Power and utility ESG lessons from CaliforniaSeptember 15, 2020By John MillerVP and ESG Senior Research Analyst, Calvert Research and ManagementWashington - Searing, sustained triple-digit temperatures across the West and Southwest forced the operators of California's largest grid system to administer rolling outages on August 14 and then again on August 15. Affecting more than two million customers on a nonsimultaneous basis, the blackouts were California's first nonwildfire-related disconnections since the Enron debacle of 2001.1 What lessons can ESG investors learn from the forced blackouts in California? In short, many. Namely, that the development of renewable energy capacity needs to grow at a faster pace, that the benefits of efficiency and demand-side resources is only just being tapped, and that the physical risks of climate change across the West demand a regional - or national - response. When combined, these takeaways highlight that climate change-related investment risk for California utilities remains large, but opportunities remain for ESG-oriented investment in renewable generation, energy storage, energy efficiency and regional transmissions development.More renewable capacityForced outages at gas-fired generators during peak ramp period on both August 14 and 15 precipitated the rolling outages. Extreme heat consistently reduces the efficiency of fossil-powered thermal generation and routinely leads to generator "trips" as equipment moves above safe operating temperatures. One way to meet this demand shape is to build additional thermal generation with the capability to quickly turn off and on, or to call on resources from outside the state that may have spare capacity to provide. This is the system California has relied upon to date. In analyzing investment flows and nuanced resource adequacy filings, we do not believe it is the system California will retain in the future. Rather, certainty of delivery will replace short-term pricing as the key market clearing mechanism. In this construct, the pace of renewable generation will accelerate, pared increasingly with a range of short- and long-term storage solutions, including battery, mechanical energy and even hydrogen. We believe renewable generation and storage solutions are the growth areas for future investment, not additional thermal resources.Energy efficiency and demand-side managementDemand for power in CAISO peaked on August 14 just above 46,500MW. Despite the day's oppressive heat, this total is nearly 7% (3,500MW) below the systems all-time peak of 50,270MW. In the 14-year period between 2006 and 2020, California's population has grown by more than 3.5 million people while its annual GDP has increased by more the $700 billion. Why then hasn't the demand for power grown along a similar trajectory?The answer is energy efficiency and demand-side management. On August 14 and 15, CAISO deployed "demand response," or resources who are paid to reduce consumption on call. While valuable in extreme scenarios, demand response plays a secondary role to the more gradual - and more impactful - rollout of energy efficiency. From improved appliances, lightbulbs, screens and monitors in the home, to commercial and industrial scale heating and cooling, the incremental deployment of energy efficiency has had a major effect on peak energy demand. Much like in the renewable and storage space, energy efficiency is only getting started as a further growth area for investment.Physical risks of climate change call for regional responseThe sustained heat weave reported in mid-August across much of the West is not an isolated event. Rather, it is a symptom of the emergence of an observable "mega drought."2 This drought will fundamentally challenge the environmental, economic and sustainability balance of the region for years to come.For any response to be successful, it must be regional and/or national. The regional power system is at an inflection point. Expanded transmission interconnections, deeper sharing and optimization of generation assets, and the expansion of the regional footprint into the Pacific Ocean through floating offshore wind offer solutions to mitigate these risks. A more flexible, reliable and low-carbon power system is possible.Bottom line: Climate change-related investment risk in California is high, particularly in electric utilities. However, sustained demand for renewable generation, energy storage, energy efficiency and regional transmissions development represent growth areas for ESG-oriented investment.