Distributed Energy Systems: More Interconnections Coming

| About: Distributed Energy (DESC-OLD)

alternative energy investing logoFrom James LoGerfo, Michael Riedinger and Joe Berwind (Alternative Energy Investing) In August 2005 a set of new interconnection rules went into effect. These rule changes are beginning to take hold a little more than a year later. In May of 2005 the FERC issued its new Rule 2006 (effective August 2005), defining, streamlining and standardizing small generator interconnection standards of the sort Distributed Energy Systems Corp. (DESC-OLD) just announced as the “first of its kind” in New York City.

Northern Power, NYSERDA (the New York State Energy Research and Development Authority) and Equity Office Properties announced the completion of a new $4.1 million, 1.6-megawatt combined heat and power [CHP] system at 717 Fifth Avenue in Midtown Manhattan. The system, “the first of its kind,” is a medium-scale combined heat and power [CHP] project synchronously interconnected to the grid.

The company also announced an event to be held in the lobby of 717 Fifth Avenue on October 12, 2006 from 11:00 a.m. to 12:30 p.m. Eastern which we understand will be attended by investors and the Governor of New York. As subscribers know, AEI will be hosing the CEO and management team of Northern Power to an investor luncheon following the company’s event.

In the press release the company describes the system as operating in parallel with the utility's grid during peak and mid-peak hours, and provides nearly two-thirds of the building's peak summer demand. This is a significant development not only for the company but also for Consolidated Edison and portends of greater cooperation between these two companies. We see new interconnect rules established last year and the need to address critical power failures in the grid intersecting excellent distributed energy project returns as the driving force behind greater cooperation between DESC and ConEd.

The press release also noted that although the 717 Fifth Avenue project is primarily one designed to increase the building's energy efficiency, the project also can perform as a “back-up system to keep the building operational during an extended power outage, such as the one experienced by office workers during the August 2003 blackout.” Power reliability and power quality are two of the hottest areas for growth in energy-technology.

Before the new interconnection rules, distributed generation projects like the one completed today at 717 Fifth Avenue were often delayed and charged a premium because of utility company roadblocks. These delays and unnecessary charges (additional and unnecessary safety equipment, fees, insurance requirements, etc) often lead to unreliable project cost estimates and sub-optimal returns. This has changed with today’s projects free from these encumbrances and project returns between 15%-20% or more. This new rule utility companies are now living under is Rule 2006 which changed all that.

Rule 2006 reduces operating risks for projects and has resulted in a vast number of new distributed generation projects on the drawing board. Promulgation of Rule 2006 has reduced project construction risk and consequently boosted average returns.

Rule 2006 is applied to distributed generation companies in three categories; small, medium and large. At the low end come generators of 10 kW or less, which typically use inverters (i.e., with small wind and solar PV systems). Because they are smaller and inverter-controlled, these receive a special expedited treatment. They will only incur a nominal fee and get almost rubber stamped approval without lengthy evaluation, assuming they are pre-certified. Second, distributed generation that output less than 2 MW can enjoy “Fast-Track” processing. This is a big deal for projects in the range of Distributed energy’s 717 Fifth AvenueCHP interconnect (1.6 MW). And, in a third category, distributed generation from 2 MW to 20 MW will undergo a consistent and affordable process.

DESC plays in the two larger categories and will benefit from rule changes as the FERC takes actions in the market to strengthen enforcement. That said, this has led to a boom in distributed generation projects on design boards across the country and an insufficiently skilled infrastructure to build them. Indeed, as experienced electricians in distributed generation are taken off maintenance and operations detail and put to work in new project development, DESC will have even greater opportunities for their outsourced M&O business (carrying the highest margins).

FERC Rule 2006 is a significant underlying catalyst for DESC shares. The company is reporting an exceedingly large pipeline of projects out for bid or actively in the design stage. The company has multiple opportunities to take advantage of this growth. We expect to hear more about it Thursday at the AEI luncheon with company executives. That said, the risk of project over-runs is falling with Rule 2006 and as natural gas prices are once again stable, Distributed energy’s docket of projects in the marketplace is beginning to grow. We think conversion rates are going to pick-up and new contract announcements will move the stock higher. We think Distributed Energy Systems could partner with large utilities to bring projects to market in the areas of greatest need particularly in the North East and California. DESC remains a recommended list stock with increasingly improving fundamentals, cash and top-notch management and good accounting practices.

DESC 1-yr chart:


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