The technology model alone has not succeeded – i.e. microturbines, fuel cells and expensive new equipment. The market demanded quick paybacks, but no one has delivered to any great success due to high equipment costs. Developers naturally turned to a services model - i.e. solving a customer’s problem with a technology-neutral approach and little or no upfront costs to the customer. It too, has met with little success, and it appears to be playing out. So, what’s next? Maybe its time to re-assess the whole industry.

Current State of the Market
The market has never materialized. Just who is responsible for high early expectations provides an interesting study of motivations, and an indication, perhaps, of future business models. Early advocates studied the airline, telecommunications, and natural gas industries to find parallels to the deregulating electric market. On the surface there appeared to be many parallels. In reality, there were only a few. As history has borne out, the road to electric deregulation is all but blocked. Everyone assumed that California, of all places, would have gotten it right. And, few gave nothing but a passing thought at the possibility of massive market manipulation. It seems that everyone forgot the most basic human trait – that everyone will act in their own self-interest. Whether it is in writing the deregulation language, or taking advantage of the rules.

The utility industry is still the keeper of the gate – that is, the route to the customer. Airline customers could go to competitors, eventually so could telecom customers. To some extent, so could gas customers, particularly pipeline customers. But, the electric gate has only partially opened. Electric utilities have never embraced the widespread adoption of onsite power generation, and likely would not have under even the best circumstances. It is primarily for this reason I believe that DG is a disruptive concept – not a disruptive technology. Utilities, like any other business, are not going to give up business without a fight, particularly if they can still control the gate.

But, let’s be realistic. It is not just the utility industry responsible for the poor market acceptance thus far. Rather, much of the blame can be laid at the feet of vendors, developers and investors who had to make DG installations pay back at rates far greater than anyone could deliver. Throw in uneven (and sometimes ridiculous) regulation and one realizes why success has been elusive, and why the business models failed.

The Future State of the Market
What seems to be missing is a realistic assessment of where the energy market is heading. While deregulation is not dead, it certainly does not have a strong pulse. But, neither are we likely to head back into full regulation. The grid has not been invested in; congestion is rampant in populated areas; NIMBY is as strong as ever (some would argue stronger); security concerns will only increase; and environmental requirements will not weaken in non-attainment areas for small sources.

That’s not to mention the fact that the natural gas depletion rates are alarming. We don’t have an energy policy to deal with any of these concerns. In short, we’re kind of stuck in no-man’s land. Problems can be solved, but who is willing to force the issues? Believers in government leadership on energy policy have to be some of the most naïve people around. Yet, who can count on environmentalists to take a business-neutral lead? Who can count on business to make the right environmental decisions? The divide between the environmentalists and big energy is wide, and the government sits in the middle, not willing or able to take serious action until something drastic happens.

So, where is this all heading? First, let’s all agree that energy technology stocks are all event-driven. The August 14th blackout has been the key event thus far, but won’t be the last. For years DG-related stocks have been heavily influenced by events – usually resulting in a short bounce on such news as the President’s energy plan, fuel cell announcements, and other events. These bounces never lasted very long. But, the bounce since August has been sustained – except for wind-related companies, which have declined due to the expiration of the tax benefits.

Since the fall of Saddam Hussein, Iraq has been a showcase on how to attack energy facilities, thus delaying an economic recovery, and fomenting unrest. Reports following the blackout here call for huge investments in the nation’s infrastructure. The August blackout is more important than the other events, because the reaction by regulators primarily. Estimates of the blackout run as high as $6 billion to the economy. Not a great deal in terms of a $10 trillion total economy, but on a regional basis, it is expensive. I have been associated with several blackouts and I’ve never seen the reaction that we’re seeing in the Northeast. The regulators there are doing what they can to ensure it does not happen again.

The message the market seems to be sending us is that energy uncertainty is increasing, and the concern is there. Savvy investors are lining up, but few have good ideas of where to put their money yet. Pure play DG stocks are a good barometer of interest in the overall DG sector. Diversified companies such as Caterpillar, GE and others are more difficult to gauge since they have many products across many segments. But, the pure plays reflect true interest in the category. Taken with other facts mentioned earlier, and we begin to see a trend of growing interest in providing solutions, and at least the outlines of emerging business models.

Because of this uncertainty, and the increasing interest level, I believe we are entering a new energy era in the United States. And not just in our country, but around the industrial world. I believe that this new era is forcing – or will force – end-users to become much more energy-minded, efficient and more aware of the true cost of energy. Not a future based on scarcity; mind you, but one that requires efficient use of energy. Look at the recent revised reserve estimates by such companies as El Paso Energy and Shell, and even Saudi Arabia – revised dramatically down. OPEC keeps raising and lowering output, and Venezuela is threatening to cut off exports to the U.S. There is no short-term answer if the oil spigot is suddenly turned off.

It takes time to explore for new energy sources that are currently off-limits. Time is the enemy of an economy (and government) that continuously hides from the realities around the corner. No one seems to be willing to take the lead. Meanwhile, risk is being passed on to end-users, who traditionally have few choices. In such times, conservation becomes much more important.

I believe that these drivers point to the strategy of the future as one of risk management. The scenario is one of Smart Energy Management. This requires a dramatically different business model than the traditional one. But, these are not traditional times. Smart Energy Management entails conservation and efficiency, and all of those things that go with them.

A New Model?
DG units will likely be used primarily as peakers to better manage demand and congestion (although there will still be opportunities for baseload operation). That means low cost equipment – perhaps even used or remanufactured equipment. More units placed in congested areas, which also tend to be non-attainment areas. Thus, there is a need for clean technology. And, this is a short-term need.

Most manufacturers and DG advocates do not want to hear this. But, it could also lead to much wider acceptance of DG as one more solution to manage customers’ energy bills. The enabling technologies for this transformation include new generations of controls and energy management systems that will seamlessly bring DG and load management together. It also means DG technologies must be clean. Winning products will include low-cost, hassle-free, plug and play and clean DG/CHP; retrofit emissions controls; and sophisticated, reliable, yet affordable controls.

There is an industry that offers many legitimate parallels to this scenario – water. And, we’ll delve into it next time.

Response from:

Brian Braginton-Smith
5.7.04

In order for distributed generation to work there is also going to be a need for suppliers to shift to a solutions approach from the component parts approach which is the norm for the conventional utility market. Consumers want an easy to undertand cost competitive comprehensive answer for their specific need, the utility marketplace has a focus on compoment parts which the utility transforms into a complete solution. Consumer based distributed generation will become the model in the 21st Century market place once the barriers are finally all eliminated and the suppliers gain a better understanding of the community market.

In addition to the above hurdles, the natural gas market has had a catastrophic impact on more than the distributed generation folks. At $8 to $10 an mmbtu there are plenty of conventional generation folks hurting because the spark spread for conventional project economic benefit models have evaporated. Like geological time, utility level market time is on the oreder of decades rather than months or years. The transition period from one paradigm to the next will be proportional to the degree of change to the market implied and it will be prone to erratic swings as the transition occurs and the new order is established. In this case there is a radical change underway in the core generation model, Therefore if the distributed market is to evolve, we will need to have patience and staying power. We cannot make the call on deregulation yet and the reality is that utility infrastructure is going to transition from the present scenario to a market based on alternative fuels and distributed generation at some point. Just When?

I would agree with you, the market is searching for a home to take seed and eventually blossom. I'd call the DG market up to now spade work in window boxes. The present established market which is almost completely central plant generation based cannot be changed over night considering it took a hundred or more years to write all the regulations to protect the utility model. Add to that the fact that beaurocracies resist change and the time scale equasion begins to take form. Your last line particularly intersted me, because I see a much more interesting transition happening on the water side as well. - BBS

Response from:

Joseph Somsel
5.10.04

On a more concrete basis, DG shifts the problems of electrical transmission to natural gas transmission and distribution. Every serious DG contender uses natural gas as its energy source. Now that IPPs have extracted most of the "latent value" in electrical transmission, DG would depend on exploiting the under-utilitization of the analogous natural gas supply system. The problem with that strategy is that natural gas is a declining resource where the long-term trend is increased price. The higher the fuel price, the more important economy of scale and efficiency.

Plain irrational regulation is still wide-spread. During the California energy crisis I personally attempted to develop plants in the San Francisco Bay Area that were based on large aggregrations of DG-type natural gas burning engines. The local air quality control board quickly dissuaded me. Of course, at the same time that they were putting the kabosh on my plants they were SUBSIDIZING the exact same engine blocks for use by local government agencies in natural gas fueled vehicles . At best, air quality regs will require use of natural gas. At worst, they will make ANY DG impractical.

Mr. Priddy's conclusion that customer peak-shaving is THE market for DG is spot-on. His identification of the basic properties of a successful DG boils down to three factors - cheap, cheap, and cheap.

But where's the profit in that?

Response from:

Jerry Jackson
5.11.04

Proof of this is that companies like Direct Energy guarantee clients savings of 10-15% of their electric bills with no client responsibility for purchasing, installing or maintaining the DG systems.