Distributed Generation - Issues for Companies Considering Generating Their Own Power

With existing and readily available technology, every industrial facility, factory, campus, hospital, hotel, commercial building, department store, apartment and house can generate enough electricity to satisfy its own needs under normal conditions and have back-up power when there is a blackout. The practice of installing and operating electric generating equipment at or near the site of where the power is used and sized for the facility’s needs is known as "distributed generation" (DG). It’s called "distributed" generation to contrast it with the traditional model of electricity generation in the U.S., which might be called "central" generation, and which consists of building and operating large power plants, transmitting the power over distances and then having it delivered through local utility distribution systems.

Many industrial companies have for years installed and operated their own power plants instead of buying all of their power from the grid. Moreover, users with critical loads such as hospitals, banks, government agencies, the military, telecom centers and, more recently, internet server hubs, have also for many years maintained on-site back-up power generation resources. In the overwhelming majority of cases, this has meant some type of diesel or reciprocating engine generator, run on relatively dirty fuel that has to be stored on site. DG plants can be large, generating dozens or even hundreds of megawatts for an industrial facility, or be as small as what is needed to cover the average electric needs of a house. In the U.S. market today, most DG plants fall into the 5-15 MW range for campuses and industrial facilities, the 1-2 MW range for plants and factories or from 150 kW to 1 MW for commercial and residential buildings.

Power generation technologies have evolved significantly in the past decade, making DG much more efficient, clean and economically viable. What also is new (or recurring) is the high price of energy resources.

Fuel Prices High - The prices of coal and gas, the chief fuels for central power generation, have risen sharply in the last few years. Also, as everyone is aware, the price of petroleum is at historic highs. While it is not necessarily logical, the markets for the chief fuels of power generation move upwardly when the price of petroleum is high. An important aspect of the spike in fuel prices is the rising industrial prowess of China and India, which rely heavily on traditional fuels and, importantly for the price of coal internationally, use up tremendous amounts of shipping capacity for their trade. Since this phenomenon is not likely to reverse itself, we can now expect that the price of fuel will remain high for many years to come.

Transformation of Integrated Utilities to Distribution Companies - Another new development is the fallout from deregulation initiatives on the federal and state level over the past few years. In response to these deregulation initiatives, many utilities have transformed themselves from integrated enterprises, generating, transmitting and distributing power, to essentially distribution companies and traders, buying power from independent producers or through regional markets and selling it to customers. One result of this is that the price of fuel is now in most utility systems simply passed through to customers, making power more expensive as the price of fuel rises.

Distributed Generators Not Necessarily Competitors to Utilities - Another result of deregulation is that utilities no longer necessarily consider on-site power generators as competitors. Up until recently, many utilities were more or less openly hostile to DG, seeing each distributed generator as a lost customer. Given their new status as distributors and traders, some utilities, and their state regulators, are beginning to see DG as part of their capacity planning, a resource that can be called upon when supply is tight or which avoids their having to finance the installation of new capacity.

Reliability - The Northeast blackout of August 2003 has also brought reliability issues to the fore. Reliability problems are a result of the ever-increasing demand for power and the inherent difficulties in building new transmission capacity. They are also to an important extent also an outgrowth of deregulation. The electric transmission system and distribution grids were designed to accommodate the central generation model, that is maintaining a stable energized grid so as to deliver electricity from power plant to customer. The legislative and regulatory push toward regional power markets is now well advanced. Today there are already several functioning regional power markets where utilities and independent power producers bid power at their best price into a centralized exchange, usually called an "independent system operator" or ISO, which is a non-for-profit entity owned by various stakeholders, and the ISO dispatches the plants (that is to say, orders power from them) according to the most economic bidders. Buyers such as utilities or other users buy power from the exchange and deliver it to customers or consume it themselves. In several parts of the country, regional or state ISOs are connected to their neighboring ones. One result of the growth of these "organized markets", as they are called, is that power now flows in all sorts of directions, over transmission lines that were not designed for this use. In many parts of the country, the transmission system is more or less at its capacity, meaning that an overload will bring it down, as happened in some western states a few years ago. Building new transmission capacity is not keeping up with the need for it due to difficulties in citing it. All this adds up to corporate planners having to face the realistic possibility that their facilities will not have power at certain times.

Technological Developments - Technological improvements are reinforcing the trend towards making DG practicable. One development is that the technology for producing power from renewable resources is becoming viable. While both solar and wind technologies have been around for some time, technological innovations are making it easier to produce more power from the resource. Fuel prices are rising almost to the point where the sun and the wind as fuel are becoming price-competitive without subsidies. Today they are not, but wind in particular enjoys significant subsidies in the form of federal tax credits, which are in place in their current form until the end of 2005 at least (with a proposal to extend them to 2007).

Also of significance is that the technology for connecting distributed generators to the grid has improved steadily. Another characteristic of the traditional transmission and distribution systems is that they were originally put together by utility engineers implementing solutions for their own needs. With the advent of software controls, different utilities implemented different software solutions. As a result, today, there is a considerable disparity between the technical characteristics of some electric distribution systems. This has tended to make connecting distributed generators to the grid a costly exercise because individualized engineering has to be done for the interconnection of each distributed generator. However, there is now a new industry technical standard known as IEEE 1547 ("Standard for Interconnecting Distributed Resources with Electric Power Systems") that gives both engineers and utilities a point of reference that is very helpful in planning on-site systems.

Finally, there has been great improvement in metering technology, with "smart" or "real-time" metering allowing users to see much more precisely how much power they are using at a given point in time and adjusting their usage accordingly. "Net" metering allows a distributed generator to measure how much power it puts back on the grid if it is generating more than its needs at a given time.

The realization that fuel prices are not likely to go down soon and a growing awareness that deregulation has consequences for both cost and reliability are engendering a shift in attitude on the part of corporate decision-makers. Before, they didn’t think too much about power and energy. True, they saw it being provided in a quasi-monopolistic way, but available when they needed it at a fairly predictable cost. Today, the cost of energy is becoming a major and unpredictable component of the price of goods and services and decision-makers are focusing attention on how to control energy prices in order to remain competitive. They are also thinking that they cannot afford to lose production and critical functions if the grid is not available and are looking for ways to obtain back-up power.

All of these market and technological developments are adding up in such a way that corporate development planners and executives should be asking themselves whether it makes sense for their companies and facilities to be generating some or all of their own power. What follows is a discussion of some of the considerations involved and how the obstacles can be navigated to result in a successful DG project. The text boxes describe recent interesting DG projects in various sectors. The U.S. Environmental Protection Agency (EPA) recognizes noteworthy projects every year as part of their Energy Star program, and the descriptions of some of these projects is taken from the EPA’s webpage devoted to it (www.energystar.gov).

The efficiency of fuel generation is measured by the percentage of the energy that is converted into electricity. The process of generating electricity itself creates heat. A traditional single-cycle stand-alone grid power plant has an efficiency of about 30%, meaning that it does not make use of the heat thrown off by the generation process and more than half of the energy is wasted. A modern combined-cycle gas fired power plant that captures some of the waste heat can reach an efficiency of about 60%.

For DG, after diesel fuel, the most prevalent types of generation technology use natural gas as a fuel. Gas turbines and so-called "microturbines" run on natural gas. The heat that is thrown off by the process of burning the fuel and generating electricity is captured by a heat exchanger and used either to generate additional power, a process called "cogeneration," or to heat water or make steam, a process called "combined heat and power" or "CHP." CHP applications can reach efficiencies of 80%, meaning that almost all of the energy of the fuel is converted into electricity, a much more efficient model than stand-alone power plants.

Fuel cells also mostly use natural gas to make electricity by a chemical process that does not combust the fuel. A few more advanced or experimental fuel cells run on hydrogen and do not need natural gas at all. Most fuel cells also can be used for CHP applications.

Landfill gas is another potential source of fuel for DG. This type of gas is created by the process of decomposing trash. While it is impure, technologies exists to refine it to near utility-quality natural gas to run cogeneration plants located at or near waste disposal sites. Gas created by the process of treating sewage and wastewater (called anaerobic digester gas) can also be captured to run DG turbines.

Other fuels fall into the category of biomass, things like wood chips, agricultural waste and manure. These also can be combusted in on-site applications to make power.

Finally, the other major fuel sources for DG are the renewables: the wind, the sun and water. A prevailing wind of 15 mph will keep the blades of a wind turbine spinning, making electricity from the generator in its base. Photovoltaic panels capture the energy of the sun to create direct current, which can be converted to utility-style alternating current. Hydro resources are a potential DG fuel in cases when the dam or river is near the load. Finally, even the churning of the tides in the ocean is a source of energy that can be captured and converted into electricity, but applications for this are still in an experimental stage.

The owner of a industrial or commercial facility can realize several advantages from installing a DG plant:

• The DG plant can serve as back-up power, ensuring continued operations during grid failures and avoiding economic losses.

• DG can save the owner of the facility money on power. Since a big part of the cost of utility power is the demand charge, that is to say pricing designed to cover the facility's peak load, simply reducing the peak demand by installing on-site generation during periods of peak usage (a technique called "peak-shaving") saves money. DG also saves money because utility power includes the costs of transmission and distribution, which do not exist when power is generated on site. Finally, since CHP applications are so efficient compared to the large-scale sources of utility power, the fuel component of the utility bill can be used far more economically.

• The thermal energy or steam is very useful, either for running industrial equipment, supplying hot water and providing heat in winter and chilled water for air conditioning in summer.

• If a facility needs more power, DG is a comparatively inexpensive and rapid way of adding capacity without having to deal with utility service upgrades in most cases.

• Energy savings realized from DG and other EEMs can cover the capital cost of the new equipment and upgrades within a few years. In successful DG projects, the capital cost of the equipment can be recovered through energy savings in 3-7 years, a much shorter period than the useful life of the equipment.

• Many states and some municipalities have programs in place that provide cash subsidies and other incentives to cover a significant part of the capital cost of the equipment (30-60%), making the payback period of the investment shorter.

• DG can provide an owner with an opportunity to make money because generally speaking the owner can sell excess power back to the grid or into an organized market (like the local ISO) or even the utility, depending on whether the plant is interconnected to the grid, what fuel it uses, and how it is sized.

• Owners of DG resources can join the demand reduction programs of the local ISO, which means regular cash payments to the owner for agreeing to make power available to the system operator during peak load periods, plus payments for the power when called on by the ISO.

• Finally, DG helps the environment, offering higher efficiencies and low sulfur oxide (SOX) and nitrogen oxide (NOX) emissions. Fuel cells have virtually no SOX and NOX emissions. Renewable fuels have none at all. A facility owner that is environmentally conscious can considerably improve the environmental profile of the facility by installing DG.

How does installing DG work in practice? The first step for a company considering it is to hire a technical consultant or an energy services company (ESCO) to study the facility’s electricity usage, loads, current needs and potential. The ESCO will also look at ways the facility can save money on energy consumption and propose "energy efficiency measures" or "EEMs" in industry parlance. If the facility’s load profile looks promising, the engineer or ESCO can put together a preliminary system design and propose other EEMs. ESCOs are also equipped to run financial scenarios that can indicate what the owner’s cost of power would be with DG, what the savings might be and how long they will take to cover the capital cost of the equipment (the pay-back period).

If the owner is satisfied with the system design, approximate cost and savings projections, the parties can proceed to more detailed engineering. Invariably, the consultant or ESCO will want to be paid a fee for this preliminary work. However, they usually will accept to roll the cost of the preliminary work up into the overall project cost of the owner decides to go ahead, such that payment of the preliminary cost is deferred.

As for project implementation after the feasibility study and design work are done, the simplest model is for the facility owner to buy the equipment outright from an equipment supplier or have it installed under a type of Design-Build Arrangement. This is done when the owner has the staff to maintain or repair the equipment. If the owner wants to own the equipment, but not operate and maintain it, the owner can contract with an ESCO to maintain, repair and operate it.

Operation of a DG system does not require on-site personnel in most cases. All the critical operating parameters (output, heat rate, efficiency, steam pressure etc) can be remotely monitored by the ESCO. Major functions (start-up, shut-down etc) can also be done by remote dispatch instructions carried over the internet. The operator or ESCO simply schedules periodic control and maintenance visits, absent unusual operating conditions.

Another widely used model is that the ESCO offers a type of BOOT (build own operate transfer) contract. The Owner and the ESCO enter into an energy service agreement, a type of turnkey arrangement where the ESCO designs and builds the plant, runs it and sells to the customer the output in electricity and thermal energy – at a price that is discounted from what the customer would have to pay from the utility. In many cases, the customer asks for a guaranty from the ESCO or its parent that some level of savings will be achieved. The term of an energy services agreement is usually 10 years, although arrangements between 5 and 15 years are not uncommon. At the end of the term, the owner either takes title to the equipment or the ESCO has the right to remove it.

A variant on this theme is a so-called "shared savings" arrangement where the owner and the ESCO negotiate as to what percentage of savings the ESCO will keep (usually up to 5%) and how the owner and the ESCO will share savings beyond that. This arrangement gives the ESCO an incentive to achieve the maximum possible energy savings. Another variation on the theme is an energy services agreement where the ESCO undertakes to provide the owner with power at the utility rate it was paying, but makes a rent payment to the owner for the use of the space where the DG system is placed. The rent represents in this scenario the owner’s energy savings.

Once an owner enters into discussions with an equipment supplier or an ESCO to install a DG system, it needs to bear in mind several factors to make sure it realizes the potential benefits of DG.

Once a facility begins to generate a part or all of its own electricity, its relationship with the local utility changes. Facility owners invariably wish to keep a utility service agreement in place so that the facility will have a flow of uninterrupted power if the DG system fails or has to be taken down for maintenance. This changes the type of utility tariff that applies to the owner. In some places, in the country, utilities charge exit fees or impose stand-by tariffs. Owners need to take into account what these might be to make sure the project makes economic sense. The ESCOs should be able to analyze this aspect. In some states, owners who install generation technologies using renewable fuels or fuel cells are exempt from exit fees or have to pay less significant stand-by charges.

Another economic issue is the type of incentives that might be available for a particular project. In some states and municipalities, there are tremendous incentives for DG including tax breaks, subsidies for building demonstration projects and other incentives that can make a project economically worthwhile. These are very local in nature and can vary even by municipality to municipality within the same state, so they have to be studied carefully on the most local level.

For fuel cells, the incentives can be even greater. The California "Self-Generation Program", for instance, provides $100 million per year of incentive funding for "ultra-clean" technologies on the basis of $4,500 per kW up to 50% of project costs. This program has been extended through 2007, enabling over 20MW of project funding per year.

An issue in every project is interconnection to the grid because a facility owner will want to make sure that power is available if the on-site system fails or is out-of-service for maintenance. If an on-site generator is interconnected, it can be one of two kinds: either an induction or synchronous generator. Induction generators cannot work without the grid – they need it to be "excited", as the engineers say, to start up and continue firing. Synchronous generators run "in parallel" to the grid and don’t need the grid to work (although they still need gas delivery if they are natural gas plants). If a DG plant has induction generators, the owner may lose one of the main potential benefits of DG – back-up power. Unfortunately, some utilities make it virtually impossible to synchronize a DG plant, due to grid stability concerns – or they allow synchronization only with installing expensive protective anti-fault current equipment, which makes the project uneconomic. This problem is particularly acute in cities that have so called "network" distribution systems as opposed to "radial" distribution systems that are common outside of urban areas.

As a result, owners need to be well-informed about how grid interconnection of DG plants is treated by their local utility company. This will drive the type of equipment used. If synchronization is not a practical option, induction equipment can be outfitted with black-start batteries to ensure start-up in the event grid power is lost and provide the back-up needed, even if this process is not instantaneous as it is with synchronous generators. This could be an issue for certain kinds of industrial processes. Owners also need to know as a practical matter how long the utility approvals for interconnection tend to take, as this will drive the process for ordering equipment and projecting a start-up date.

If there is an interconnection, and thus any possibility of power going back to the grid, the owner and developer of a project have to consider the effect of the Public Utility Holding Company Act of 1935 (PUHCA) and the Federal Power Act (FPA), the two principal federal statutes governing the sale of electricity in the U.S. If the facility makes sales of its electricity, the owner may be regulated like a utility by the federal government, even though its core business in entirely unrelated. The way to avoid this is for the owner to obtain an exemption from the application of PUHCA. The exemption can take one of two forms – certification as a qualified facility (QF) under Public Utility Regulatory Policies Act of 1978 (PURPA) or obtaining the status of an exempt wholesale generator (EWG). QF certification is the more typical route if waste heat is being used. Thus, satisfying the criteria for PUHCA exemptions is an important aspect of a project. These are relatively straightforward if the owner of the plant is not itself a utility affiliate. They have to do with meeting certain technical operating and efficiency requirements in the federal regulations, which focus mainly on the amount of waste heat that is recovered. Modern CHP systems meet these handily. If the owner or ESCO (if it owns the equipment) is an affiliate of a utility, the analysis is far more complicated.

The federal regulatory aspects of DG project development are complex and unfamiliar to most owners. This aspect of the process will be made more simple if proposed energy legislation in Congress passes, since it involves partial repeal of PUHCA, but its prospects for passage are uncertain at this time.

While many types of on-site generation equipment are developing good track records, the technologies are relatively new and owners need to obtain assurances from financially responsible parties that the technologies will work as promised. Owners can look either to ESCOs or the equipment manufacturers for warranties, but these can be limited in scope or duration. It is thus important for owners to contract with a reputable maintenance company to make sure that performance problems are addressed over time. Many maintenance companies will undertake to repair or replace defective equipment for some period of time and also guarantee certain levels of output and heat rate performance.

DG plants generally cannot be financed in the traditional limited recourse project model because they are too small. As a result, the credit of the owner will usually have to be tapped in some way to make the project happen. If the owner does not want to use its own credit resources, then it should look to an ESCO willing to own the equipment on the owner’s premises. Some venture capitalists and funds are looking at more innovative structures for DG finance. Owners may consult these players if they don’t want to employ the more traditional methods.

Owners should be aware that DG plants can be considered structures in some areas such that local building permits are required before they can be installed. As in all projects, owners should look carefully at all potential permitting issues, beginning with the most local level and working up. For DG plants that use combustion technologies, owners will have to comply with federal and state clean-air and local emission standards.

• A General Motors assembly plant in Oklahoma City has started using methane gas from a nearby landfill to power a steam boiler – this is the seventh GM plant in the country to use this technique as part of a GM program to reduce its energy consumption by 25% between 1995 and 2005.

• Weyerhaeuser's Albany, Oregon containerboard mill was outfitted with a 93 MW CHP system fueled by natural gas and biomass that can power the mill, two adjacent Weyerhaeuser plants and can supply power to the grid depending on mill demand. The steam from the CHP system is used in processes in the mill. The plant operates at 70% efficiency and uses 17% less fuel than purchased electricity. This project was a 2005 winner of the US EPA's Energy Star Certificate of Recognition.

• Trigen-Cinergy Solutions, an ESCO, has installed a 5.2 MW CHP system on Lafarge North America's drywall manufacturing plant. The ESCO owns and operates the system and sell the output to Lafarge. The exhaust from the combustion turbine is used to dry gypsum wallboard. The system operates at 87% efficiency and uses 20% less fuel than typical onsite thermal generation and purchased electricity, making it a 2004 recipient of an EPA Energy Star CHP Award.

• Starwood Hotels installed a fuel cell plant in 2004 in the Sheraton New York hotel, a 1750 room hotel and is installing a 1 MW fuel cell plant (4 x 250 kW fuel cells) for a CHP application at Sheraton San Diego Hotel & Marina for operation in late 2005; the latter project is part of a master energy services agreement with a consortium composed of a fuel cell manufacturer and an ESCO; the agreement is now open to all properties in the Starwood chain, with an initial focus on California.

• Northern Power Systems is installing a 1.6 MW CHP plant on the premises of 717 5th Avenue, a commercial building in New York City, providing 75% of the building's peak summer demand; this project is noteworthy because the generator is synchronous and it is the first synchronous generator Con Ed has ever allowed to be interconnected to its midtown network distribution system, meaning continuous operation in the event of a blackout.

• In San Francisco, 365 Main, an internet data center building, is installing ten 2.1 MW reciprocating engine continuous power systems, meaning several levels of redundancy over the building's load; the building manager will store 60,000 gallons of fuel on site for 72 hours full-load power capacity in case of grid failure.

• The owners of the new Bank of America tower on 42nd Street in Manhattan are installing a 4 MW induction gas-fired generating system to cover about a third of peak demand; this system will power a chiller that will make ice at night, which is melted during the day for refrigeration in the air conditioning system.

• The Department of Veterans Affairs has installed a CHP system at its La Jolla, California Medical Center. The system is based on a Solar Turbines Mercury 50 combustion turbine, which produces up to 4.5 MWe of electricity while recovering exhaust heat from the turbine to drive an absorption cooler for space cooling. With an estimated operating efficiency of 60%, the system requires 27% less fuel than typical on-site generation and purchased electricity. The project is another 2005 EPA Certificate of Recognition project.

• In 1997, Northwest Community Hospital, near Chicago, Illinois, installed three 1.1 MW Waukesha VHP rich-burn engines, yielding total megawattage of 3.45 with heat recovery used for domestic hot water and steam at a rate of approximately 2000 Btu/kW of electricity produced, or around 2000 pounds per heat per hour; the exhaust heat also powers an 850-ton York absorption chiller, which supplements two 1,300 ton centrifugal chillers; to address growth of loads and to bring the system up to serve all building loads, in 2005 the hospital is commissioning a fourth Waukesha generator, adding 1.1 MW in generating capacity; this system is sized to cover full electric load for peak shaving in a utility territory where demand charges are very high; according to estimates from hospital administrators, the CHP system saves about $560,000 in electricity per year and about another $100,000 in heat energy gains.

• In 2003, the California Institute of Technology replaced an older on-site system with a new 12.5 MW system, which consisted of a Solar Turbines Mars 100 natural gas turbine, a heat recovery steam generator, a steam turbine and an absorption cooler. It generates 80-90% of the university's peak load and 44,500 pounds of steam per hour. It is over 70% efficient and requires 40% less fuel than typical onsite thermal generation (a boiler) and purchased electricity. This project was the winner of a 2004 EPA Energy Star CHP Award.

• In San Francisco, the U.S. Postal Service has ordered a 250 kW fuel cell to be installed at its processing and distribution center there; this project is of interest because it also includes a separate 285 kW solar system for peak shaving and thus represents over 500 kW of generating capacity with no emissions.

• The U.S. Postal service has awarded a contract to an ESCO to install a 1.5 MW CHP system running on lean burn natural gas-fired reciprocating engines at a mail processing and distribution center in San Diego, California; the CHP system will provide 85% percent of the facility's power requirements, while heat recovered from the generator's exhaust will be used as energy for a 300-ton absorption chiller provided chilled water to the facility's HVAC system; the system is expected to reduce electricity consumption by 1.7 million kWh per year and the absorption chiller to reduce the amount of natural gas bought by 165,000 therms annually, for a total annual energy savings of $4.1 million.

Our attorneys have represented owners, developers, ESCOs and utilities alike in issues relating to on-site power generation and interconnection to the grid. We are familiar with all aspects of the development process and can guide facility owners through it. In particular, we can:

• Advise an owner on how to approach an ESCO, what to look for in the agreements with ESCOs and equipment suppliers and how to draft terms for guaranteed output and performance of the plant;

• Draft and negotiate energy service, equipment supply, operations, maintenance and service and financing agreements;

• For the critical interconnection questions, analyze the owner’s tariff schedule and utility service agreement to determine the effect of moving to self-generation, as well as assist in negotiating an interconnection agreement with the local utility;

• Analyze what types of incentives are available from state and local government agencies and demand response programs from the local independent system operator, and guide the owner through the contracting process;

• Advise owners on how to avoid regulation as a public utility, as we are experts in federal and state regulation of power generation;

• Research and report on all levels of permitting requirements so as to ensure that projects will not be held up by failure to apply for key permits;

• Monitor the implementation of energy services and other agreements to ensure compliance with the obligations undertaken by equipment suppliers, contractors and ESCOs.

In short, we can support an owner in every step of the process of making DG a reality if it makes the decision to move in that direction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.