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Infrastructure conundrums: Investment and urban sustainability
Technology in Society 28 (2006) 125–135 www.elsevier.com/locate/techsoc
Infrastructure conundrums: Investment and urban sustainability Michael F. Bobker * CUNY Institute for Urban Systems, Association for Energy Affordability, 505 Eighth Avenue, Suite 1801, New York, NY 10018, USA
Abstract This paper examines the case of electrical capacity for New York City as an example of the relationship between infrastructure, investment, and urban sustainability under conditions of de-regulation. The electrical system is one example of network infrastructures, traditionally regulated or state-owned, that have been subject to recent trends towards de-regulation and privatization. Power system deregulation introduces new investment market dynamics into the development of electrical resources. A game theoretic perspective provides an explanatory model for observed behavior in the New York metropolitan area power market, suggesting that large project development is constrained by uncertainties about other, competing projects and that, as a result, investment decisions may not occur in necessary timeframes to avoid severe capacity shortfalls. Such infrastructure shortfalls can greatly impact the sustainability of a city that competes in regional and global markets. The potential of smaller, demand-side investments is noted for avoiding the investment-decision uncertainties of large supply-side projects; however, the cost-effectiveness of such projects depends on their connection to an established network infrastructure. Reduced ability to control power plant investment in a deregulated market makes the mobilization of demand-side resources a more critical part of market performance in sustaining services over time. q 2005 Elsevier Ltd. All rights reserved. Keywords: Electrical capacity planning; Infrastructure investment; Power markets; Urban sustainability; Deregulation
1. Introduction Cities exist because they have roles to play in their regional or global economies. History shows us that there is almost always competition between cities for primacy in these roles. Failure to be able to support a city’s mission can cause its decline. Sustainability of cities, then, * Corresponding author. Tel.: C1 212 279 3902; fax: C1 212 279 5306. E-mail address: [email protected].
0160-791X/$ - see front matter q 2005 Elsevier Ltd. All rights reserved. doi:10.1016/j.techsoc.2005.10.003
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is based importantly on providing key critical services that make possible the fulfillment of the city’s economic purpose. To a substantial degree, these services are based on the availability and maintenance of networked infrastructures, examples of which include energy (fuels and electricity), communications, water, sewer, and transportation. Networked infrastructures determine the quality of life in cities. Water supply and waste management are prime examples of the necessity of infrastructure for public health. In other respects infrastructure underlies the mission and role of a city in its regional or global economy. More than being simply population aggregations, cities are fundamentally economic entities, with evolving functionalities. For the example in this paper, New York City originally a center of trade, immigration, and light industry dependent on its port, has evolved into a center of global finance dependent upon its electronic telecommunication and, underlying that, electrical infrastructures. Failure of these infrastructures would cause a loss in global competitiveness threatening economic failure that could make the present city unsustainable. Another key aspect of networked infrastructures is that they generally exhibit properties of ‘natural monopolies’ in which it is considered economically inefficient to develop multiple, privately-owned and competitive systems. This is the theoretical basis for infrastructure industries developing and operating under regulation or state-ownership although over the past two decades ideology and technology have combined to reverse this pattern. Infrastructure costs money to build and to maintain and therefore investment is another key element of urban sustainability. The way regulatory (or deregulatory) changes affect the pattern of investment decisions is, as yet, only dimly understood.
2. Network infrastructure capacity development, free markets and game theory Under regulated (or state-owned) regimes utilities have the obligation to serve their monopoly service area. This obligation includes planning and building the necessary capacity to assure reliable service. In exchange for this obligation, the utility receives a guaranteed return on its invested capital; the regulator sets rates as necessary to assure this. The utility establishes its load (demand) projections and a plan to meet it, subject to the regulator’s review and approval. Once approved, the utility is able to go to the financial markets with a secure proposition. Deregulation (or privatization) completely changes this development process. No longer is there a single organization responsible for assuring infrastructure capacity (e.g., adequate supply of electricity). Instead, market demand is supposed to elicit the free and timely entrance of new capacity. In New York State’s electrical deregulation process, extensive collaborative proceedings considered and developed the workings of daily markets, creating institutions (the NY Independent System Operator, NYISO, in particular) and specific mechanisms, rules and procedures for market participants. Much less was established concerning the longer-term investment dynamics of merchant generation and transmission. The operation of free markets is idealized in introductory economics textbooks and in the minds of politicians. Deregulation may make market entrance possible where it was not before possible, but it is never ‘free’. A generating plant or transmission line or other infrastructure component is certainly not free—it is an expensive proposition that requires the faith and backing from investors who participate in financial markets. There are procedural rules for siting new plants and transmission that, at least in the USA, require rounds of public hearings and comment and there are a host of permits to be obtained. Observers have changed the term deregulation to re-regulation to capture the maze of new rules that apply. Observers of
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privatization-in-action have seen the need to call for government regulation of the new operating entities. Economic textbooks also tend to simplify the process of new supply responding to demand. In the real world, it is a process of investment decisions made by market players. Each of these market players looks not only at market demand but also at other suppliers. Especially where there are only a few suppliers as in oligopolistic situations as is typical of large infrastructure projects, decision-making is importantly based on other players’ moves. These kinds of situations are best analyzed in a framework known as Game Theory, sometimes called interactive decision theory, a discipline that concerns the behavior of decision makers (players) whose decisions affect each other [1]. Without developing the kind of mathematical analysis typical of Game Theory, we can gain a valuable insight through understanding that market players’ decisions will be based on their evaluation and expectations of other market players’ actions. Situations such as the classic ‘Prisoner’s Dilemma’ pose conditions in which each player’s most desirable outcome is placed at risk by the other player’s strategy. A less desirable choice may be made to reduce risk. The total payoff for all players (society) is less than what might have been realized but is more secure and predictable. Another field of economics, operations research, has come to similar conclusions: that decision-making behavior often seeks a ‘satisfying’ solution that is less than optimal but minimizes risk. A game theoretic framework to the privatization of network utilities is elaborated and applied to recent cases by David Newberry in his Walras-Pareto Lectures published as Privatization, Restructuring and Regulation of Network Utilities, MIT Press 2001. The following section presents a recent history of New York City electrical supply, since deregulation was introduced in New York State starting in the mid-1990’s, as a case illustrative of infrastructure investment dynamics.
3. Infrastructure dynamics: The New York City electrical load pocket The recent history of New York City’s electrical capacity shows a pattern that may be indicative of many urban infrastructure situations as their planning and growth are increasingly put into market environments. A structure of incremental, steady demand growth with lumpy, long time-horizon resource supply is difficult enough to plan for; we will see that introducing oligopolistic market forces adds a significant additional level of uncertainty. Even though the NYC case takes place in one of the most advanced economic settings, the structure of forces carries lessons for other contexts. Electrical load pocket status is characteristic of most urban areas, consisting of a situation in which the city’s load exceeds, at least for some of the time, the transmission capacity. For economic analysis, this situation is treated as a case of ‘congestion pricing’ in which a market balance must be struck between the combination of remote generating resources with transmission and in-city generating resources [2]. The remote resources are assumed to be less expensive, justifying the payment for transmission rights when they are available. The situation, shown graphically in Fig. 1, between New York City and the broader New York State distribution system, is characterized by † Constrained transmission into the city, less than the city’s peak requirement, creating a ‘load pocket’. The City’s baseload of 7000 MW also exceeds the transmission capacity.
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M.F. Bobker / Technology in Society 28 (2006) 125–135 NYS Peak Load, 2002: 30,910 MW 18%reserve: 5,564MW
Existing Transmission into NYC: 5,000MW
NYC Peak load (2001): 10,665MW 18% reserve: 1,920MW In-City Generation: 8,000MW
Fig. 1. NYC load pocket: peak load and capacities. Source: author compilation.
The transmission capacity consists of just two separate high capacity lines. Despite much discussion of additional transmission, actual progress has been limited. The regulatory situation has been cloudy at the federal level for the past several years. The most advanced transmission project in the region, a line from Connecticut to Long Island crossing beneath the Long Island Sound, is fully constructed but has been delayed for over a year in the courts from being put into service; while part of the NYC metropolitan area, Long Island is not part of the city proper and is not reflected in the load balance described. As a result of the imbalance between in-city demand and transmission capacity, sufficient incity resources must be maintained. This was understood and planned for under the regulatory regime. The physical need is no less with de-regulation but a new, market-based mechanism has been required. The need for in-city capacity is the basis of an ‘installed capacity market’ mandated by the NY independent system operator (ISO), requiring that all retailers purchase contracts for in-city installed capacity equal to 80% of their purchased capacity. This capacity market is separate from the daily market for the capacity of commodity (e.g. actual kilowatt hours moved through the system) and the capacity payments are made to generators whether or not their equipment is needed and put into use. † Summer peak demand approaching the margin of present supply capacity Since electricity prices are a function of real-time electricity availability1, especially under deregulation, this situation is most significant for a city that already faces among the highest electricity prices in the nation, well above national, regional and state averages. In 2002, the ISO suggested potential price increases of 15–20% by 2005 unless capacity is significantly increased. Over the past 3 years, electricity prices have risen steadily, even before the sharp upward spiking of natural gas and oil prices in 2005. The attractiveness of the City for businesses, the competitiveness of businesses already located here, and the associated tax base are all impacted.
1
Electricity, unlike many other commodities, cannot be readily stored in large quantitites, so that a balance must be continuously maintained between supply and demand. Failure to maintain this balance will cause a system collapse— power failure or blackout. Price swings cannot be buffered by inventories, although a certain amount of demand-response is possible and can be quite effective.
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Even more impacted are the city’s working and low-income populations, who are burdened with energy costs as a higher percentage of their budgets and have no way to pass along these costs. With energy prices made in a unitary wholesale market and cross-class subsidies out of favor, price spikes at system peak from a concentrated commercial sector are spread across the prices everyone pays. There are, then, political pressures to keep prices moderated, regardless of market conditions. In 2003 and 2004, the ISO implemented summer price caps. The public’s perception of their immediate needs and short-term interests is always part of the regulatory setting [3]. In NYS, the de-regulatory policy had to answer politically to the public. But the problem with ‘political’ pricing is that an incorrect price signal goes to the market. Under-pricing peaks can bring about under-investment in peak capacity, aggravating the original condition.2 Beyond price spikes, marginal capacity has a physical aspect, affecting the system’s voltage stability. NYC’s key banking and financial industry has a digitized infrastructure with missioncritical power reliability and quality requirements. Failures of physical infrastructure to perform as needed can surely threaten a city’s sustainability, in terms of providing a desirable home for business. The above discussion suggests what is not shown by the diagram of load pocket structure, the dynamics of pricing, investment, and capacity expansion that has characterized the market experience and policy considerations since the implementation of electric market de-regulation in New York State in 1999–2000: † Uncertainties in siting, investment and timing of new generation and transmission projects This situation requires a long-term perspective because of the ‘lumpiness’ of power sector investment on the supply and transmission side. ‘Lumpiness’ describes both time and investment. Siting infrastructure is a delicate and highly charged political issue in metropolitan areas and the regulatory review process and political debate drags on for years, even with procedural protocols established by NYS law, Article X for plant siting and Article VII for transmission line siting, established with the intent of providing for public participation while keeping decisions out of the court system. While demand grows fairly steadily in small increments, in response to economic growth, population, and increasing affluence, supply of infrastructure capacity does not. At least not for the traditional kinds of infrastructure development and planning approaches. Fig. 2 shows the effect on system surplus capacity (shown in relation to the system’s reserve margin) of incrementally increasing demand when supply is constant. The reserve margin, considered desirable at 18% of peak load, protects the system’s reliability, but also protects against the exercise of market power on prices, which proved so devastating in California. In a worst-case scenario of no capacity additions, the NYISO projected reserve margin shortfall starting in 2003. While enough resources have been brought on-line to avert an absolute capacity shortfall in NYC3, the principle is demonstrated: a system can move from what seems like robust capacity surplus to marginal shortage in a matter of a few years. 2
This point is discussed at some length by Palast et al. [4]. Capacity shortfall has been avoided by a combination of timely favorable weather, aggressive action by the NY Power Authority in 2002 at the direction of the Governor circumventing public hearing siting procedures, 100 MW made available from the World Trade Center collapse, and, most recently, capacity from re-powering of several existing plants. 3
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M.F. Bobker / Technology in Society 28 (2006) 125–135 Target reserve capacity, 18%
%
year
Fig. 2. Annual capacity net of demand growth, with 0 generating plant addition. Source: NY ISO ‘Power Alert’ 2001.
Since, this is also the timeframe for the development and construction of large plants, delays in the flow of projects can fairly quickly drive a system to criticality. In California, the surplus capacity that encouraged the original discussion of deregulation with guaranteed cost-savings to consumers had vanished by the time the legislative process was complete. 3.1. Projecting capacity requirements Understanding this, the NY independent system operator (ISO) has indicated, starting in 2001, the need by 2005 for 7–8000 MW of added capacity statewide, 3000 of which should be within NYC [4,5]. To put this in perspective, a MW of new, standard utility plant capacity costs approximately $1 million, so the associated capital requirements are, respectively, $8 billion and $3 billion. Unlike its regulatory predecessors, however, the ISO has no authority to actually implement a plan to accomplish this; it only suggests what the market needs to accomplish. This is a flaw and a weakness in market-based mechanisms to which infrastructure planners need to be attuned. Seeing this in 2000, the Governor directed the state-owned New York Power Authority to install, as an emergency measure eleven turbine systems in NYC neighborhoods, each just under 80 MW (thereby exempt from the Article X siting process that includes public hearings), thus providing a safety margin until several re-powering projects come on-line (KeyspanRavenswood, Con Ed-East River, and NYPA-Poletti). More recently, starting in 2003, the City of New York itself realized that it faces a critical infrastructure issue and organized a task force to address it. Their findings are consistent with those of the NYISO, finding a need for just under 3000 MW by 2008, as calculated in Table 1. Table 2 goes further, showing the specific resources in the approval pipeline and Table 3 tallies up what the task force report refers to as ‘distributed resources’ that include efficiency, cogeneration and demand-response. The exercise of developing infrastructure plans in a participatory, stakeholder process is well worth conducting at the municipal level. While this paper emphasizes economic issues, there is a political dimension that equally needs attention.
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Table 1 NYC Electric resource net need (2003–2008) Projected demand
MW
1. Need to meet demand growth 2. Need to assure market stability 3. Need to replace aging power plants Total capacity need Less Projected supply and Distributed resource 4. Power plants under construction 5. Distributed resources (base case) Net capacity need through 2008
665 1000 2115 3780
(875) (300) 2605
Source: NYC Mayor’s Energy Task Force. Table 2 Resource in approval process Power plants certified for construction
MW
Astoria energy Reliant Astoria re-powering (net) Power plants in certification process Sunset energy TransGas Transmission certified for construction PSEG cross Hudson (Bergen) Transmission in certification process Conjunction LLC empire connection Total
1000 562 520 1100 550 2000 5732
Source: NYC Mayor’s Energy Task Force. Table 3 Distributed resource, low–high estimates
Peak load management Energy efficiency Clean on-site generation TOTALS, high–low range
MW
MW
127 300 142 569
127 868 343 1338
Source: NYC Mayor’s Eenergy Task Force.
4. Game theory conundrums Investment in the NY power capacity market has not been forthcoming as smoothly as might once have been expected. Projects across the state approved under Article X have not gone forward into design and construction. The late 1990’s were a troubled time for investment generally, with the Internet-bubble collapse leading a broad stock market decline. Investors are especially wary of the energy sector following the Enron scandal and a continuing wave of difficulties for merchant power producers. In fact, while the constrained NYC load pocket focuses on peak capacity shortage as its driving consideration, the broader merchant power industry appears to have over-built, causing a poor financing picture for new plants for some years to come [6]. This suggests that out-of-city
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electricity would be significantly less expensive than in-city supply were sufficient transmission available, even independent of the fuel considerations that work in the same direction.4 As New York State deregulated it was argued that new entrants would bring cleaner, more efficient technologies into the market to compete with and eventually drive out and replace older, less efficient plants. Despite a spate of combined-cycle gas plants, older coal and heavy oil fired plants have remained in the market, increasing their operating hours and seeking to increase their capacities; this is what the political fight over New Source Review rules is about [7]. This is also the projection for the coal and heavy oil fired generators along the Hudson River Valley that are well positioned to supply the NYC market [8]. Notice that even within the NYC load pocket the supply projects in the queue (see Table 2) are more than double the projected resource need. If all the listed projects were constructed in the 2008 timeframe, there would be a large capacity surplus and prices would collapse, making all the projects uneconomic. This scenario does not even consider the Distributed Resource (see Table 3), which is conservatively assessed.5 Looked at in this way, it may become more understandable why investors are hesitant to move ahead on any given project. Electric sector deregulation requires a new and still largely unrealized market mechanism for raising capital. The interactive decision-making framework of game theory helps us understand the detailed conundrums faced by independent but interacting market participants. Table 4 provides some examples: Table 4 Power investment decision conundrums † An in-city power plant investment cannot price and value its revenue stream without knowing what new transmission lines may be brought into the city † A transmission investment cannot price and value its revenue stream without knowing what power supply will be available within the city † An out-of-city plant investment cannot evaluate its access to the NYC market without knowing transmission logistics † An in-city power plant investment must be able to assure and price its natural gas supply from pipelines † Natural gas pipeline investment, while presently tied up in right-of-way disputes with local communities, cannot be fully evaluated independent of electric transmission plans
The risk-minimizing decision for the investor in these unresolved interactive situations is to do nothing. Under the regulatory system such issues were resolved by planning. Planners and regulators determined which projects would move ahead and assured investor returns. No such assurances exist in deregulated markets.6 How market arrangements will work out the complexities of infrastructure timing remains to be seen. But here enters the interplay of investment and construction lumpiness: with a 3–5 year construction timeframe, investment delays point towards capacity shortages 5–10 years in the future. Looking only at the kind of
4
Air emission rules prohibit coal-burning within NYC and both residual and diesel oils are restricted. The demand-response estimate is limited in the high-case to the presently existing participation in the ISO’s demandresponse programs. The high-end efficiency estimate is little more than 10% of NYC baseload, when energy audits of individual facilities typically find 25–40% electrical reductions cost-effectively available. The on-site power estimate is limited substantially below the 3000 MW of cogeneration opportunity found technically feasible in NYC by a NYSERDA study in 2002. 6 Ashok Gupta of the NRDC has proposed various forms of buying pools with long-term contracts be established as a response to this market issue. Personal communication. 5
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large infrastructure projects for supply and transmission resources, this scenario looks more and more inescapable. Risk-minimizing individual delays flirt with disaster for society as a whole. 4.1. Optimizing the demand side Discussion of adding electrical capacity inevitably turns to the role of ‘distributed resources’. DR can have a broad meaning including efficiency (load reduction), demandresponse (load management), cogeneration, and on-site renewables. These kinds of projects that reduce demand or slow its growth have essentially the same system impact as new capacity, but are individually much smaller and incremental in character than supply-side resources. Richard Goldstein of the Natural Resources Defense Council (NRDC) points out that ‘energy efficiency standards for appliances (are) saving as much energy every year as the entire output of the US nuclear energy program [9].’ In so far as many energy efficiency measures are less expensive than new construction of plant capacity and have lower on-going operating costs, they actually improve the economic performance of the system. It is important to realize however, that the attractive economics of DR are based on their association with an already existing electrical grid. The demand-side activity provides a very cost-effective optimization of the networked infrastructure. The interconnection with an existing network also allows the distributed resource to be optimized for cost-effectiveness. Interconnected, the DR does not have to assume sole responsibility for reliability or for meeting peaks. DR developed in isolation from a grid or as a virgin strategy where no services exist will lose much of its cost-effectiveness. Isolated co-generators must be built to meet short-duration peaks and with redundant capacity to provide full back up for reliability. Isolated photovoltaic systems must incorporate battery banks, a dominant costfactor in such systems. Such decentralized technologies work best in tandem with networked resources, making systems more robust and cost-efficient, rather than providing stand-alone solutions to replace networked infrastructure. Water and waste analyses have followed similar logics and it may be a useful characteristic of networked infrastructures generally. Understanding the connection of DR to the networked infrastructure, the simultaneous beauty and difficulty of demand-side resources can be seen to lie precisely in the institutional structure of efficiency investments, of involving private sector funds at the property and end-user level. The power sector effectively gains new sources of funding, leveraging private facility investment and operating budgets. Because each such project investment is only a small enhancement of overall property revenue and can act as hedge against future energy price increases, they are not subject to the full weight of interactive conundrums facing major infrastructure merchant investors. At the same time, from the utility planner’s perspective the real estate sector’s decision-making is unwieldy, alien, and unreliable. Producing power or ‘negawatt power’ is not the real estate owner’s line of business—can they be relied upon to make timely decisions and then do what is necessary to sustain load avoidance for the next 10 or 20 years? Examining the New York State experience in the early 1990’s as shown in Fig. 3 is instructive. Under regulatory rules and incentives known as integrated resource planning (IRP) the NYS Public Service Commission (NYS PSC) mandated efficiency programs by utilities. Beyond mandating them, they found a way to properly incentivize them [10].
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M.F. Bobker / Technology in Society 28 (2006) 125–135 Cumulative Power Capacity (MW) from Energy Efficiency, 1990-2005 1600 1400 Cumulative MW
1200 1000 800 600 400
Investment, in million $
200 0 1990
1992
1994
1996
1998
2000
2002
2004
year Fig. 3. NYS utility energy efficiency, 1990–2005. Source: NY State energy plan 2002 NYSERDA.
Con Edison became for a time the largest procurer of energy efficiency projects in the region, providing aggressive incentives for many end-user installed technologies. Between 1990 and 1995 more than 1300 MW of capacity (‘negawatts’) were obtained statewide.7 Since deregulation in the mid-1990’s, incentives to mobilize the real estate industry for this kind of investment has been addressed by system benefit fund programs administered by the NYS Energy Research and Development Authority (NYSERDA) on behalf of the NYS PSC.8 As the chart shows, investment has dropped off since, the days of aggressive IRP with a leveling-off of the demand resources obtained. Nevertheless, this history shows that the answer to the question of whether aggregate response can be effectively mobilized on the demand side is probably that ‘yes, it can be’. Although our system planners are not trained in such statistical, probabilistic models out on ‘the other side of the meter’ and would much prefer a few centralized decisions than many, many small incremental ones, faced with expansion challenges in deregulated markets, they may have few choices. Facility with demand-side programs can be an important element in bridging the gaps likely in the timing of merchant-supplied infrastructure. 5. Conclusion It is impossible to visualize New York City or the other capitals of the global economy without fully reliable electricity. Of course, it is equally impossible to visualize without a variety of other infrastructure systems that, failing, would result in loss of business function and 7 Hopefully many of the projects reaching their 10-year life are not actually being retired (and therefore showing up as capacity reductions in the data that account for the curve’s downturn after 2002) but instead are being maintained and sustained by private sector (facility) funding so that the picture may not be quite what this graph suggests. 8 SBC-NYSERDA investment at $150 million per year is just more than half of what utility efficiency investment had been at its 1992–1993 peak.
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habitability. To avoid such failures, those thinking about urban sustainability need to consider the structure and dynamics of investment decision-making. Those responsible for sustaining infrastructure need to consider how investment decisions are made—or, as this paper suggests, possibly not made—in unfamiliar economic frameworks.
References [1] Newman P, Eatwell J, Milgate M, editors. The new palgrave dictionary of economics. Hampshire, UK: Palgrave Macmillan; 2002. [2] Stoft S. Power system economics: designing markets for electricity. 1st ed. Piscataway, NJ: Wiley/IEEE Press; 2002 p. 390–4. [3] Palast G, Oppenhiem J, MacGregor D. Democracy and regulation: how the public can govern essential services. London: Pluto Press; 2003. [4] New York Independent System Operator (NYISO). Power alert: New York’s energy crossroads. New York: NYISO; 2001. [5] New York Independent System Operator (NYISO). Power alert II: New York’s persistent energy crisis. New York: NYISO; 2002. [6] Fisher J. Working off a surplus. Hart’s Energy Mark 2003;8(2). [7] Barcott B. Changing all the rules. New York Times Sunday Magazine 2004. [8] Pace Law School Energy Project. A clean energy strategy for the Hudson River Valley. New York: Presentation of research findings at the Hudson River Foundation; 2004. [9] Goldstein R. On earth. Washington DC: Natural resources Defense Council; 2002. [10] Hirsh R. Power loss: the origins of deregulation and restructuring in the American utility system. Cambridge: MIT Press; 2001.
Michael Bobker is a Certified Energy Manager and holds a Master of Science in Energy Management from New York Institute of Technology as well as graduate degrees in Sociology and Anthropology from Oberlin College and Business Management from New York University. He is a Fellow at the CUNY Institute for Urban Systems. He has worked in the NYC buildings sector for over 25 years in various capacities revolving around energy efficiency technology implementation, policy, and training. He can be contacted at [email protected].
Infrastructure conundrums: Investment and urban sustainability Michael F. Bobker * CUNY Institute for Urban Systems, Association for Energy Affordability, 505 Eighth Avenue, Suite 1801, New York, NY 10018, USA
Abstract This paper examines the case of electrical capacity for New York City as an example of the relationship between infrastructure, investment, and urban sustainability under conditions of de-regulation. The electrical system is one example of network infrastructures, traditionally regulated or state-owned, that have been subject to recent trends towards de-regulation and privatization. Power system deregulation introduces new investment market dynamics into the development of electrical resources. A game theoretic perspective provides an explanatory model for observed behavior in the New York metropolitan area power market, suggesting that large project development is constrained by uncertainties about other, competing projects and that, as a result, investment decisions may not occur in necessary timeframes to avoid severe capacity shortfalls. Such infrastructure shortfalls can greatly impact the sustainability of a city that competes in regional and global markets. The potential of smaller, demand-side investments is noted for avoiding the investment-decision uncertainties of large supply-side projects; however, the cost-effectiveness of such projects depends on their connection to an established network infrastructure. Reduced ability to control power plant investment in a deregulated market makes the mobilization of demand-side resources a more critical part of market performance in sustaining services over time. q 2005 Elsevier Ltd. All rights reserved. Keywords: Electrical capacity planning; Infrastructure investment; Power markets; Urban sustainability; Deregulation
1. Introduction Cities exist because they have roles to play in their regional or global economies. History shows us that there is almost always competition between cities for primacy in these roles. Failure to be able to support a city’s mission can cause its decline. Sustainability of cities, then, * Corresponding author. Tel.: C1 212 279 3902; fax: C1 212 279 5306. E-mail address: [email protected].
0160-791X/$ - see front matter q 2005 Elsevier Ltd. All rights reserved. doi:10.1016/j.techsoc.2005.10.003
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is based importantly on providing key critical services that make possible the fulfillment of the city’s economic purpose. To a substantial degree, these services are based on the availability and maintenance of networked infrastructures, examples of which include energy (fuels and electricity), communications, water, sewer, and transportation. Networked infrastructures determine the quality of life in cities. Water supply and waste management are prime examples of the necessity of infrastructure for public health. In other respects infrastructure underlies the mission and role of a city in its regional or global economy. More than being simply population aggregations, cities are fundamentally economic entities, with evolving functionalities. For the example in this paper, New York City originally a center of trade, immigration, and light industry dependent on its port, has evolved into a center of global finance dependent upon its electronic telecommunication and, underlying that, electrical infrastructures. Failure of these infrastructures would cause a loss in global competitiveness threatening economic failure that could make the present city unsustainable. Another key aspect of networked infrastructures is that they generally exhibit properties of ‘natural monopolies’ in which it is considered economically inefficient to develop multiple, privately-owned and competitive systems. This is the theoretical basis for infrastructure industries developing and operating under regulation or state-ownership although over the past two decades ideology and technology have combined to reverse this pattern. Infrastructure costs money to build and to maintain and therefore investment is another key element of urban sustainability. The way regulatory (or deregulatory) changes affect the pattern of investment decisions is, as yet, only dimly understood.
2. Network infrastructure capacity development, free markets and game theory Under regulated (or state-owned) regimes utilities have the obligation to serve their monopoly service area. This obligation includes planning and building the necessary capacity to assure reliable service. In exchange for this obligation, the utility receives a guaranteed return on its invested capital; the regulator sets rates as necessary to assure this. The utility establishes its load (demand) projections and a plan to meet it, subject to the regulator’s review and approval. Once approved, the utility is able to go to the financial markets with a secure proposition. Deregulation (or privatization) completely changes this development process. No longer is there a single organization responsible for assuring infrastructure capacity (e.g., adequate supply of electricity). Instead, market demand is supposed to elicit the free and timely entrance of new capacity. In New York State’s electrical deregulation process, extensive collaborative proceedings considered and developed the workings of daily markets, creating institutions (the NY Independent System Operator, NYISO, in particular) and specific mechanisms, rules and procedures for market participants. Much less was established concerning the longer-term investment dynamics of merchant generation and transmission. The operation of free markets is idealized in introductory economics textbooks and in the minds of politicians. Deregulation may make market entrance possible where it was not before possible, but it is never ‘free’. A generating plant or transmission line or other infrastructure component is certainly not free—it is an expensive proposition that requires the faith and backing from investors who participate in financial markets. There are procedural rules for siting new plants and transmission that, at least in the USA, require rounds of public hearings and comment and there are a host of permits to be obtained. Observers have changed the term deregulation to re-regulation to capture the maze of new rules that apply. Observers of
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privatization-in-action have seen the need to call for government regulation of the new operating entities. Economic textbooks also tend to simplify the process of new supply responding to demand. In the real world, it is a process of investment decisions made by market players. Each of these market players looks not only at market demand but also at other suppliers. Especially where there are only a few suppliers as in oligopolistic situations as is typical of large infrastructure projects, decision-making is importantly based on other players’ moves. These kinds of situations are best analyzed in a framework known as Game Theory, sometimes called interactive decision theory, a discipline that concerns the behavior of decision makers (players) whose decisions affect each other [1]. Without developing the kind of mathematical analysis typical of Game Theory, we can gain a valuable insight through understanding that market players’ decisions will be based on their evaluation and expectations of other market players’ actions. Situations such as the classic ‘Prisoner’s Dilemma’ pose conditions in which each player’s most desirable outcome is placed at risk by the other player’s strategy. A less desirable choice may be made to reduce risk. The total payoff for all players (society) is less than what might have been realized but is more secure and predictable. Another field of economics, operations research, has come to similar conclusions: that decision-making behavior often seeks a ‘satisfying’ solution that is less than optimal but minimizes risk. A game theoretic framework to the privatization of network utilities is elaborated and applied to recent cases by David Newberry in his Walras-Pareto Lectures published as Privatization, Restructuring and Regulation of Network Utilities, MIT Press 2001. The following section presents a recent history of New York City electrical supply, since deregulation was introduced in New York State starting in the mid-1990’s, as a case illustrative of infrastructure investment dynamics.
3. Infrastructure dynamics: The New York City electrical load pocket The recent history of New York City’s electrical capacity shows a pattern that may be indicative of many urban infrastructure situations as their planning and growth are increasingly put into market environments. A structure of incremental, steady demand growth with lumpy, long time-horizon resource supply is difficult enough to plan for; we will see that introducing oligopolistic market forces adds a significant additional level of uncertainty. Even though the NYC case takes place in one of the most advanced economic settings, the structure of forces carries lessons for other contexts. Electrical load pocket status is characteristic of most urban areas, consisting of a situation in which the city’s load exceeds, at least for some of the time, the transmission capacity. For economic analysis, this situation is treated as a case of ‘congestion pricing’ in which a market balance must be struck between the combination of remote generating resources with transmission and in-city generating resources [2]. The remote resources are assumed to be less expensive, justifying the payment for transmission rights when they are available. The situation, shown graphically in Fig. 1, between New York City and the broader New York State distribution system, is characterized by † Constrained transmission into the city, less than the city’s peak requirement, creating a ‘load pocket’. The City’s baseload of 7000 MW also exceeds the transmission capacity.
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M.F. Bobker / Technology in Society 28 (2006) 125–135 NYS Peak Load, 2002: 30,910 MW 18%reserve: 5,564MW
Existing Transmission into NYC: 5,000MW
NYC Peak load (2001): 10,665MW 18% reserve: 1,920MW In-City Generation: 8,000MW
Fig. 1. NYC load pocket: peak load and capacities. Source: author compilation.
The transmission capacity consists of just two separate high capacity lines. Despite much discussion of additional transmission, actual progress has been limited. The regulatory situation has been cloudy at the federal level for the past several years. The most advanced transmission project in the region, a line from Connecticut to Long Island crossing beneath the Long Island Sound, is fully constructed but has been delayed for over a year in the courts from being put into service; while part of the NYC metropolitan area, Long Island is not part of the city proper and is not reflected in the load balance described. As a result of the imbalance between in-city demand and transmission capacity, sufficient incity resources must be maintained. This was understood and planned for under the regulatory regime. The physical need is no less with de-regulation but a new, market-based mechanism has been required. The need for in-city capacity is the basis of an ‘installed capacity market’ mandated by the NY independent system operator (ISO), requiring that all retailers purchase contracts for in-city installed capacity equal to 80% of their purchased capacity. This capacity market is separate from the daily market for the capacity of commodity (e.g. actual kilowatt hours moved through the system) and the capacity payments are made to generators whether or not their equipment is needed and put into use. † Summer peak demand approaching the margin of present supply capacity Since electricity prices are a function of real-time electricity availability1, especially under deregulation, this situation is most significant for a city that already faces among the highest electricity prices in the nation, well above national, regional and state averages. In 2002, the ISO suggested potential price increases of 15–20% by 2005 unless capacity is significantly increased. Over the past 3 years, electricity prices have risen steadily, even before the sharp upward spiking of natural gas and oil prices in 2005. The attractiveness of the City for businesses, the competitiveness of businesses already located here, and the associated tax base are all impacted.
1
Electricity, unlike many other commodities, cannot be readily stored in large quantitites, so that a balance must be continuously maintained between supply and demand. Failure to maintain this balance will cause a system collapse— power failure or blackout. Price swings cannot be buffered by inventories, although a certain amount of demand-response is possible and can be quite effective.
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Even more impacted are the city’s working and low-income populations, who are burdened with energy costs as a higher percentage of their budgets and have no way to pass along these costs. With energy prices made in a unitary wholesale market and cross-class subsidies out of favor, price spikes at system peak from a concentrated commercial sector are spread across the prices everyone pays. There are, then, political pressures to keep prices moderated, regardless of market conditions. In 2003 and 2004, the ISO implemented summer price caps. The public’s perception of their immediate needs and short-term interests is always part of the regulatory setting [3]. In NYS, the de-regulatory policy had to answer politically to the public. But the problem with ‘political’ pricing is that an incorrect price signal goes to the market. Under-pricing peaks can bring about under-investment in peak capacity, aggravating the original condition.2 Beyond price spikes, marginal capacity has a physical aspect, affecting the system’s voltage stability. NYC’s key banking and financial industry has a digitized infrastructure with missioncritical power reliability and quality requirements. Failures of physical infrastructure to perform as needed can surely threaten a city’s sustainability, in terms of providing a desirable home for business. The above discussion suggests what is not shown by the diagram of load pocket structure, the dynamics of pricing, investment, and capacity expansion that has characterized the market experience and policy considerations since the implementation of electric market de-regulation in New York State in 1999–2000: † Uncertainties in siting, investment and timing of new generation and transmission projects This situation requires a long-term perspective because of the ‘lumpiness’ of power sector investment on the supply and transmission side. ‘Lumpiness’ describes both time and investment. Siting infrastructure is a delicate and highly charged political issue in metropolitan areas and the regulatory review process and political debate drags on for years, even with procedural protocols established by NYS law, Article X for plant siting and Article VII for transmission line siting, established with the intent of providing for public participation while keeping decisions out of the court system. While demand grows fairly steadily in small increments, in response to economic growth, population, and increasing affluence, supply of infrastructure capacity does not. At least not for the traditional kinds of infrastructure development and planning approaches. Fig. 2 shows the effect on system surplus capacity (shown in relation to the system’s reserve margin) of incrementally increasing demand when supply is constant. The reserve margin, considered desirable at 18% of peak load, protects the system’s reliability, but also protects against the exercise of market power on prices, which proved so devastating in California. In a worst-case scenario of no capacity additions, the NYISO projected reserve margin shortfall starting in 2003. While enough resources have been brought on-line to avert an absolute capacity shortfall in NYC3, the principle is demonstrated: a system can move from what seems like robust capacity surplus to marginal shortage in a matter of a few years. 2
This point is discussed at some length by Palast et al. [4]. Capacity shortfall has been avoided by a combination of timely favorable weather, aggressive action by the NY Power Authority in 2002 at the direction of the Governor circumventing public hearing siting procedures, 100 MW made available from the World Trade Center collapse, and, most recently, capacity from re-powering of several existing plants. 3
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M.F. Bobker / Technology in Society 28 (2006) 125–135 Target reserve capacity, 18%
%
year
Fig. 2. Annual capacity net of demand growth, with 0 generating plant addition. Source: NY ISO ‘Power Alert’ 2001.
Since, this is also the timeframe for the development and construction of large plants, delays in the flow of projects can fairly quickly drive a system to criticality. In California, the surplus capacity that encouraged the original discussion of deregulation with guaranteed cost-savings to consumers had vanished by the time the legislative process was complete. 3.1. Projecting capacity requirements Understanding this, the NY independent system operator (ISO) has indicated, starting in 2001, the need by 2005 for 7–8000 MW of added capacity statewide, 3000 of which should be within NYC [4,5]. To put this in perspective, a MW of new, standard utility plant capacity costs approximately $1 million, so the associated capital requirements are, respectively, $8 billion and $3 billion. Unlike its regulatory predecessors, however, the ISO has no authority to actually implement a plan to accomplish this; it only suggests what the market needs to accomplish. This is a flaw and a weakness in market-based mechanisms to which infrastructure planners need to be attuned. Seeing this in 2000, the Governor directed the state-owned New York Power Authority to install, as an emergency measure eleven turbine systems in NYC neighborhoods, each just under 80 MW (thereby exempt from the Article X siting process that includes public hearings), thus providing a safety margin until several re-powering projects come on-line (KeyspanRavenswood, Con Ed-East River, and NYPA-Poletti). More recently, starting in 2003, the City of New York itself realized that it faces a critical infrastructure issue and organized a task force to address it. Their findings are consistent with those of the NYISO, finding a need for just under 3000 MW by 2008, as calculated in Table 1. Table 2 goes further, showing the specific resources in the approval pipeline and Table 3 tallies up what the task force report refers to as ‘distributed resources’ that include efficiency, cogeneration and demand-response. The exercise of developing infrastructure plans in a participatory, stakeholder process is well worth conducting at the municipal level. While this paper emphasizes economic issues, there is a political dimension that equally needs attention.
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Table 1 NYC Electric resource net need (2003–2008) Projected demand
MW
1. Need to meet demand growth 2. Need to assure market stability 3. Need to replace aging power plants Total capacity need Less Projected supply and Distributed resource 4. Power plants under construction 5. Distributed resources (base case) Net capacity need through 2008
665 1000 2115 3780
(875) (300) 2605
Source: NYC Mayor’s Energy Task Force. Table 2 Resource in approval process Power plants certified for construction
MW
Astoria energy Reliant Astoria re-powering (net) Power plants in certification process Sunset energy TransGas Transmission certified for construction PSEG cross Hudson (Bergen) Transmission in certification process Conjunction LLC empire connection Total
1000 562 520 1100 550 2000 5732
Source: NYC Mayor’s Energy Task Force. Table 3 Distributed resource, low–high estimates
Peak load management Energy efficiency Clean on-site generation TOTALS, high–low range
MW
MW
127 300 142 569
127 868 343 1338
Source: NYC Mayor’s Eenergy Task Force.
4. Game theory conundrums Investment in the NY power capacity market has not been forthcoming as smoothly as might once have been expected. Projects across the state approved under Article X have not gone forward into design and construction. The late 1990’s were a troubled time for investment generally, with the Internet-bubble collapse leading a broad stock market decline. Investors are especially wary of the energy sector following the Enron scandal and a continuing wave of difficulties for merchant power producers. In fact, while the constrained NYC load pocket focuses on peak capacity shortage as its driving consideration, the broader merchant power industry appears to have over-built, causing a poor financing picture for new plants for some years to come [6]. This suggests that out-of-city
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electricity would be significantly less expensive than in-city supply were sufficient transmission available, even independent of the fuel considerations that work in the same direction.4 As New York State deregulated it was argued that new entrants would bring cleaner, more efficient technologies into the market to compete with and eventually drive out and replace older, less efficient plants. Despite a spate of combined-cycle gas plants, older coal and heavy oil fired plants have remained in the market, increasing their operating hours and seeking to increase their capacities; this is what the political fight over New Source Review rules is about [7]. This is also the projection for the coal and heavy oil fired generators along the Hudson River Valley that are well positioned to supply the NYC market [8]. Notice that even within the NYC load pocket the supply projects in the queue (see Table 2) are more than double the projected resource need. If all the listed projects were constructed in the 2008 timeframe, there would be a large capacity surplus and prices would collapse, making all the projects uneconomic. This scenario does not even consider the Distributed Resource (see Table 3), which is conservatively assessed.5 Looked at in this way, it may become more understandable why investors are hesitant to move ahead on any given project. Electric sector deregulation requires a new and still largely unrealized market mechanism for raising capital. The interactive decision-making framework of game theory helps us understand the detailed conundrums faced by independent but interacting market participants. Table 4 provides some examples: Table 4 Power investment decision conundrums † An in-city power plant investment cannot price and value its revenue stream without knowing what new transmission lines may be brought into the city † A transmission investment cannot price and value its revenue stream without knowing what power supply will be available within the city † An out-of-city plant investment cannot evaluate its access to the NYC market without knowing transmission logistics † An in-city power plant investment must be able to assure and price its natural gas supply from pipelines † Natural gas pipeline investment, while presently tied up in right-of-way disputes with local communities, cannot be fully evaluated independent of electric transmission plans
The risk-minimizing decision for the investor in these unresolved interactive situations is to do nothing. Under the regulatory system such issues were resolved by planning. Planners and regulators determined which projects would move ahead and assured investor returns. No such assurances exist in deregulated markets.6 How market arrangements will work out the complexities of infrastructure timing remains to be seen. But here enters the interplay of investment and construction lumpiness: with a 3–5 year construction timeframe, investment delays point towards capacity shortages 5–10 years in the future. Looking only at the kind of
4
Air emission rules prohibit coal-burning within NYC and both residual and diesel oils are restricted. The demand-response estimate is limited in the high-case to the presently existing participation in the ISO’s demandresponse programs. The high-end efficiency estimate is little more than 10% of NYC baseload, when energy audits of individual facilities typically find 25–40% electrical reductions cost-effectively available. The on-site power estimate is limited substantially below the 3000 MW of cogeneration opportunity found technically feasible in NYC by a NYSERDA study in 2002. 6 Ashok Gupta of the NRDC has proposed various forms of buying pools with long-term contracts be established as a response to this market issue. Personal communication. 5
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large infrastructure projects for supply and transmission resources, this scenario looks more and more inescapable. Risk-minimizing individual delays flirt with disaster for society as a whole. 4.1. Optimizing the demand side Discussion of adding electrical capacity inevitably turns to the role of ‘distributed resources’. DR can have a broad meaning including efficiency (load reduction), demandresponse (load management), cogeneration, and on-site renewables. These kinds of projects that reduce demand or slow its growth have essentially the same system impact as new capacity, but are individually much smaller and incremental in character than supply-side resources. Richard Goldstein of the Natural Resources Defense Council (NRDC) points out that ‘energy efficiency standards for appliances (are) saving as much energy every year as the entire output of the US nuclear energy program [9].’ In so far as many energy efficiency measures are less expensive than new construction of plant capacity and have lower on-going operating costs, they actually improve the economic performance of the system. It is important to realize however, that the attractive economics of DR are based on their association with an already existing electrical grid. The demand-side activity provides a very cost-effective optimization of the networked infrastructure. The interconnection with an existing network also allows the distributed resource to be optimized for cost-effectiveness. Interconnected, the DR does not have to assume sole responsibility for reliability or for meeting peaks. DR developed in isolation from a grid or as a virgin strategy where no services exist will lose much of its cost-effectiveness. Isolated co-generators must be built to meet short-duration peaks and with redundant capacity to provide full back up for reliability. Isolated photovoltaic systems must incorporate battery banks, a dominant costfactor in such systems. Such decentralized technologies work best in tandem with networked resources, making systems more robust and cost-efficient, rather than providing stand-alone solutions to replace networked infrastructure. Water and waste analyses have followed similar logics and it may be a useful characteristic of networked infrastructures generally. Understanding the connection of DR to the networked infrastructure, the simultaneous beauty and difficulty of demand-side resources can be seen to lie precisely in the institutional structure of efficiency investments, of involving private sector funds at the property and end-user level. The power sector effectively gains new sources of funding, leveraging private facility investment and operating budgets. Because each such project investment is only a small enhancement of overall property revenue and can act as hedge against future energy price increases, they are not subject to the full weight of interactive conundrums facing major infrastructure merchant investors. At the same time, from the utility planner’s perspective the real estate sector’s decision-making is unwieldy, alien, and unreliable. Producing power or ‘negawatt power’ is not the real estate owner’s line of business—can they be relied upon to make timely decisions and then do what is necessary to sustain load avoidance for the next 10 or 20 years? Examining the New York State experience in the early 1990’s as shown in Fig. 3 is instructive. Under regulatory rules and incentives known as integrated resource planning (IRP) the NYS Public Service Commission (NYS PSC) mandated efficiency programs by utilities. Beyond mandating them, they found a way to properly incentivize them [10].
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M.F. Bobker / Technology in Society 28 (2006) 125–135 Cumulative Power Capacity (MW) from Energy Efficiency, 1990-2005 1600 1400 Cumulative MW
1200 1000 800 600 400
Investment, in million $
200 0 1990
1992
1994
1996
1998
2000
2002
2004
year Fig. 3. NYS utility energy efficiency, 1990–2005. Source: NY State energy plan 2002 NYSERDA.
Con Edison became for a time the largest procurer of energy efficiency projects in the region, providing aggressive incentives for many end-user installed technologies. Between 1990 and 1995 more than 1300 MW of capacity (‘negawatts’) were obtained statewide.7 Since deregulation in the mid-1990’s, incentives to mobilize the real estate industry for this kind of investment has been addressed by system benefit fund programs administered by the NYS Energy Research and Development Authority (NYSERDA) on behalf of the NYS PSC.8 As the chart shows, investment has dropped off since, the days of aggressive IRP with a leveling-off of the demand resources obtained. Nevertheless, this history shows that the answer to the question of whether aggregate response can be effectively mobilized on the demand side is probably that ‘yes, it can be’. Although our system planners are not trained in such statistical, probabilistic models out on ‘the other side of the meter’ and would much prefer a few centralized decisions than many, many small incremental ones, faced with expansion challenges in deregulated markets, they may have few choices. Facility with demand-side programs can be an important element in bridging the gaps likely in the timing of merchant-supplied infrastructure. 5. Conclusion It is impossible to visualize New York City or the other capitals of the global economy without fully reliable electricity. Of course, it is equally impossible to visualize without a variety of other infrastructure systems that, failing, would result in loss of business function and 7 Hopefully many of the projects reaching their 10-year life are not actually being retired (and therefore showing up as capacity reductions in the data that account for the curve’s downturn after 2002) but instead are being maintained and sustained by private sector (facility) funding so that the picture may not be quite what this graph suggests. 8 SBC-NYSERDA investment at $150 million per year is just more than half of what utility efficiency investment had been at its 1992–1993 peak.
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habitability. To avoid such failures, those thinking about urban sustainability need to consider the structure and dynamics of investment decision-making. Those responsible for sustaining infrastructure need to consider how investment decisions are made—or, as this paper suggests, possibly not made—in unfamiliar economic frameworks.
References [1] Newman P, Eatwell J, Milgate M, editors. The new palgrave dictionary of economics. Hampshire, UK: Palgrave Macmillan; 2002. [2] Stoft S. Power system economics: designing markets for electricity. 1st ed. Piscataway, NJ: Wiley/IEEE Press; 2002 p. 390–4. [3] Palast G, Oppenhiem J, MacGregor D. Democracy and regulation: how the public can govern essential services. London: Pluto Press; 2003. [4] New York Independent System Operator (NYISO). Power alert: New York’s energy crossroads. New York: NYISO; 2001. [5] New York Independent System Operator (NYISO). Power alert II: New York’s persistent energy crisis. New York: NYISO; 2002. [6] Fisher J. Working off a surplus. Hart’s Energy Mark 2003;8(2). [7] Barcott B. Changing all the rules. New York Times Sunday Magazine 2004. [8] Pace Law School Energy Project. A clean energy strategy for the Hudson River Valley. New York: Presentation of research findings at the Hudson River Foundation; 2004. [9] Goldstein R. On earth. Washington DC: Natural resources Defense Council; 2002. [10] Hirsh R. Power loss: the origins of deregulation and restructuring in the American utility system. Cambridge: MIT Press; 2001.
Michael Bobker is a Certified Energy Manager and holds a Master of Science in Energy Management from New York Institute of Technology as well as graduate degrees in Sociology and Anthropology from Oberlin College and Business Management from New York University. He is a Fellow at the CUNY Institute for Urban Systems. He has worked in the NYC buildings sector for over 25 years in various capacities revolving around energy efficiency technology implementation, policy, and training. He can be contacted at [email protected].