DO YOU HAVE THE RIGHT ELECTRIC RELIABILITY STRATEGY? PART 2: IDENTIFYING AND EVALUATING CRITICAL TRADE-OFFS

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1 Energy Utilities POINT OF VIEW FEBRUARY 2013 DO YOU HAVE THE RIGHT ELECTRIC RELIABILITY STRATEGY? PART 2: IDENTIFYING AND EVALUATING CRITICAL TRADE-OFFS AUTHOR Alan Feibelman Partner DEVELOPING A RELIABILITY STRATEGY TO MEET CUSTOMER NEEDS TODAY AND CREATE THE GRID FOR TOMORROW When the lights go out, people get agitated: the business owners who must close temporarily, the people who lose freezers full of food, the alums who miss watching their alma mater win a bowl game, and the families that must skip homework time and sit in the dark. But today, the indignation extends well beyond those directly inconvenienced. Media, public utility commissioners, and politicians as well as the public have become increasingly vocal and active in response to power outages. Ten years ago, it took outages of 50,000 or 100,000 customers to generate headlines. Today, reports of outages affecting a few thousand customers appear on local news websites. In addition, the investment choices utility executives must make have become more critical in the face of continuing budget and resource constraints and aging distribution infrastructure. Upgrading old distribution equipment as it breaks rather than pre-emptively seems like a frugal approach, until the breakdowns multiply in a neighborhood full of people committed to writing angry s to the local media.

2 Maintaining the current utility infrastructure seems like a wise use of resources until weather patterns change and a hurricane exposes fundamental weaknesses in the existing system. Now is the time to reevaluate distribution reliability and asset management strategies. (See Exhibit 1, which outlines the internal and external factors contributing to the need to reevaluate these strategies.) As utility executives consider significant infrastructure investments, from traditional replacements, upgrades, and hardening to smart grid and other modernization initiatives, it s critical to assess key choices and trade-offs. This means facing a series of important decisions: Maintain or replace existing assets, or modernize with more storm-resistant or automated equipment? Address the least-reliable neighborhoods (or circuits) first, or neighborhoods where the political outcry is loudest? This article explores these choices in order to cut outages, while helping customers and politicians understand what their money does, and does not, cover. Exhibit 1: FACTORS AFFECTING RELIABILITY AND ASSET MANAGEMENT STRATEGIES External factors Regulatory scrutiny of responses to recent major storms and calls for infrastructure hardening Continuing state regulatory attention to service quality standards New and evolving federal regulations and standards for transmission reliability, cybersecurity, and other issues Impact of new power generation sources on grid capacity and planning Connecting renewable resources, such as wind and solar Adding distributed generation sources, causing two-way power flows Accommodating electric vehicles New technology options for grid modernization, such as smart grid, advanced metering, and other network automation Internal factors Different constituencies within a company competing to fund pet programs Constraints on operations and maintenance budgets and capital spending DEFINING GOALS AND PERFORMANCE OBJECTIVES The most critical decision to make is to define your target level of reliability. Establishing your company s reliability performance objectives often boils down to this: How good is good enough? It is already costly to maintain current reliability levels. Improving reliability typically requires greater and more wisely targeted spending on operations, maintenance, and capital projects. Executives must evaluate the impact of new investment on system reliability and customer bills. Start by answering these questions: How much reliability do people want? How much are they willing to pay for it? What reliability levels do customers want? How will it impact bills? What standards do regulators want? Will they allow rates to rise? Copyright 2013 Oliver Wyman 2

3 What does good reliability mean? Is it just above state public utility commission service quality standards, average, or excellent, that is, first quartile or first decile compared with other utilities? Should current performance levels be maintained (somewhat of a challenge given aging infrastructure), or should reliability improve? To what extent should reliability strategies focus on: Reducing outage frequency, measured by the System Average Interruption Frequency Index, or outage duration, measured by the Customer Average Interruption Duration Index? (Discussed in detail in our earlier article: Do You Have the Right Electric Reliability Strategy?) Balancing storm resiliency against day-to-day reliability? Improving reliability in poorly performing areas or seeking to raise the system average with corporate programs? Pleasing customers by making improvements in neighborhoods perceived to be low performing or in neighborhoods (or circuits) that actually are the worst performing? What incremental reliability gains are associated with investments in infrastructure? How much spending is required to maintain current reliability levels? How much additional spending is required to improve reliability? What is the projected reliability gain per dollar invested? ESTABLISHING YOUR RELIABILITY STRATEGY AND SPENDING PRIORITIES Now that you have decided how much and what sort of reliability you want, it s time to determine your reliability strategies, tactics, and spending priorities. You ll have to consider some trade-offs, which are highlighted in the following exhibit and discussed below. Exhibit 2: KEY DECISIONS AND TRADE-OFFS Today s System Maintaining and improving health and resiliency of current infrastructure Standardized System-wide reliability programs Perceived Reliabilty Addressing areas with greatest customer or political sensitivity to reliability performance VS. VS. VS. Tomorrow s System Investing in next-generation technologies and hardening to address changing climate pattern Customized Regionally varying or local improvement strategies Actual Reliability Addressing worst physical reliability performance Legislative mandates and regulatory requirements (threshold level of investment) Copyright 2013 Oliver Wyman 3

4 TO REINFORCE TODAY S SYSTEM OR TO BUILD TOMORROW S SYSTEM? The desire to invest in the infrastructure of tomorrow is often offset by the need to maintain the infrastructure of today. New, modern technologies introduce greater flexibility into the system and enable real-time monitoring of circuits. Similarly, reinforcing infrastructure to withstand changing or more severe storm patterns can enhance both long-term and near-term reliability. However, such worthy endeavors are costly and must share the budget with the upkeep of the current system and the maintenance of basic, near-term infrastructure reliability. Today s system: Maintaining and improving the health and resiliency of the current infrastructure. Typical actions may include: Enhanced inspection, testing, and maintenance programs. Replacement of existing assets, including targeted upgrades or storm hardening investments. Tomorrow s system: Investing in next-generation technology or taking bolder, longrange storm hardening actions to address changing climate patterns. For example: Distribution automation and other smart technology to enhance remote monitoring and control of assets, automated switching, etc. Control and modeling technologies to support a grid composed of numerous small distributed generation and power sources (e.g., solar, wind, biomass, and even electric vehicles) and increasingly changing flow patterns. Localized grids that can provide superior power quality to support new manufacturing or service economic zones. Redesigned infrastructure to withstand projected new (possibly climate change induced) weather, storm, and flood patterns. For example, elevating substation equipment that could be prone to flooding from storm scenarios like Hurricane Sandy. TO IMPLEMENT STANDARD IMPROVEMENT PROGRAMS OR TO CUSTOMIZE? Many companies aspire to a strategy based on a menu of system-wide programs. Regional managers can select particular programs from that menu to address their specific, local reliability issues. Such a customized strategy should improve reliability performance better than a generic, one-size-fits-all approach. But it requires the following sophisticated analytic and management capabilities: Analysis and identification of the root causes of local outage frequency and duration issues in order to select the appropriate strategies. This often requires database skills and analytic techniques, such as de-averaging or segmentation, which are not typically found within today s utilities. Copyright 2013 Oliver Wyman 4

5 Management of the development of localized reliability strategies and evaluation of their effectiveness. Managing a set of localized strategies is more demanding than a one-size-fits-all program. It requires extensive leadership oversight, sharing of experience, and development of staff expertise and skills. Finding the right balance between a standardized and customized approach to asset and reliability management can be difficult. Utilities employ a large variety of practices. Several utilities work predominantly at the state or local project level when developing reliability improvement strategies, dedicating funds to areas of greatest need as they arise. Others have a stronger standardized strategy. One utility holding company considers investment planning from a top down perspective, rolling regional targets together and addressing them as a whole. TO ADDRESS NEIGHBORHOODS WITH GREATEST CUSTOMER OR POLITICAL SENSITIVITY OR TO FIX NEIGHBORHOODS AND CIRCUITS WITH POOREST RELIABILITY PERFORMANCE? Engineers must determine the best ways to improve reliability where performance is poor. Senior managers, on the other hand, must also grapple with customers and politicians clamoring for improved service in neighborhoods where reliability is not, actually, so bad. A reliability strategy must include mechanisms for managers to make trade-offs between addressing worst actual or physical reliability (e.g., worst performing circuits, customers experiencing multiple interruptions) and customer or political perception of poor reliability. TO MEET LEGISLATIVE MANDATES AND REGULATORY REQUIREMENTS? The asset management strategy must ensure that the company can meet regulatory service quality standards, incorporate capital project costs into the rate base, and respond to changes in the regulatory or legislative environment. Your asset management plan must account for your company s regulatory and political environment. Projects designed purely around asset health improvements might not get funding if they don t meet the regulator s desires or willingness to place funding into the rate base. Further, politics may call for lower-priority projects to be completed right away. Thus, a portfolio should balance top-priority, performance improvement projects with projects that address political and regulatory needs. One company utilized a scoring system that weights capital projects that address political issues differently from the rest. This allowed the utility to generate a balanced list of projects that met both reliability performance and political objectives. Copyright 2013 Oliver Wyman 5

6 DEVELOPING YOUR RELIABILITY IMPROVEMENT AND ASSET MANAGEMENT STRATEGY We have discussed establishing how much reliability you want and making the hard decisions about how to get there. So, how do you develop your reliability strategy and implement this approach? Exhibit 3: RELIABILITY IMPROVEMENT APPROACH TOP-DOWN ASSET MANAGEMENT STRATEGY INVESTMENT PLAN COMPELLING STORY Overall performance objectives Standardized strategy or menu of asset management and reliability improvement programs Metrics for comparing/prioritizing projects and evaluating success Investment targets by category (top-down) Bottom-up allocation of projects to categories Regional variation targeted at addressing local reliability challenges Alignment of priorities and projects with available resources, overall and locally Clear articulation of company vision and plans Expected benefits and results of strategy highlighted Description of how company priorities align with regulatory and political priorities First, it is important to develop a top-down strategy for reliability and asset management. State your performance objectives clearly. Outline how to plan and prioritize projects. This will help maintain consistency across the company, with plans tailored and targeted to meet regional or local needs. Consequently, a menu of asset management programs may be designed, with each implemented regionally, as appropriate. You also should develop common metrics for comparing, prioritizing, and evaluating programs. This may include the use of a standardized model or matrix to weigh projects along a number of dimensions, such as risk, spending, regulatory, or political demand. A number of companies measure dollars per customer interruption. Other common metrics include standard measures of reliability and, of course, spending. Second, make sure your new strategy fits with available budget and staffing resources. Establish an investment plan. Directly link resource allocation to project priorities. Balance top-down performance and asset health objectives with bottom-up project spending. Identify standard categories of spending, such as vegetation management and storm hardening, and set annual investment targets. A robust investment strategy can help you track investments, understand returns from reliability improvement projects (per dollar invested), and prevent under- or over-spending in any category. Copyright 2013 Oliver Wyman 6

7 Include grid modernization and hardening in this menu. Many utilities have already allocated significant resources to install new technologies. Develop programs to roll out technology to parts of the grid, and set aside money each year to pay for it. Finally, tell a compelling story to garner the regulatory, customer, and employee support for the asset management and reliability program. A compelling story describes the company s vision and plans and clearly articulates the benefits and necessity of each program. Do not assume that great engineering will speak for itself. Convincing stakeholders is crucial to achieving your asset management and regulatory strategies. The management team must also keep in mind how to align the company s priorities with those of regulators. A persuasive story can demonstrate to regulators this alignment of interests and facilitate agreement on the plans to maintain near-term reliability while transitioning into the system of the future. Good communication can clear a path for regulatory approval of increased spending and rate base recovery of investments. CONCLUSION A reliability and asset management strategy is vital to maintain the infrastructure of today while preparing for the system of tomorrow. The management team must determine how much reliability customers want, and how much they are willing to pay. Then executives must set priorities and a budget to get there, and implement the strategy with a top-down approach. It is crucial to communicate the reliability strategy widely, with employees, regulators, politicians, and customers, presenting clear and convincing rationales for the strategy and projects. Developing an overall reliability or asset management strategy can be a formidable task, but if done properly, it can improve your company s asset and investment plans for years to come. Copyright 2013 Oliver Wyman 7

8 ABOUT OLIVER WYMAN Oliver Wyman is a global leader in management consulting. With offices in 50+ cities across 25 countries, Oliver Wyman combines deep industry knowledge with specialized expertise in strategy, operations, risk management and organization transformation. The firm s 3,000 professionals help clients optimize their business, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is a wholly owned subsidiary of Marsh & McLennan Companies [NYSE: MMC], a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With 52,000 employees worldwide and annual revenue exceeding $10 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in risk and reinsurance intermediary services; and Mercer, a global leader in human resource consulting and related services.for more information, visit Follow Oliver Wyman on Oliver Wyman s Energy team helps utilities and related energy companies address strategic and operational challenges through proven, results-oriented approaches. We have completed hundreds of engagements for more than 75 leading electric, gas, and water utilities across North America and Europe, creating sustainable shareholder value. For more information, please contact: David Hoffman, Practice Leader david.hoffman@oliverwyman.com Alan Feibelman, Partner alan.feibelman@oliverwyman.com Copyright 2013 Oliver Wyman All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The information and opinions in this report were prepared by Oliver Wyman. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisors. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. The report is not an offer to buy or sell securities or a solicitation of an offer to buy or sell securities. This report may not be sold without the written consent of Oliver Wyman.