The Dbriefs Energy & Resources series presents:

The Math Does Not Lie: Factoring the Future of the U.S. Electric Power Industry
Greg Aliff, Deloitte LLP Marlene Motyka, Deloitte Financial Advisory Services LLP Branko Terzic, Deloitte Services LP

January 16, 2013

Agenda
Objectives of Paper Planning for the Near Term The Math The Numerator The Denominator The Math at Work Electricity Sectors Response

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Objectives of Paper

Objective
To explore what is changing in the electric industry and introduce a straightforward approach to examine the future through a simple framework using a mathematical equation. Two emerging trends

Steeply rising costs

Moderating electricity consumption

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Poll question #1
How do you think U.S. electricity consumption will change between 2012 and 2020? It will: Increase at an average annual rate of 2% or more Increase at an average annual rate of less than 2% Remain essentially the same Decrease at an average annual rate of less than 2% Decrease at an average annual rate of 2% or more

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Planning for the Near Term

Planning for the Near Term - 2020

Eight years is not far away:
Longview Powers 695 MW (net) supercritical pulverized coal-fired power plant in Maidsville, W.V., completed recently, took 5 years to come online Georgia Powers Vogtle and SCANAs V.C. Summer nuclear plants are expected to take 9 to 10 years to complete
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Planning for the Near Term

During eight short years, many unknown factors will impact the U.S. electric power industry, such as:
The global and U.S. economy Coal, natural gas and nuclear fuel prices Federal and state policy and regulation Technological advances Changing customer behaviors and demands

Despite uncertainty, if constituents use a simple mathematical equation as the framework, they can focus on the variables and analyze them in relation to each other The math does not lie.
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The Math

The future can be evaluated with a simple mathematical equation

Cost of electricity sold ($) Cost per kWh sold ($/kWh) Number of kilowatt hours (kWh) consumed

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Variables to Include in the Equation

The Numerator: Cost of Electricity Sold
Capital and Operations Costs
Capital costs Generation, transmission and distribution additions Environmental regulation compliance Renewable portfolio standards Nuclear safety regulations Cost of capital/interest rates Operations costs Cost of fuel Incremental operations costs of environmental compliance retrofits New operating technologies
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The Denominator: kWh Consumed

Consumption
Changes in weather Changes in the economy New sources of electricity demand Technological advances in energy efficiency Customer attitudes and behaviors

Poll question #2
Which of the following variables do you think will have the greatest impact on the electricity sectors costs from 20122020? Investment in generation, transmission, and distribution (associated depreciation and interest costs) Environmental compliance costs (associated depreciation, interest, and operating costs) Compliance with Renewable Portfolio Standards (RPS), (associated depreciation and interest costs) Smart Grid Deployment (associated depreciation and interest costs)

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The Numerator

The Numerator Capital Costs

Aging fleet and early retirements Over $150 billion in new generation capacity from 2012-2020.1 Generation Investment Grid reliability and renewables integration From $100-$120 billion in new transmission assets between 2012 and 2020.2 Transmission Investment Changing infrastructure and smart meter installations $4.4 to $11.6 billion investment in new smart meters alone through 2015.3 Distribution Investment
based on U.S. Energy Information Administrations (EIA) forecasts for new additional capacity, overnight capital costs, and lead time for various technologies. 2 Based on The Brattle Group, Employment and Economic Benefits of Transmission Infrastructure Investment in the U.S. and Canada. Johannes P. Pfeifenberger and Delphine Hou, prepared for WIRES - Working Group for Investment in Reliable and Economic Electric Systems, May 2011. 3 Based on $150-$400 per meter deployment cost, MIT, The Future of the Electric Grid. Dec 2011 and estimated 29 million smart meters to be deployed from mid 2012 through 2015 (IEE 14 Utility-Scale Smart Meter Deployments, Plans& Proposals, May 2012).
1 Estimate

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The Numerator Capital Costs

Evolving federal, state and local environmental regulations EPAs Mercury and Air Toxics Standards (MATS) - estimated incremental compliance Environmental Compliance cost of nearly $55 billion through 20201 Investment Twenty-nine states have set mandatory Renewable Portfolio Standards (RPS) and eight states set voluntary goals U.S. needs to add 3.62 GW of renewable capacity annually between 2012 and 2020 to meet RPS2 Renewables Capacity Investment New safety regulations required by the Nuclear Regulatory Commission (NRC) post-Fukushima will result in new compliance-related investment at nuclear plants Nuclear Safety Investment
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U.S. Environmental Protection Agency, Regulatory Impact Analysis for the Final Mercury and Air Toxics Standards, December 2011, p 3-14 Copyright 2013 and Uncertain Federal Support 2012. 2 U.S. Partnership for Renewable Energy Finance Ramping Up Renewables: Leveraging State RPS Programs Deloitte Development LLC. All rights reserved.

The Numerator Capital Costs

Future interest rates remain uncertain but are likely to increase from the current record low
Interest rate on a 10-year T- Note, 2004-2012 (through August)
6 5 Interest Rate (%) 4 3 2 1 0

Average: 4.3 %

Average: 3.1 % Average: 1.8%

Source: U.S. Department of the Treasury

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The Numerator Operations Costs

Natural gas price needs to rise to ~$4.50/MMBtu1 to make much of U.S. shale production economical

Fuel for Electric Generation

Recent technological advancements such as smart grid and electricity storage could decrease operations costs New Technologies Emissions retrofits can increase electric plant operating costs other than fuel by over 50 percent2 Emissions Retrofits
Roberts, Ethylene Good Today, Better Tomorrow A Year Later, Goldman Sachs Chemical Intensity Day, Lyondellbasell, March 2012 Based on a sample 300 MW coal fired power plant and investment costs converted to $/kWh using a 15 percent fixed charge rate and 60 percent capacity factor. Source: Jim Lazar and David Farnsworth, Incorporating Environmental Costs in Electric Rates, Regulatory Assistance Project (RAP), October 2011, p.15
2 1Tim

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The Denominator

The Denominator - Kilowatt hours consumed

Increased electronics Computer server farms Electric vehicles (EV) Water management Resurgence of U.S. manufacturing Advances in energy efficiency

New sources of demand

Energy Efficiency Customers will be able to do the same Technology with less

kWh consumed
Customer Behavior U.S. Economy Permanent demand destruction? Recovery uncertain?

Changing electricity consumption trends by businesses and consumers

Increases kWh consumed

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Uncertain Impact on kWh consumed

Decreases kWh consumed

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Consumer Resourcefulness Extends to Electricity

Findings of Deloitte reSources 2012 Study* of over 2,200 demographically-balanced household decision makers
83 percent of consumers reported they took steps to reduce their electricity consumption up from 68 percent in the 2011 Study. The primary steps taken were behavioral in nature turning off lights (78 percent), shutting down electronics when not in use (65 percent), adjusting the thermostat in the summer and winter (61 percent), and changing over to compact fluorescent lights (60 percent). While interest in purchasing smart energy technologies is relatively low, it is noticeably growing, with younger adults clearly more receptive to making the investment
* Deloitte Development LLC. Deloitte reSources 2012 Studies: Insights into Corporate Energy Management Trends and Insights into Emerging Trends of Energy Customers. May 2012
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Businesses commitment to energy management practices intensifies

Findings of Deloittes reSources 2012 Study* of business activities of over 600 companies with greater than 250 employees:
90 percent of U.S. businesses have set goals for managing electricity usage with 49 percent having reported formal goals vs. 45 percent in 2011. Of these companies, 85 percent cite reducing electricity costs as essential to staying competitive up from 76 percent in 2011. The average target for reduction in electricity consumption is 23 percent over approximately a 3.5 year period. 35 percent of businesses report some level of self-generation of electricity with another 17 percent planning to do so in the future.
* Deloitte Development LLC. Deloitte reSources 2012 Studies: Insights into Corporate Energy Management Trends and Insights into Emerging Trends of Energy Customers. May 2012
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Federal Government Impacts on Consumption

Federal Facilities Energy Reduction Targets: Annual energy intensity decrease by 2015 using 2003 as a baseline year - 3 percent , i.e. a total of 30% by the end of fiscal year 2015

The Department of Defense (DOD) Energy Reduction Targets Even Greater: Annual energy intensity decrease in DOD facilities using a baseline year of 2003 - 21 percent by 2012 - 37.5 percent by 2020 Renewables as a percentage of energy consumption- 12 percent in 2012 - 20 percent by 2020
Source: Department of Energy and Department of Defense

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Poll question #3
As a consumer, have you taken steps to reduce your energy consumption? If so, which one have you taken? Turning off lights Shutting down electronics when not in use Adjusting the thermostat in the summer and winter Changing over to compact fluorescent lights More than one of the above

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The Math at Work

The Math in Action:

The numerator is going up and the denominator may well be going down over time for the first time in the history of the U.S. electric industry

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The New Math Suggests a Dilemma

Will rising electricity costs and prices lead to further decreases in the denominator and even higher costs per kWh? Will the price to individual consumers invoke even greater end-user investment in energy efficiency? Will there be a wave of new, economically priced technologies designed to enable greater consumer and business control over their electricity consumption? Since variables affecting results will vary from company to company, every company must do its own math
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The Electricity Sectors Response

Avenues to Evaluate
Identify and reduce/defer controllable costs Consider mergers, acquisitions, or strategic dispositions where significant synergy savings can be achieved

Reduce numerator

Increase electricity demand

Electric vehicles (EV) Computer servers/data centers

Grow denominator

Identify new regulated revenue streams

Utilitys value proposition to on-site generation Opportunities in residential and business electricity generation or storage Incremental value for EV beyond electricity? Opportunities in related areas such a water scarcity
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Poll question #4
Which potential new revenue stream holds the most promise for the electricity sector? On-site generation Residential and business electricity generation or storage Electric vehicles Water scarcity (e.g. desalination)

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Another Avenue: Change the regulatory paradigm

Evaluate changes to the current regulatory paradigm with policy makers and regulators against the backdrop of the New Math to arrive at mutually acceptable solutions. Examples of recent changes from the traditional model include: Deregulation of generation Decoupling of electric rates Renewable portfolio standards Demand response programs

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Explore Alternative Business Models

Changing global marketplace and energy landscape suggests a re-evaluation of future business strategies
Invest in new unregulated revenue streams Diversify the companys overall marketplace risk Evaluate opportunities for new products and services Bundle electricity services with other services, regulated or unregulated Re-consider business structures: Consider joint ventures and public-private partnerships

Ride the technology wave Customer acceptance of new technologies creates new electricity demand, e.g. Best Buys Geek Squad Expansion

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Navigating the Future

The U.S. electric power industry has weathered previous storms, but it could be navigating uncharted waters in the form of significantly rising costs to produce and deliver a unit of product in the face of consistently flat or declining electricity consumption.

The time for true innovation in the electricity sector may have arrived

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Question and Answer

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Contact info
Branko Terzic bterzic@deloitte.com Greg Aliff galiff@deloitte.com Marlene Motyka mmotyka@deloitte.com

Copyright 2013 Deloitte Development LLC. All rights reserved.

This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

Copyright 2013 Deloitte Development LLC. All rights reserved.

About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Copyright 2013 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu