Green power
How California's PG&E is transforming itself into the very model of a modern utility company.

By Katherine Ellison
Business 2.0 Magazine
September 26 2007

(Business 2.0 Magazine) -- A 22-foot-long, neon-green banner hangs from the high-ceilinged lobby of the San Francisco headquarters of Pacific Gas & Electric, California's largest utility. "GREEN IS resisting the urge to drive to yoga," it declares. "GREEN IS saying no thanks to the daily disposable coffee cup." Never mind that right beneath the banner a woman is selling coffee in plastic-foam cups. There's richer irony here. Why in the world, you might well ask, is a giant utility telling people not to use products that consume energy?

The answer: This energy company has risen from bankruptcy to become one of the planet's most prestigious - and profitable - brokers in green power. Wrapped in the mantle of environmentalism and touting the virtues of saving kilowatts, planting trees, and driving electric cars, the 155-year-old, $12.5 billion behemoth these days is acting less like a robber baron than a Silicon Valley venture capitalist. It's exploring, even incubating, cutting-edge technologies - from solar power to wave energy to biogas produced from cow manure. Along the way, it's giving other big energy firms a lesson in how to adapt to a carbon-constrained world, without - at least so far - getting burned.

In short, PG&E is turning itself into a role model for 21st-century utilities. That means making money by transmitting renewable energy wherever it may be generated - from the water flowing under the Golden Gate Bridge to the batteries of hybrid electric cars - all while managing an interactive power grid. Peter Darbee, CEO and chairman of PG&E Corp., the company that owns Pacific Gas & Electric, describes the sophisticated network that will hold it all together as the energy equivalent of the Internet.

While PG&E isn't the only American power firm that's going green, it is way ahead of the pack of investor-owned utilities in some important ways, including its connections in Silicon Valley and its willingness to use its political muscle to support environmental initiatives, such as limits on greenhouse-gas emissions. "It's certainly a viable strategy, out West in particular," notes Morningstar analyst Travis Miller. "The regulators have given PG&E a blank checkbook to go ahead and build everything they need to expand that renewable portfolio, and that's going to give them a lot of growth."

These are nervous times for America's electric power industry. More than two dozen states have followed California's lead and now require utilities to obtain a portion of their electricity from renewable sources. (The Golden State's target is 20 percent by 2010.) In Washington, D.C., meanwhile, there's a new push to curb national greenhouse-gas emissions, about 40 percent of which come from electric utilities. Rather than trying to hold back the tide, PG&E is surfing the green wave, throwing its weight behind Gov. Arnold Schwarzenegger's environmental initiatives and the state's landmark global-warming law as well as some congressional greenhouse-gas-cutting efforts. It's not exactly a popular position among PG&E's peers in the $387 billion segment of the industry composed of publicly traded companies, especially those in the coal-burning business. But as Darbee sees it, it's better to be at the table than on the menu. (Better still, in Darbee's case, to be splashed across the glossy pages of Vanity Fair, whose May issue hailed him as an "eco-warrior.")

"This is a defining moment for utilities," says Darbee, a golden-haired former high school wrestling champ, from his 24th-floor office with stunning views of San Francisco Bay. "Are we going to be central players in shaping the new energy economy that is now emerging, or are we going to leave these challenges to others?" Change won't be easy for the giant utility, and PG&E is taking a big risk. It's betting heavily on technologies with little or no track record. It must also counter a growing movement among California cities and counties to abandon the investor-owned utilities and buy their own power, a trend that could leave PG&E stranded with costly new investments in technologies nobody wants.

The city furthest along on this path is PG&E's hometown of San Francisco. In June, the city's board of supervisors gave staff the go-ahead to put together a plan that advocates say could provide San Francisco with 50 percent renewable energy by 2017.

On a national level too, the stakes are high. Many observers anticipate that the United States will impose some sort of cap on greenhouse gases within the next few years. Utilities that fail to cut their emissions could end up paying heavy penalties in carbon taxes. PG&E is preparing for greenhouse-gas caps by investing in a more efficient grid and fostering innovation in renewable energy. Says Des McGinnes, business development manager at Ocean Power Delivery, a nine-year-old Scottish wave-energy firm that's in discussions with PG&E about building a wave farm off the Northern California coast, "PG&E is walking the talk."

PG&E's origins stretch back to the Gold Rush, with the company's founding in 1852 as the San Francisco Gas Co. A series of mergers produced the Pacific Gas & Electric Co. in 1905; the company survived the great earthquake one year later to grow into a powerful regulated monopoly. But a century of growth and prosperity came to an abrupt end on April 6, 2001, when PG&E filed for bankruptcy. California's three-year experiment in energy deregulation had produced not lower prices but rolling blackouts and a $7 billion utility bill.

Darbee, then CFO, had joined PG&E during the first year of deregulation after a career in telecommunications and finance, including stints at Goldman Sachs (Charts, Fortune 500) and Salomon Bros. He vowed to turn things around, and he got his chance in January 2005 when he took over as CEO. Darbee was then 51, and certainly no eco-warrior; he wasn't even convinced that climate change was real. But as it turned out, those hard times helped free PG&E and other California utilities to adapt to the climate-change era. Forced to sell off most of its power plants during deregulation, PG&E was now a buyer of energy and could choose what kind of energy it wanted to purchase. This coincided with the greening of the Governator, who in 2006 signed a landmark law to reduce greenhouse-gas emissions 25 percent by 2020.

Watching all this transpire, Darbee asked his staff whether PG&E had a strategy to deal with climate change. To his surprise, it didn't. So, early in 2006, Darbee invited a group of experts to conduct a crash course in global warming for the company's top managers. One scientist, Stanford University climatologist Stephen Schneider, gave the executives some blunt advice: "Sooner or later, there's going to be another [Hurricane] Katrina, and you could get an irrationally high carbon tax stuffed down your throat," he said. "So why don't you stop trying to derail the train and try to drive it?"

Darbee took Schneider's pragmatism to heart. PG&E began to lobby for more -not less - regulation of its industry. It was also the only big California utility to actively back the state's global-warming bill. Without that key support, the legislation might not have passed, says former Schwarzenegger adviser Terry Tamminen. In return, he says, PG&E was able to negotiate "a lot of changes" that made the bill more flexible.
Among utilities, PG&E is particularly well suited for thriving in a carbon-constrained world. With just 2 percent of its in-state electricity generated by coal, it was already greener than most of the nation's big utilities. It also benefits from the way California regulates its utilities. Their sales are separated, or "decoupled," from revenue, so they neither earn more by selling more energy nor lose money by promoting efficiency measures that reduce those sales.

Instead, California's utilities make a guaranteed profit on all their investments - $2.8 billion this year for PG&E. The regulators have also approved big budgets for energy efficiency, something that has helped PG&E's top business clients save money, while boosting PG&E's bottom line. The $300 million PG&E set aside for energy efficiency in 2007 includes a lot of "customer education," which often doubles as public relations for the company. "This is not a normal business, like the bubble-gum business, where you can make money by selling more gum. If a regulator will let you, you can make money by selling less of the product," notes David Victor, director of Stanford's Program on Energy and Sustainable Development. "The single most important relationship is with the regulators."

Yet as concern about global warming increases, PG&E's fortunes also will depend on its relationships with the entrepreneurs the utility hopes will supply enough green energy to meet the targets set by the state's energy bureaucrats. And that's giving green startups a chance to score some very big deals.

At 'Summer Davos,' hard talk about soft power

On another unseasonably warm early-spring morning in downtown San Francisco, about three dozen entrepreneurs sit in a darkened PG&E auditorium as a company executive tells them the utility is "open to any and all offers" to provide as much as 800 megawatts of clean power. Among those in the audience is John Pimentel, a business-suited former state bureaucrat who has a plan to make biofuel and energy from nonrecyclable trash. This is PG&E's fourth annual request for proposals as it seeks to meet the state's renewable-energy target of 20 percent by 2010. It's still short; only 12 percent of the utility's delivered energy currently meets that standard - though it has signed contracts for 18 percent. "We have a lot more renewable megawords than renewable megawatts," scoffs renewable-energy lobbyist V. John White, executive director of the nonprofit Center for Energy Efficiency and Renewable Technologies. In fact, Southern California Edison, with a much less vividly green public profile, has surged ahead of PG&E, with 17 percent of its mix from renewable energy.

So the heat is on PG&E - and it's getting hotter. State officials recently approved a new target of 33 percent renewables by 2020. And earlier this year, regulators banned utilities from signing long-term contracts with out-of-state coal-fired power plants - the source of 20 percent of California's electricity.

That's why PG&E is turning for help to Silicon Valley, where there's a boom in new clean-energy technology fueled by venture capital. To be sure, it's a brave entrepreneur who will chase this holy grail and risk failure at the hands of a lumbering corporate bureaucracy and the numerous government agencies that regulate the industry. "They're opening the door," Pimentel says, "but there's still a thick forest to walk through." Darbee maintains that only a few current technologies offer the hope of a fast scale-up at a price reasonably competitive with that of fossil fuel. One of these is wind power, which PG&E is pursuing. PG&E is also betting that solar power - or, more specifically, massive-megawatt "Big Solar" power plants operating in the deserts of California and the Southwest - will help it meet its targets.

Cash in on the rebuilding boom

The utility is working on three major solar projects expected to start delivering power between 2009 and 2011. Each is in the 200-to 500-megawatt range, enough to light as many as 700,000 homes at prices competitive with those for natural gas. The first deal was a 500-megawatt agreement with Bright-Source Energy, an Oakland, Calif., startup funded by Silicon Valley VCs and run by veteran solar entrepreneur Arnold Goldman. Goldman says he's convinced that PG&E is committed to his technology. "It's a funny-strange feeling, going in there and finding a group within a utility that's actually trying to see how we can make these things happen," he says.

Then in July, PG&E announced the world's largest solar deal to date: an agreement to buy 553 megawatts of electricity from a plant to be built in the Mojave Desert by Israeli firm Solel. Silicon Valley VC Vinod Khosla, a leading green-tech investor, is working on the third potential PG&E deal with a solar power company called Ausra, which recently relocated to Palo Alto from Australia. He shares Goldman's enthusiasm about the utility. "They're not really acting like a big company," says Khosla, who appreciates the utility's nimble grasp of what he calls the "massive opportunities" to profit by adapting to climate change. "I mentioned I needed to do some due diligence, and within three or four days, they'd sent a team to Australia," he recalls.

PG&E is making progress on other fronts as well. It's leading the herd, for instance, in the emerging industry of "cow power." That's the polite name for extracting methane - a potent greenhouse gas - from cow manure and turning it into biogas that can be piped to power plants. During the past year, PG&E has signed long-term contracts with two biogas startups: Microgy, based in Golden, Colo., and BioEnergy Solutions in Bakersfield, Calif. Each aims to produce enough gas in the next two years to power 50,000 homes. "PG&E has been way out in front on this," says Microgy senior vice president Jeffrey Dasovich, who adds that the utility has devoted considerable time and resources to engineering the system to connect Microgy's machinery to its pipes.

Further out on the horizon are PG&E's plans to produce electricity from ocean currents off the Northern California coast. The utility's WaveConnect project will test wave-energy technologies with the aim of getting two 40-megawatt power plants up and running within a few years. That could provide a big boost to other wave-energy startups. McGinnes at Ocean Power Delivery, which makes a semisubmerged 459-foot cylindrical wave-energy converter called the Pelamis, says PG&E is the first U.S. utility to include wave power as part of its green-energy mix. "We see this technology as ultimately being competitive with other renewables," he says. PG&E is also seeking federal permits to test tidal power under the Golden Gate Bridge.

Perhaps just as important as where PG&E gets its power - where the wind blows, where the waves crash, where the sun shines, where the cows poop - is how it plans to share it. Instead of generating electricity in colossal centralized power plants and pushing electrons into homes and businesses, energy distribution in the future may be more a matter of give and take, of energy managed over a web that draws electricity from wherever it's abundant and sends it wherever it's needed.

We got a peek at that future one morning in May when Kyle Aarons, a 20-something PG&E employee whose title is project manager for clean air transportation, took a plug attached to a mutant Toyota Prius hybrid and stuck it in a wall socket in the utility's underground garage in San Francisco. A meter moved clockwise, showing that the nearly 9-kilowatt lithiumion battery pack installed in the back of the Prius was charging like a cell phone. Then Aarons flipped a switch, and the meter moved in the opposite direction, demonstrating how the car can also send electricity back into the grid.

Call it user-generated power. In June, PG&E and Google (Charts, Fortune 500) took the concept one step further by unveiling a solar-panel-covered carport at the Googleplex in Mountain View, Calif., where employees will be able to plug in a fleet of hybrid vehicles that the search giant is creating for an electric-car-sharing program.

Much work remains to be done, but the plug-in technology is revolutionary on several counts. It could help ramp up wind power, which is now nearly cost-competitive with natural gas but has the drawback of being intermittent. Vehicle-to-grid technology could change all that if plug-in hybrids become common. A driver could charge a car in the evening, tapping renewable energy when the winds blow most strongly but demand is low. When electricity demand peaks during the afternoon, hybrids plugged in at office parking lots could send power back into the grid (while owners rack up microcredits on their utility bills). If automakers embrace vehicle-to-grid, utilities could end up with valuable credits to sell to companies that exceed their greenhouse-gas-emission limits.

Of course, this will work only if the grid knows where your car is, what time you're plugged in, and what rate to charge or to credit you with. The grid, in other words, needs to be intelligent. That's where PG&E's SmartMeter comes in. This electronic device monitors a home's energy consumption in real time, allowing the utility to charge different rates as electricity demand rises and falls during the day. The meters move PG&E's model closer to Darbee's vision of "the smart energy web."

"In the future," says Roland Risser, the utility's efficiency czar, "we might send you a message and say, Do you realize your pool pump is coming on at 3 p.m.? Or that the compressor on your air conditioner is about to go out?" Such a system would create new opportunities for companies that make devices smart enough to communicate with the grid- everything from your Toyota to your toaster.

Even as PG&E goes green, it continues to make investments in less benign technologies, like liquefied gas and gas-fired power plants. Executives characterize that spending as a "bridging strategy." Darbee has also been putting out the word that more nuclear power could be a good thing for a warming world, California's 30-year-old moratorium on new nuclear plants notwithstanding.

Positions like these have alienated San Francisco's liberal board of supervisors, who think they can move faster on fighting climate change than a profit-motivated utility can. Mayor Gavin Newsom has quietly supported efforts to seek independent sources of green energy, and now several other California cities and counties are preparing similar plans. That, however, doesn't seem to have hurt PG&E's bottom line. Its financial prospects, in fact, would make any respectable utility manager green - with envy. PG&E Corp.'s stock price jumped 27.5 percent last year and hit an all-time high closing price of $52.11 in April. Counting dividends, PG&E shareholders earned a 31.6 percent return for 2006.

Darbee is confident that his company is now more prepared than just about any U.S. utility to weather a predicted new storm of climate-change legislation. "There's going to be mandatory carbon regulation within the next two to three years," Darbee says, "and the probability reaches 100 percent in four years. We're going to be ready for it. There's a saying I learned during my days on Wall Street: You don't fight the tape."

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