4 Wild Cards for Utilities in 2013: Risks & Opportunities

Articles

by futurist Richard Worzel, C.F.A.

The utility industries thrive on stability, yet they may well face a number of surprises in 2013 and beyond, both pleasant and unpleasant. And although some of these will be “unknown unknowns”, others may be unfamiliar, but can be identified using futurist techniques. In particular, the concept of Wild Cards is appropriate.

A Wild Card is a low probability event, which, if it occurs, will have dramatic consequences. The 2011 earthquake and tsunami in Japan is an example of one such Wild Card, as were the terrorist attacks of 9/11. With that in mind, let me suggest 4 potential Wild Cards that utilities may face in the 2013 and beyond. And although I’m going to present 4 individual Wild Cards, the real surprises may come from the downstream consequences of these events, or even from how they interfere with and affect each other. Such ripple effects are much more difficult to anticipate and prepare for.

1) Cheap oil. Since its 1998 lows, the price of oil has been driven upwards by the emergence of the Rapidly Developing Countries (“RDCs”), notably China and India. Their demand, added to the natural growth in the developed world, lead to an all-time peak price of $146/bbl in June of 2008 that threatened to put the global economy into a dead stall. The Great Recession of 2009 solved that problem and brought oil prices crashing down along with economic activity, but the recovery caused them to recover to the $100/bbl mark before stagnating. Yet, the most commonly held view is still that steadily rising global demand will push oil prices inexorably higher, with some commentators calling for $200/bbl. I suspect that won’t happen.

To see where cheap oil may come from, consider what happened to the price of natural gas as fracking became widespread. Prices peaked in March of 2008, before the economy cracked, because of oversupply, and fell precipitously. This significantly changed the global energy equation, and dramatically lowered the cost of electricity generation from gas turbines, and the price to consumers for natural gas providers. And now the same thing may be in the process of happening to the price of oil.

Globally, there are probably more reserves of oil locked up in shale today than in conventional sources, and processes similar to fracking are now being used to unlock it. What’s more, oil companies already know the locations of enormous fields of oil shale. The United States, for instance, has the largest known reserves of oil shale in the world, exceeding the reserves of Saudi Arabia, which has the greatest reserves of conventional oil. For instance, it’s been know for decades that there’s a lot of oil locked up in the Bakken shale formation, which was already producing 458,000 barrels a day by the end of 2010. But an even more important field may be farther south and west.

Royal Dutch Shell is reported to be testing a technique called the In-situ Conversion Process (“ICP”) to extract oil in western Colorado. They estimate that they can extract one billion barrels of oil per square mile in the northwest corner of Colorado, and that there are an estimated 1,000 square miles of largely barren, under-populated land that have such potential. But the real kicker is the price, as Shell is estimating they can produce oil at a cost of $40 a barrel. In other words, they are saying they may be sitting on top of one trillion barrels of oil at a cost that’s distinctly lower than today’s market rate.

The ripples of a huge, new, inexpensive supply of the world’s pivotal energy source would be dramatic. The emergence of a widespread, affordable means of unlocking the huge deposits of shale oil would re-make the global political map, rob the Middle East of much (but not all) of its geopolitical importance, transform America from being an oil importer to being an oil exporter, and bring (or increase) oil revenues to a wide range of other countries, including Canada, Australia, Brazil, Estonia, Sweden, Israel, Jordan, Morocco, China, Russia, Thailand, and Turkey, that also have significant shale oil deposits.

Meanwhile, the price of oil, and therefore of most forms of energy, would plummet. This would cause real problems for those who have invested heavily in renewable energies, but would act like the repeal of a universal tax on most economic activity. The price of gasoline would fall, penalizing the car companies’ investments in alternative fuels, hybrids, and electric cars, but boosting demand for other, larger vehicles. Economic activity would see a permanent up-shift, increasing wealth and prosperity, but also increasing greenhouse gases, and accelerating the effects of climate change.

For electric utilities, it would significantly change the economics of renewable energy sources, making them much less attractive. It would virtually eliminate the need to plan for the changing demand patterns which might have occurred through a proliferation of electric vehicles. And it would push power companies towards switching combustion generators towards (or back towards) using oil.

It would shift, again, the price/demand equation for home heating fuel, making oil relatively more attractive compared to gas or electricity. It would also lower the cost of operating, which might improve financial results as regulated rates tend to lag rapid market moves.

And it would create public relations headaches as increased demand for fossil fuels, brought on by lower prices, pushed up GHG emissions, leading to a conflict between consumers who want lower prices, and environmentalists, who want lower emissions, with utilities caught in the middle.

Will this happen? We’ve known about shale oil for over a century, but it’s never been economic to produce it. As one ironic saying goes, “Shale oil is the energy source of the future – and always will be.” And yet, with fracking producing dramatic changes in the natural gas markets, cheap shale oil must now be considered a real possibility. Indeed, a November, 2012 study by OPEC indicates that it is already starting to affect global oil supply – and prices.[1]

Shale oil may be about to become a massive economic reality. It’s an issue that will have significant consequences, and hence one you should watch carefully and be prepared to act on.

2) Climate change. Although there are still holdout climate deniers, anyone who is prepared to look at the data dispassionately must accept that climate change is happening. I’ve seen estimates that range from 95 to 98% of climatologists are agreed that climate change is happening, and that humanity is at least a significant contributing factor. As well, there are no longer any recognized scientific societies that dispute this. So the people who are qualified to hold an opinion are pretty well united in this view.

But there’s a huge distance from accepting that climate change is happening, and being prepared for it. Hurricane Sandy, in October of last year, was not a product of climate change because no specific weather event can be pinned down in that way. But Sandy does illustrate two important developments. First, climate change warms the oceans, at least in our parts of the world, and increases the probability of damaging storms of all kinds. And second, even though there was ample warning for the areas affected, many people were still not prepared for what happened.

Indeed, the power utilities that served the New York City area were roundly criticized for how long it took them to respond to power outages. And that, in turn, illustrates what we should expect with future disasters that can be attributed to climate change, or that become more frequent because of climate change.

Such disasters cannot be ignored. You can’t walk away from having your house destroyed if you’re a homeowner, and you can’t ignore widespread damage to infrastructure if you’re a utility. So, even if you’re not interested in climate change, you may have the consequences shoved into your face.

It also means that contingency planning should be taken very seriously. After the earthquake and tsunami hit Japan in March, 2011, Fukushima proved to have merely gone through the motions of contingency planning, with simple, one-page notes that had clearly been prepared simply so the utility could say they had them. In the event, they proved to be completely useless, and Fukushima found itself improvising a recovery plan after the disaster had occurred, and generally making a hash of it.

Recovery from these kinds of disasters can be ruinously expensive, as shown by Fukushima. Con Ed of New York City estimated that the costs of restoring power to the NYC area could approach half a billion dollars.

And one of the most difficult issues to gauge will be public opinion. As I said earlier, if oil prices fall, GHG emissions will rise, which will almost certainly produce a public relations backlash that will catch many utilities in the middle. Accordingly, you should be watching developments in climate change, public opinion, and energy costs very closely. And you should seriously revisit and re-evaluate your disaster contingency plans.

3) Big Data and Analytics. Big data and analytics are related but different, and are emerging now because of the continuing, and accelerating, revolution in computers and communications.

Big data is assessing the enormous quantities of data that are now becoming available, and looking for patterns that may be useful. Examples of big data include all the material assembled through the Internet, such as search requests, or Wikipedia entries or articles accessed; or the massive amounts of data emerging from genetic research, including reading entire genomes, which consist of 3 trillion base pairs per genome.

Analytics involves using newly emerging, and hence non-traditional analytic techniques to assess such massive data arrays. Traditional statistical analysis can’t hack it; the processing time takes too long, and this kind of pattern searching almost inevitably involves multivariate analysis, which multiply processing times for linear processes. New methods, like evolutionary techniques, such as genetic programming, evolve possible solutions, and search for pattern descriptions that produce steadily improving results.

Where utilities might want to investigate the use of big data and analytics are in fields that today are seen as too complex, such as long-range weather forecasting, climate forecasting, or power network behavior.

Weather and climate are both chaotic systems, and such systems are impossible to predict perfectly. But improving your ability to anticipate what might happen is possible, and evolutionary or other analytic approaches might well yield better results that dovetail with contingency planning measures. They can also help in determining forward purchases of natural gas, balancing electric generating capacity, managing maintenance schedules, and determining capacity requirements that directly affect both operating and capital budgets. As such, they can be effective tools to increase financial results, and mitigating the costs of disasters and surprises.

Likewise, power networks are so complex, and involve actions by a range of actors, that their behavior is unpredictable. Here again, using advanced analytic techniques, including pattern simulations, can help anticipate problems, enabling better capacity management and contingency planning.

Big data and analytics, then, are emerging tools that should be seriously studied as a means of avoiding or mitigating some of the other Wild Cards ahead.

4) Financial market uncertainty. By now, the term “fiscal cliff” is getting almost as overused as “European crisis”. Yet, there are actually four related, but different issues hiding behind this label, and any one of them could spell big trouble, and all call for contingency plans.

Dealing with them in the order in which they’re likely to matter, the first is the expiry of the Bush tax cuts, which will happen December 31st, unless Congress and the President agree otherwise. If that happens, the federal budget deficit will likely go down – but so will economic activity as taxes rise, and consumer and business spending slips.

The second issue is sequestration, which was a Russian-roulette compromise made by the Republican House majority, the Democratic Senate majority, and President Obama. It was agreed to as a compromise to allow the debt ceiling to be raised in July of 2012. It required the government to cut spending by up to $1.2 trillion, equally split between defense and non-defense spending, if the parties couldn’t agree on another way to reduce the budget deficit by an agreed-upon amount. The idea was that this would be so unpalatable to both sides that they would be forced to come to agreement. They did not, with the result that spending is to be cut beginning on 2013 – unless the Congress and President agree on another solution.

The combined economic effect of the expiry of the tax cuts, and the mandatory reductions in spending are estimated to reduce GDP by as much as 5%, shoving America’s economy back into recession.

The third issue is that the federal government in once again approaching the debt ceiling limit on Treasury borrowing, probably sometime in the first three months of 2013. That last time that happened, there was a standoff between Congressional Republicans and President Obama that created an artificial crisis, caused one of the major rating agencies to cut America’s AAA rating, and cost the Treasury billions in additional interest costs.

The fourth issue is the ballooning unfunded liabilities due to the aging of the population. Part of this relates to benefits paid to civil servants at all levels of government, and part to benefits due to retirees, notably Social Security and Medicare. The colossal size of these liabilities threatens to overwhelm the finances of governments at all three levels in America, leading to a Greek-style crisis. Fortunately, this won’t happen immediately. Unfortunately, it’s a compound interest problem, which means that the longer it’s left, the more expensive it is to solve. Indeed, this is one of the bones of contention between Republicans and Democrats, though neither side has come up with workable solutions.

These issues could lead to a financial panic and return to the Great Recession or worse. They even have the potential to cause the collapse of the global financial system, and throw the world economy into a new Great Depression, reminiscent of the 1930s. I expect that compromises will be reached, and solutions will be found for these disputes, but this is not a given. It’s quite possible that in playing “Chicken”, one or both of the two sides will miscalculate, and lead us off a cliff out of an excess of testosterone. And because there are four separate issues for the two sides to fight over, this compounds the chances of a misplay.

Yet, even if the two sides do eventually agree on all four issues, there will be plenty of scare headlines, and lots of uncertainty. This kind of uncertainty is made for the use of a set of techniques like scenario planning. It would be possible to flesh out scenarios for each of these possible events, and develop contingency plans to prepare for the various possibilities. And if that seems like a lot of work, then consider the potential consequences and costs if something goes wrong in the various negotiations.

—–

These are four Wild Cards that I believe utilities should be actively considering, all of which will either happen or begin to show themselves in 2013. However, let me end with an even more sobering thought: Suppose these Wild Cards happen in combination? Suppose, for instance, that Congress and President Obama do not agree and precipitate a fiscal, economic, and financial market crisis – and then a major storm or earthquake hits a major economic and population center?

Moreover, there are other Wild Cards that I haven’t mentioned here in the interests of space, any of which could have significant effects on your operations.

There’s no question that 2013 will prove to be interesting. The question management should be asking themselves in preparation is: Are we ready? Or are we just imagining we’re ready?

© Copyright, IF Research, December 2012


[1] Lawler, Alex, “OPEC admits significant impact of shale oil on supply”, Globe & Mail website, 8 November 2012, http://www.theglobeandmail.com/report-on-business/international-business/opec-admits-significant-impact-of-shale-oil-on-supply/article5113101/

Comments on this entry are closed.

  • k.d.hutchinson Dec 12, 2012

    sorry .I do not agree with your statement that humans are at all responsible for climate change.
    I do agree that climate change is occurring,which it has done for millennia.It is the result of natural occurring phenomena such as solar effects.I do agree that ocean levels will rise,etc but we should be putting dollars and efforts to preparation for such events,not into carbon credit scams,etc.I suggest you read/look at theFriends of Science website.

    • Richard Worzel Dec 26, 2012

      You’re certainly entitled to your own opinion, but there are no (zero) recognized professional societies of scientists that oppose the concepts that climate change is happening, and that humanity is at the very least a contributing factor. Moreover, climatologists are almost unanimous (but not quite) in their view that the climate change that we are experiencing is, at least, being significantly accelerated by human activity, most notably the emission of greenhouse gases. Since they’re the ones who are actually qualified to opine on this subject, I defer to their conclusions.

      This is not to say that even the most astute observers know that’s going to happen. I exchanged emails with a geophysicist from Columbia University who believes that the previous two ice ages the Earth has experienced were preceded by periods of global warming that exhibited very similar patterns to what we are witnessing now.