Mr. Chairman, I appreciate this opportunity to testify before the Committee on the implications for research and development and the renewable energy industry from electric industry restructuring. As you may know, Chairman Keese of the Energy Commission testified before Mr. Regula's Interior Appropriations subcommittee in January. My testimony here supplements that testimony, focusing more on the issue of research and development and technological leadership.

California is proud of its accomplishments in energy during the Wilson administration. We remain one of the lowest per-capita users of electricity and we're getting better. We have one of the lowest overall emissions from electrical generation and even this is decreasing. We have perhaps the most diverse set of options available to our customers. This has all been accomplished while regulation of market entry has decreased and our economy has improved. It has taken the cooperation of many stakeholders.

Ensuring the United States' continued technological leadership in energy will also take the cooperation of all participants and beneficiaries of restructuring. Such technological leadership will ensure that the economic and environmental benefits promised by industry restructuring will occur and be available to all and realized by most. The federal government and the various states will continue to play important, albeit changing, roles in facilitating continued technological advancement to benefit the nation.

The opportunities that can be seized with appropriate electric industry R&D are:

• Greater product and service options for customers, leading to higher value-added goods and services

• Improved output from the energy used by the nation leading to increased GDP and improved international trade

• An improved environment

• Reduced energy costs

• More competitive products

• Growing marketplaces for American products.

Why Is It Important To Re-Focus Electric Technology RD&D?

Under the regulated monopoly paradigm, utilities undertook both private-benefit RD&D and RD&D with broader public benefit. This was acceptable, because utilities did not face competition for market share, and costs to perform RD&D could be passed along to all ratepayers on an equitable basis. With competition for market share now emerging, profit margins will be very thin and likely not sufficient for individual companies to fund the RD&D of "public goods." New players are entering the markets and all must re-evaluate their responsibilities for technological development. Successful companies will recognize the importance on innovation to their long term vitality.

Traditional utilities will become "pipes and wires" companies and should only engage in enough R&D (funded with ratepayer funds) to meet regulated market responsibilities. Newly emerging unregulated utility affiliates will likely fund R&D when they see opportunities for relatively quick payback, or through cooperative ventures, longer term applied research. Some utilities' parent companies have already established unregulated R&D subsidiaries. Collaboratives like the Electric Power Research Institute (EPRI) will likely become increasingly important players in electricity market oriented research. EPRI is already in the process of reinventing itself to better serve its members in the new market. We anticipate that the amount of collaborative R&D funding will remain flat, in dollar terms, during the transition to the new market place and then grow at a moderate pace. Collaborative R&D is generally done at the pre-competitive level, and is a very effective way to use available funding.

Equipment suppliers who wish to maintain or expand market share will fund R&D to ensure that their products have the characteristics and features demanded by competitive market participants. Industry consolidation combined with rapid organizational learning will build strong supplier companies, who will practice a new form of R&D that integrates marketing and manufacturing knowledge into the early R&D phases to ensure market acceptance. Government has typically funded specific technologies and technologists. The goal was to "perfect" a technology so that it would be ready for the market place. Little attention was paid to market or manufacturing knowledge and input. In the case of fundamental R&D this remains a sound approach. This has not been a successful approach for applied R&D. In its new role, government must partner with industries and fund pre-competitive R&D that benefits a large number of market players, including suppliers and customers. A second major role is to continue to fund the fundamental R&D that often is forgotten by industries. Materials, information technologies, mathematics and physics are some areas for basic research that national level efforts can fund and lead.

Venture capitalists have been mostly absent from the electricity industry because of lack of financial incentives and regulated rates of return. Recently, however, at least two venture firms have been created to enter the energy technology field. They anticipate placing over one billion US dollars this year and up to $10 billion in 5 years. Their investments will be more in the development phases of R&D and not in the research phases. This infusion of cash into the later phases of RD&D will relieve governments' role and allow government programs to remain focused on the early stages of R&D, and maintain the long term perspective.

Having Re-Structured Its Electric Industry, What Has California Done To Maintain Appropriate Public Interest RD&D?

California's program to restructure it's electricity market includes specific provisions to continue public interest RD&D. Dubbed the PIER Program (Public Interest Energy Research), the California Energy Commission has begun to administer much of the research historically undertaken by electric utilities as part of regulatory requirements. This program is aimed at advancing science and technologies not adequately provided for by regulated and competitive markets. In designing our program, we have benefited by a public outreach approach to determine where priorities exist.

California bases its energy RD&D on the following principles:

Those who fund research should benefit in some direct fashion, and those who benefit from research should be responsible for funding.

Ratepayer benefits are foremost. Our focus is to maximize the affordability, safety, and reliability of energy while minimizing risk and environmental and health costs.

Goals and objectives are quantifiable -- there must be direct and measurable benefits to ratepayers.

Energy RD&D projects must include a commercialization plan that includes estimates of what the project "should cost" in the competitive market.

Projects should be results driven, avoiding funding "sinkholes." Programs that fail to meet mutually agreed upon guidelines should be terminated.

What Should Be Done At The Federal Level To Accommodate Changes In The Electric Industry?

Collaboration in RD&D is crucial to eliminate redundant programs, to ensure adequate funding levels and share the benefits of research. The Energy Commission recognizes that neither California nor any other research entity can afford "to go it alone," particularly in a restructured market.

Strategies for market placement of the research project should be required as part of contractor bids. Unless there is a clear "path to market" it is unlikely that promised benefits will ever materialize, irrespective of the technological merits of a development. Moreover, programs should be administered in the same manner as private sector fund managers, guided by performance goals, expedient triage of "money sinks," and the resulting re-alignment of program priorities and redirection of budgets. Market placement strategies should consider the appropriate time for different entities to take the lead. While government should focus on long term and basic research, and equipment manufactureres on commercialization, placement strategies should identify both roles in the development timeline.

Perhaps the single most important consideration, also akin to private sector fund management, is the concept of portfolio management. This concept has two important effects on RD&D programs. First, programs should be designed primarily with objectives set for the overall program's performance rather than for individual projects. When individual projects are each ‘measured' researchers tend to become more and more risk averse, and less likely to take technological leaps. Second, program portfolios should be designed using scenario analysis. Traditionally, many research programs in energy have focused on avoiding the risks associated with increasing world oil prices; but what happens to the lost opportunities if world oil prices drop, or remain highly volatile? Research programs developed using scenario analysis are likely to be more robust than those built using a single set of risk factors.

DOE has been criticized in the past for spreading program funds too thinly across the spectrum of possible programs. This has often resulted in individual awards which are inadequate to achieve meaningful results with available funding. Conversely, states and researchers have been criticized for large funding requests requiring significant portions of available funding.

We suggest two principles should generally apply in determining program fund disbursement. First, preference should go to those entities with proven track records. Second, the research dollar should be invested for the highest public benefit return. Entities with experience and proven leadership in research or infrastructure development should be targeted to receive the majority of funds. Some funds, however, should be reserved for innovative project proposals originating with small businesses.

Funding for information transfer to maximize "reaping of the benefits" should be a key consideration as should commercialization assistance. Product commercialization does not normally fall within the purview of government. Companies conduct market assessments, take their product to market and succeed or fail. The Energy Commission strongly supports this view. Based on our experience, however, we recognize that in certain situations, government assistance, limited in cost and time, is necessary and appropriate. Results of public funded RD&D should receive assistance to overcome market barriers resulting from government regulations or the lack of consumer education. Some technologies, even after successful RD&D, fail to make it into the market. We support recommendations for government to: (1) educate financial institutions on the true market risk of new technology, encouraging these institutions to develop financing options, and simplified or standardized procedures for loan acquisition; and (2) removal of government regulations, rules, procedures or policies that unfairly or unintentionally block market entry for innovative technology.

American energy firms also compete with foreign companies that receive sizable subsidies from their governments, in the international market. The federal and state governments are not in a position to provide substantial direct subsidies to our firms seeking a foothold overseas but may conduct independent and cooperative energy technology export programs. These programs assist American companies to position themselves in the global market, improving their opportunities for winning energy projects and service contracts in an expanded market. Incorporating RD&D programs into this trade model ensures successful foreign market introduction of government-funded RD&D programs, with future RD&D more easily paid for by today's successes.

As an example, the Energy Commission's investment in its export program has resulted in $400 million in sales by California energy companies, a 37 to 1 ratio for every government dollar spent. In many cases, creating international markets prepares products and technologies for successful introduction in the competitive domestic market. The federal government has assisted the Commission in funding these endeavors. With modest financial assistance, we believe federal-state partnering can leverage sizable returns and maximize the results of our collective RD&D.

I would like to make a few remarks specific to the renewable energy technology industry.

Renewable energy R&D has been funded predominately by public agencies or ratepayer money spent by electric utilities. Because the renewable energy industry, as a whole, has made little profit to date, there has been little industry money to apply to R&D. In addition, most developers of renewable technologies have been universities, national laboratories, and small businesses.

With industry restructuring, many consumers are demanding and now demonstrating a willingness to pay for power derived from renewable sources that are clean. This major change in the market is not due to a change in consumer attitudes as much as the new opportunity to exercise choice. This change has not gone unnoticed by major power providers who are now investing heavily in renewable resources. These market players will compete to sell the power that best meets the consumers' set of values at the lowest cost. To be among the most profitable of those suppliers they will have to invest in R&D in the renewable technologies. These investments will focus on reliability, cost and environmental issues.

The purpose of California's renewable program under Assembly Bill 1890 is to assist our renewable program to transition to a mature industry within a competitive market. Funded for four years, the goal is to phase out artificial support such as mandatory purchases (such as through our previous PURPA driven resource plan auctions) or continuous subsidies. Our experience has shown that such mandatory purchases and direct subsidies, while important to ‘kick start' some aspects of new industries, typically fail to sustain technological progress within those industries. They may also divert resources from economically viable long tem products to products that benefit from short term government subsidies. Consumer choice, market economics, and collaborative public/private RD&D are key to bringing renewable energy technologies into a viable market position.

How should Federal Program Priorities be Set?

We recommend that program priorities be established in a collaborative fashion, similar to the Energy Commission's strategic plan for the PIER program and the way in which DOE has developed the Industries of the Future. PIER's strategic plan was developed collaboratively by an ad hoc group of over 70 separate organizations and individuals. This group led the development of the PIER Program and represented a broad cross-section of entities concerned with California's energy-related public interest RD&D activities, including representatives from private sector companies, investor-owned and municipal utilities, research organizations, universities, public interest organizations and various government agencies.

What Program Priorities should be set?

Program priority should be given to energy RD&D in five subject areas.

1. End-Use Efficiency
2. Environmental Enhancement
3. Renewable Energy
4. Advanced Generation
5. Strategic Research Including Reliability and Market Enabling Technologies

End-use efficiency technologies

DOE's and the Energy Commission's research programs have each dramatically reduced the energy used in buildings and appliances. Advanced window coatings and electronic ballasts are two results of this expertise. In light of our past collaborative efforts, DOE and state energy offices can build on our success. On a related note, building and appliance efficiency programs should account for total energy when making inter-fuel comparison. Increasing energy efficiency usually requires making improvements to a system not just to the components of a system. This requires taking into account the interaction between the components of a system as well as the separate efficiency of the individual components. DOE should include opportunities to improve the overall efficiency of hot water systems, as they review appliance standards for water heaters. DOE should include systems analysis in future reviews of other appliance standards, as well.

We wish to make the Committee aware of one effect of restructuring on advanced energy technologies, particularly those for end-use efficiency. In California, energy will be bid into a Power Exchange and, within the direct access market made available, on an hourly basis. Current interval meters and communication/control systems (capable of "responding" to hourly pricing and automatically matching load to lowest prices or shifting load off peak periods) is cost effective only for large customers. RD&D is needed to bring down the cost of this "smart" equipment so it can be installed or retrofitted economically into new and existing small businesses and homes. This also has implications for grid level reliability, if that smart technology can more readily sense transients and respond to early warning signs of grid collapse.

Hourly pricing allows for and encourages further cost-effective savings through a wide variety of load management approaches. These include more efficient commercial lighting; advanced heating, ventilation and cooling (HVAC) systems; duct sealing and insulation; and, high technology windows and weatherization. Commercial lighting and HVAC systems could reduce their duty cycles during high cost periods if appropriate controls were available. Federal support of RD&D should definitely continue in these areas.

Environmental Enhancement Technologies

Electro-technology is using electricity cost-effectively in place of conventional fuel technologies. Electro-technologies offer considerable potential benefits by reducing or eliminating pollution. Examples such as electrically driven ultra-violet (blue-light) cures are now being used as substitutes for solvent-based evaporatives in varnishes and urethanes. Another example is using microwaves to dry agricultural products rather than using natural gas fired dryers. Electro-technologies are promising and should be a key RD&D focus area.

Renewable Energy Technologies

The high cost of renewable technologies makes it difficult for existing and new renewable projects to compete in restructured electricity markets. RD&D is needed to significantly improve the efficiency, reliability, costs of these technologies and to reduce those negative environmental drawbacks of some renewable technologies. Research should include improving the operating flexibility of renewable technologies, to enable them to more readily respond to hourly fluctuations likely to become prevalent in the restructured electric industry. Serious attention also needs to be devoted to valuation and improvements of non-energy benefits. For example, the non-energy benefits of some biomass technologies include: volume reduction of removing biomass and municipal solid waste from landfills; improved forest health, water quality, air quality, and fire suppression management. These multiple societal benefits and their costs and benefits should be considered when evaluating the cost of renewable technologies, and affords an excellent opportunity for collaborative research across sectors. In other words, volume reduction benefits should be paid for by waste generators--not electric ratepayers.

Other research should focus on small distributed renewable resources that can be integrated into the system at the distribution level.

Advanced Generation and Distributed Power

Prior to restructuring, older electricity generation units were generally retained for emergency or backup purposes. With the introduction of new, low-cost, highly efficient facilities, these older units will either be closed or retrofitted.

Alternatives to large central facilities, principally distributed power technologies, will be in demand as many communities opt for small, dispersed power facilities. DOE's continued funding of advanced generation technologies and its leadership, exemplified by the Coordination Council for Power Generation RD&D, will be critical elements to the success of efficient competitive markets.

Strategic and Reliability Enhancing Technologies

Perhaps the most exciting area for research is in strategic technology areas, including those to improve the interface between generators, the grid, and end users. A reliable and efficient transmission grid is required for public health, safety, and economic well-being, yet the singular responsibility for reliable operations of past years has been splintered. The major electrical outages of July and August 1996 in the western United States helped drive California's restructuring law. The outages exposed the lack of smart, fast control and communication systems to adequately maintain reliability. Advanced monitoring, communication and control systems that maintain the grid or minimize or prevent cascading outages are critical. These systems should be a critical target for federal RD&D.

Another facet of the transmission system is congestion in the delivery of power, which threatens reliable access to the electricity marketplace. While congestion bids and pricing are now being developed to alleviate these transmission constraints, the RD&D of the "next" generation of directional power flow equipment, phase shifters, thyristors and related technologies may offer more efficient solutions. Because much of the commerce in electricity will take place over the internet, energy RD&D should target improvements to the effective use of existing bandwidth and expansions to bandwidth infrastructure. This naturally marries to and facilitates the smart meter and smart appliance technology noted above. It also suggests cooperative research between the energy and other sectors of our economy.

What Are The New Roles Of The Federal Government, The States And Industry In Maintaining Cutting Edge Technology Development?

Long-term energy research and technology development requires a multi-year commitment. In the states, demand for short and mid-term research activities will limit funds available for long-term research.

The federal government energy research and energy related programs need to be focused on the nation's priorities, but the nation's priorities stem from the unique opportunities and perspectives of the various states. Collaboratives which leverage the funds of the federal government, states and industry, and public-private partnerships in cooperative ventures should be the foundations for implementing national research strategies.

The national laboratories perform a valuable service in technology transfer and possess incomparable physical facilities and intellectual capabilities. Their outreach is vital to developing successful partnerships with states and industry. The labs are striving to be more responsive to the states and industry.

DOE should set advanced generation efficiency targets in collaboration with states and industry. We view goals that go beyond best practice as critical components of successful targeted RD&D programs, yet need to have clear paths to markets and ways to overcome financing inertia. The California Energy Commission is developing such goals in its Public Interest Energy Research Program. The Commission looks forward to sharing its Public Interest Energy Research Program (PIER) experiences with the Committee.

Distributed power technologies include fuel cells, wind, battery and other storage technologies, reciprocating engines, advanced gas turbines, microturbines, and photovoltaics. States, having jurisdiction over the distribution system, have the responsibility for removing or minimizing state regulatory and market barriers to distributed power technologies.

Setting of appropriate safety and interconnection standards remains a key DOE role. In the technological arena, DOE could facilitate the development of minimum national standards for grid interface of distributed generation units, and standard communication protocols for meters and smart appliances. Industry, standards setting associations, and states will need to work closely with DOE.

Conclusions

The federal government must continue to be a pivotal player in promoting and advancing energy RD&D and energy-related programs. Congress cannot assume that the states will institute or continue integrated RD&D programs as utilities cut back or eliminate RD&D programs. In California, the PIER Program is funded at $62 million per year but does not have a provision extending program funding beyond four years.

DOE is moving effectively to becoming an "integrator" of technology development, bringing together industry partners and states and interest groups.

DOE should focus on programs that benefit the ratepayers and continue to improve program administration. Program administration suggestions include the requirement that bids contain business plans detailing commercialization pathways. Further, DOE should administer its program like a private sector fund manager responsible for cutting losers and redirecting funds appropriately. Some DOE programs are being administered this way. These activities should not require additional budget augmentation and the rewards in terms of successes could be substantial.

We recommend that preference should go to entities with proven track records and that the government's investor dollar should be targeted for the highest rate of return. Entities with experience and proven leadership in research or infrastructure development should be targeted to receive the majority of funds. The results should then be shared with other states to save the time and money of the nation's taxpayers. Structured correctly, targeted funding can translate to more effective program results at lower funding levels.

DOE should continue collaborating with states and industry, to devise and achieve RD&D that meets the needs of the market and positions US companies to effectively complete in global markets. For example, DOE's Industries of the Future program and its Coordination Council for Power Generation RD&D are excellent examples of coordinated work and collaborative funding of DOE, EPRI, GRI and several states including California , New York, Wisconsin, Florida, and West Virginia. DOE should remain involved in pre-competitive energy activities, but also look to collaborate in research for those enabling technologies such as telecommunications, not traditionally seen as "energy."

Industry, for its part, should be encouraged to partner with states and DOE and to cost-share public interest RD&D. When competitive pressures result in broad industry RD&D programs, government RD&D funding may be inappropriate or counter-productive. Rather, funds should only be directed to promising RD&D not pursued by the private sector. It may be appropriate, however, for government to reduce barriers which hinder these privately developed technologies from advancing to the market place.

It is crucial for the federal government to avoid a "one-size fits all" approach to RD&D as electricity markets evolve in the states. Each state and region has different opportunities and unique challenges. In California, we have responded to those challenges and opportunities, through comprehensive and integrated state legislation, which includes a coordinated mechanism to continue public interest RD&D and transition renewable technolgies into the competitive market. The continued viability of these two components is highly dependent on the preservation of the entire California package. Nothing should be done at the federal level to alter this highly balanced approach. We look forward to cooperating with other states and the federal research programs.

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