, could in fact be very stable.
One thing that is very clear to me, having come from outside the industry, is that the regulated model has protected the electric utilities sector from the forces of American business for the last 35 years. One of the big [business] themes of the last 35 years has been companies figuring out how to become more capital efficient through adoption of new business models, new technology, and changes in financial incentives. In the utility sector, it’s been the opposite.
Another example in the last 35 years has been companies reengineering themselves away from where the value add was in production to it being about satisfying the customer — reengineering their business so the customer is first. The utility sector is still a push model, not a pull model.
Another example is most companies that have been in the commodity business in the last 35 years have faced relentless cost deflation, and they’ve had to figure out how to reduce their costs, or how to get into more value-added services to customers. The utility sector offers the same product it did 35 years ago, at a higher and higher cost!
I could go on. So I understand that it’s scary for the utility industry, but these changes are not scary for the rest of the American economy. We’ve been living through this for 35 years. It’s about opening up the utility sector to things that have already been invented elsewhere.
The final thing I’ll say goes back to the existing wallet share of energy services. This is an overused analogy, but, I’m sorry, it still works: We pay less per phone call than we used to, but the wallet share, what we pay for telecommunications and entertainment services, is much higher, because we get more value out of that stuff. So there’s a very large potential pool of money to be earned by a [distributed energy services] platform provider.