Energy Security: Creating a Competitive Advantage for Industry

1. Energy Security:Creating a Competitive Advantage for Industry Hugh Baker President, Hunt Power AHC Group Corporate Affiliates Workshops June 21, 2005

2. Energy Security • National Energy Security • Energy is the lifeline of our economy • We require affordable energy • We require a continuous supply of energy • “Local” Energy Security • Energy is the lifeline of your business • Energy must be cost effective • Energy must be in an “on” state • Energy must have a quality component

3. Factor 1: Energy Prices • The price of energy “has been substantial enough and persistent enough to bias business-investment decisions in favor of energy-cost reduction.” – Alan Greenspan (4/5/05) • There has been a fundamental reset in the market price of energy. • The increased volatility in energy prices adds significant risk to business operations.

4. Rising Natural Gas Prices 1

5. Rising Electric Prices 2

6. Regional Disparities in Generation 3

7. Factor 2: Grid Issues “Between 1984 [official start of recording blackouts in North America] and 2000, utilities logged 11 outages affecting more than 4,000 megawatts – making the probability of any one outage 325 times greater than mathematicians would have expected.” – IEEE Spectrum, Aug. 2004

8. Bottlenecks in U.S. Transmission 4

9. Utility Outages • Documentation of utility outage data is a relatively new concept • SAIDI – records the yearly average outage duration for each customer sampled • SAIFI – records the average yearly frequency of outages per customer • The data to accurately measure these indices is not readily available • The limited available data suggests, on average, a utility customer in the U.S. will experience: • 1.2 outages per year • 106 minutes per outage 5

10. Peak Demand Outpaces Transmission Capacity Annual transmission investments decrease despite increasing load demand 6

11. U.S. Outages Costs 8

12. Factor 3: Changing Nature of Electric Loads Utility customers “expect a different product today than they did twenty years ago. What’s more, utilities and regulators haven’t caught up to that fact.” – Allison Silverstein, formerly FERC Chairman Pat Wood’s Chief of Staff and Chair U.S. - Canada Power System Outage Task Force (August 2003 Blackout); Hunt Power private interview 5/9/05

13. The Service Based Economy U.S. Energy Use Per Capita 9 Energy-to-GDP Ratio Falling 10 year

14. Growth of Microprocessors 11 The microprocessor market was $27.4 billion in 2003, and it will increase by 28.5% to $35.2 billion by 2007. "The average middle-class American household has about 40 microprocessors / microcontrollers in it. The average new car has about 12 microprocessors / microcontrollers in it." - Jim Turley, editor in chief of Embedded Systems Programming

15. Trends Driving Electric Loads • Global competition drives industries toward greater automation • Microprocessor growth will continue to expand, driven by new rules and new technologies • Voice over IP • Sarbanes – Oxley • HIPPA • Nanotechnology – In spite of “Flat World” the US remains competitive because we are the world’s innovators. Can we power our innovation?

16. Power Quality • Refers to subtle deviations in the quality of delivered electricity that causes some customer equipment to fail or damage • 98% of fatal power quality events last < 15 seconds • Outages lasting < 1 sec cycles can cause hours of downtime 12

17. Momentary and Sustained Interruptions Costs 13 • U.S. utility customers lose an estimated $80 billion dollars annually due to outages. • Roughly 2/3 of costs and lost revenue was due to momentary downtimes.

18. The Energy Environment Primary Energy Supply Awareness Control Transportation of Primary Energy Bulk Conversion Nodes Electric Transmission System Electric Distribution System "Last Mile" Distribution System Meter Facility Distribution System End-Use Energy Conversion Nodes

19. A Solutions Framework • Cost of Energy vs. Value of Energy “Which means more to you?” • Cost of Energy • Operations: Absolute Price significantly affects bottom line • Marketing and Sales: Relative Price influences competitive position • Financial: Volatile expense items reduce the firm’s value through greater risk profile • Value of Energy • Operations: Spoilage, lost production, data loss, damaged equipment • Marketing and Sales: Loss of customer goodwill due to disruptions or inability to provide goods and services • Financial: Lost wages, downtime, insurance premiums

20. Cost Based Energy Security • The key issue is Price of Energy • Anything that reduces volatility and uncertainty in energy prices creates value for the firm • Simple payback evaluation approach may not be appropriate if the “base case” has greater uncertainty than the “alternate case”

21. Cost Based Solutions • Hedging activities • Negotiated utility rates • Over the counter forwards and options • Exchange traded futures and options • Energy efficiency • Low hanging fruit • Many times the most cost effective “technology” • Self Generation • Combined Heat and Power (CHP)

22. Value Based Energy Security • The key issue is Value of Energy • Sensitivity of operations energy disruptions • Financial effects of outages on your bottom line and customer retention • Does not take a “blackout” to affect a firm’s competitiveness • Example – Upon a momentary power disruption, it takes an average of 16 hours for certain data centers to resume normal operation

23. Value Based Solutions • Energy Auditing • Infrared Scans, Power Quality Assessment • Standby Power Systems • UPS, On-site Generator, Fuel Storage, Transfer Switch Scheme

24. Power Failure Protection After the 2003 Blackout Emergency generator providing power to your facility Uninterruptible power system (UPS) providing power to your facility UPS for the individual load Self-generator utilized for everyday power needs Equipment designed to cover momentary voltage dips Insurance to compensate for damage caused by power failure 14 Sample size = 604 commercial/industrial customers

25. Thank you Discussion

26. References • EIA/DOE, 2004. Historical Natural Gas Data (Average Price Sold to Commercial Consumers, by State). • EIA/DOE, 2004. Historical Electricity Data (Annual Retail Price, State by Sector). • EIA/DOE, 2001. Electric Power Sector Consumption Estimates, 2001. • FERC, 2001. Electric Transmission Constraint Study. • Lawrence Berkeley National Laboratory/DOE, 2004. The Economic Cost of Power Interruptions to U.S. Electricity Consumers. • Hirst/Edison Electric Institute/DOE, 2004. U.S. Transmission Capacity: Present Status and Future Prospects. • Deregulation, Restructuring, and Changing R&D Paradigms in the US Electrical Utility Industry, Paroma Sanyal, Brandeis University and Linda Cohen, USC. • Balducci et al., 2002; Willis and Scott, 2000; Hunter et al., 2003; IEEE, 1997; EPRI, 2001a, 2002 • EIA/DOE, 2003. Annual Energy Review 2003. • Brown/Federal Reserve Bank of Dallas, 2005. Energy Prices and the Economy. • LaPedus, 2004. • Souder/DOE, 2005. DOE’s Role Regarding Grid Modernization and Electric Reliability. • DOE, 2004. The Economic Cost of Power Interruptions to U.S. Electricity Consumers. • Ariu/CRIEPI/SERC, 2003. Impact of the 2003 North America Blackout on Commercial/Industrial Customers of Electric Power Companies.