The Energy Industry After the Great Recession: A Passing Storm or Tidal Shift?

Dr. John Caldwell Director of Economics, EEI

What Constitutes a Recession?

Source: Federal Reserve Board

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

19

47

19

49

19

51

19

53

19

55

19

57

19

59

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61

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63

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01

20

03

20

05

20

07

20

09

20

11

20

13

Historical Real U.S. GDP

Interruptions

in Long-Run

Growth

-60%

-50%

-40%

-30%

-20%

-10%

0%

DJIA

(P

eak-t

o-T

rou

gh

)

Stock Market Loss

0

2

4

6

8

10

12

14

16

18

20

Length (Months)

-4.5%

-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

Ch

an

ge in

Real

GD

P

Loss of Output

How Serious Was This One? Comparison with Past Recessions

1929 = 42 months 1929 = 25%

1929 = 27% 1929 = 89%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Unemployment Rate (Peak)

Why Was This One So Severe?

• It Had a Stock Market Crash and a Housing Bubble . . .

• . .. And More Personal Savings are Invested in Both Corporate Equity Markets and Real Estate . . .

• . . . While the Level of Debt Has Risen As Well

Household Averages 1989 2007

Share of Total Assets Invested in Equity 9% 18%

Ratio of Mortgage Debt to Income 0.8 1.5

Share of Households with Debt Payments > 40% of Income

10% 15%

A Decade of Borrowing

Source: Federal Reserve Board of St. Louis and U.S. Bureau of Labor Statistics

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

$55,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

20

13

Do

llars

(p

er

Cap

ita)

Debt and Income

Household Debt

Disposable Income

In the decade prior to the

Great Recession, household

debt mushroomed while

income growth was stagnant.

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

(20

10

$)

Median Family Net Worth

Nearly 40% of Household Savings Were Erased

Source: Federal Reserve Bulletin, “Changes in U.S. Family Finances from

2007 to 2010: Evidence from the Survey of Consumer Finances”, June 2012

Median

Income

SPENDING

SAVING

An Economic Balancing Act

Not Your Grandfather’s Recession A Weak Recovery by Historical Standards

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

START OF RECESSION1 YEAR AFTER 2 YEARS AFTER 3 YEARS AFTER 4 YEARS AFTER

RECOVERY OF GDP GROWTH

2007-2009 RECESSION

(PRE-RECESSION GDP)

FOLLOWING ALL OTHER POSTWAR RECESSIONS Range of GDP growth rates at each quarter of recovery

Source: U.S. Bureau of Economic Analysis

5 YEARS AFTER 6 YEARS AFTER

The Economic Recovery: A Large, Lingering Gap Remains

0.0

3.0

6.0

9.0

12.0

15.0

18.0

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

Un

em

plo

ym

en

t R

ate

(%

)

GD

P (

20

09

$)

U.S. GDP and Unemployment

Actual Unemployment Rate

Potential GDP

Actual GDP

Natural Unemployment Rate

Source: U.S. Federal Reserve, Bureau of Labor Statistics, and

Congressional Budget Office

5% gap in

economic

output

Pumping Up the Economy

QE1

$1.25 trillion of mortgage-

backed securities; $300

billion in treasury bonds; and

$175 billion of agency debt

QE2

$600 billion of longer-term

treasury securities

QE3

$85 billion/month of

mortgage-backed

securities and treasury

debt (now tapered down

to $25 billion/month) $

11

QE III

The Voyage of

the Fed: Navigating Between

the Twin Terrors

A Jobless Recovery Unlike Any Other

Source: U.S. Bureau of Labor Statistics

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76

Loss

fro

m E

mp

loym

en

t P

eak

Months

1970 1974 1980 1981 1990 2001 2007

Employment Changes in the U.S. More than Just a “Jobless Recovery”

Occupational Growth Rates, Indexed to 2001

Source: National Employment Law Project:: “The Low Wage Recovery: Industry Employment and Wages Four

Years into the Recovery”, April 2014, and “The Low Wage Recovery and Growing Inequality”, August 2012.

22% 44%

37% 26%

41% 30%

Net Change in Private Sector Employment (in thousands)

The National Debt

• Currently at $17.7 trillion (106% of GDP, $56,000 per person)

• Why is the National Debt a Problem?

– Could lead to inflationary pressures / high interest rates

– 34% of it is owed to foreign countries

– Interest expense on debt becomes a significant share of government budget when interest rates rise

Where We Are Headed: Historical and Current Policy

Projections for Federal Receipts and Spending

1980-2088

Source: “A Citizen’s Guide to the

Fiscal Year 2013 Financial Report

of the United States Government”

What Is to be Done?

• Shift Away from an Economy Based on Consumption:

• High Energy Intensity

• Waste

• Borrowing

• “Consumerist” Culture

• . . . and Toward an Economy Based on Investment:

• In Education

• In Infrastructure

• In R&D

• In Personal Savings

Energy Sales Outlook

17

Energy Sales Growth and the Economy

Source: Energy Information Administration and U.S. Bureau of Economic Analysis

-5%

0%

5%

10%

15%

20%

Electricity Growth and Change in GDP: 1950-2013 Change in GDP

Change in Electricity

Usage

-10%

-5%

0%

5%

10%

15%

20%

Natural Gas Growth and Change in GDP: 1950-2013 Change in GDP

Change in Natural Gas

Usage

The Recovery Challenge: Electricity Growth Continues to Slow

Electricity sales growth has been declining long before the recent recession.

Source: Energy Information Administration

-5%

0%

5%

10%

15%

20%

19

50

19

53

19

56

19

59

19

62

19

65

19

68

19

71

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80

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83

19

86

19

89

19

92

19

95

19

98

20

01

20

04

20

07

20

10

20

13

Period Sales Growth 50's 9.3% 60's 7.4% 70's 4.4% 80's 2.8% 90's 2.4% 00-13 0.7%

. . . While the Future Trend for Natural Gas is Less Clear

-5%

0%

5%

10%

15%

20%

19

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00

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06

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08

20

10

20

12

Period Sales Growth 50's 7.0% 60's 5.8% 70's -1.3% 80's -0.7% 90's 1.9% 00-13 1.0%

Natural gas consumption

growth actually

rebounded after

deregulation in the late 1970s and

1980s.

Source: Energy Information Administration 20

Recession Impacts on Energy Demand

Source: Actual and forecast data – Energy Information Administration;

Weather adjustments to historic data performed by EEI.

13,000

14,000

15,000

16,000

17,000

20

22

24

26

28

2007 2008 2009 2010 2011 2012 2013 2014 2015

GD

P (

20

09

$)

Co

nsu

mp

tio

n (

Bcf

)

U.S. Weather-Normal Natural Gas Consumption Historic Forecast

GDP

13,000

14,000

15,000

16,000

17,000

3,500

3,600

3,700

3,800

2007 2008 2009 2010 2011 2012 2013 2014 2015

GD

P (

20

09

$)

Sale

s (b

illio

n k

Wh

)

U.S. Weather-Normal Electricity Sales

Historic Forecast

GDP

The Energy Industry in the Post-Recession Economy:

Many Challenges (and Some Opportunities) 22

Why is the Current Electricity Model Under Siege?

A Walk in the Clouds Some General Theories on Business Strategy

• Peter Thiel: Creative

Monopoly

• Michael Porter: “What

is Strategy?”

• Clayton Christensen:

Disruptive Innovation

• Pamela Morgan: Find

the Next “S-Curve”

Having the “Right Stuff” for Success Peter Thiel and the “Creative Monopolist”

• Peter Thiel (founder of PayPal): the Most Successful Businesses are not Great Competitors, but Great (Creative) Monopolists

• Four Qualities of a Creative Monopolist:

– Branding

– Scale Advantages

– Innovation / Proprietary Technologies

– Network Effects

25

Michael Porter on Strategy

Operational

Effectiveness:

Performing

similar activities

better than

rivals perform

them.

Strategic

Positioning:

Performing

different activities

from rivals’ or

performing

similar activities

in different ways.

• Constant improvement in operational effectiveness is

necessary but not usually sufficient to achieve

superior profitability.

• A company can outperform rivals only if it can establish a

difference that it can preserve. From Michael E. Porter, “What is Strategy?”,

Harvard Business Review, Nov.-Dec. 1996

A Brand: ‐ Is a mark of quality. ‐ Signals that this product is worth more than generic

alternatives, or similar offerings by competitors. ‐ Represents a compact with its customers that certain

unique things come with this product that these customers prefer.

What is (or could be) an electric utility’s brand? ‐ Power quality/reliability ‐ Superior customer service ‐ Supplemental products or services ‐ Convenience

Branding How Can Companies Maintain Customer Loyalty?

Scale/Cost Advantages Regulated Utilities Had Them Once: Do They Have Them Now?

$0.00

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

$0.70

1 3 5 7 9 11 13 15 17

Co

st/

KW

h

Electricity Production (Millions of MWh/Year)

Cost Advantages Can Come from Other Sources

• Experience/Expertise

• Proprietary Processes/Technologies

• Lower Financing Costs

• This still holds for delivery systems.

• Does it still apply to generation?

• And could DG make T&D delivery

systems obsolete?

Clayton Christensen and Disruptive Innovation

• Disruptive Innovation: a new development (generally technological) that helps create a new market and value network, while eventually challenging an existing one by displacing an earlier technology

• Non-threatening – A disruptive innovation is often regarded as inferior by an incumbent and/or appealing to customers in the incumbent’s market that are of marginal importance

• Examples: Steamships, the telephone, digital watches, steel mini-mills, Google, digital cameras, MP3s

• The Solution? Sustaining Innovation (by incumbent), e.g., Miller Lite, HP inkjet printers, Amazon Kindle

From Clayton Christensen, The Innovator’s Dilemma, 1997

Finding the Next S-Curve Pamela Morgan and Product/Service Redefinition

The S-Curve is a Common Growth Trajectory in Both Nature and Business

Product Saturation Could Result in the Death of Earnings Growth, or the Downfall of an Entire Product Line

The Solution to Saturation is to Create a New S-Curve, by Taking a “Systems” View of What It Is That Can be Offered

From Pamela Morgan, “From VHS to DVD: Need for a New Business Model for the Electricity Industry in the 21st Century,” Electricity Policy, Sep. 21, 2010

Network Transformation: The Road to Evolution . . . Or Extinction?

Retail

Booksellers

Did Not Read

the Writing on

the Wall

Railroads Overrun

by the Interstate

Highway System

Video Rentals

Didn’t See the

Big Picture

Source: Jesse Berst 31

Copyright: 2011 John Caldwell, Edison Electric Institute. All rights reserved.

Social/Economic Network Example:

15th-Century Florentine Marriages

Source: Padgett, J.F., and C.K. Ansell (1993) “Robust Action and the Rise of the Medici, 1400-1434,”

American Journal of Sociology 98:1259-1319.

A Modern Economic Network: Amazon.com

Book

Publishers

Retail Book

Sellers

Other

Manufactured

Goods

Cu

sto

mers

Amazon.com

• Internet

sales/purchases

• Purchase suggestions

• Links to other sites

• Customer

Ratings/Rankings

• Kindle

From Channel (Business-As-Usual) to Network: What Roles Can the Utility Play?

The Market Enabler

manages decentralized

energy sources on the grid,

acting as a hub between

customers, the utility, and bulk power markets.

The DG Asset Developer focuses on developing and/or owning distributed

generation on the customer side of the meter.

The Solution Integrator

provides custom energy solutions

involving customers asset development,

natural gas supply, energy

information services, and

energy retrofits.

From Paul De Martini, Eric Ackerman, and John Caldwell, “Utility DG Business Opportunities,” unpublished EEI manuscript, 2014

The Energy Industry in a Post-Recession Economy

• Energy Efficiency will Be a Predominant Social Goal

• Supports Climate Policy Objectives

• Reduces Household and Business Energy Costs

• Technological Innovation will Become the New Panacea (As Deregulation was 20 Years Ago) for Meeting our Energy Needs at Affordable Prices

• Natural Gas: Extracting Supply from Unconventional Sources and Developing New End Uses

• Electricity: The Distributed Energy Network

• But the Structural Weaknesses in Our Economy will Persist for Years, Potentially Limiting Substantial Opportunities for Revenue Growth in the Industry

Thank You!