RealEnergy emerged in 2001 introducing small cogen systems to the commercial property industry.
Founded in 1999 by Dan Cashdan and four partners, including two with energy-industry backgrounds, RealEnergy eventually attracted $75 million in venture capital. But it was all gone by 2004 when one of the partners, Kevin Best, bought the name and intellectual assets. The 13 MW of physical assets the company had built and installed were sold to DG Energy Solutions of San Diego, CA.
What happened? According to a 2001 Wall Street Reporter story, Chairman and CEO Cashdan was confident that the company's "knowledge base, because we are technology agnostic, will be the best real source of information. It's a dirty sweaty business with screwdrivers and wrenches and hooking things up. If we can't do it, none of these other engine companies are likely to have much success."
Unfortunately, it was a basic misunderstanding of the "dirty sweaty business" combined with poor engineering and maintenance decisions that undid the company, according to interviews with most of the partners and others in the industry. And at least one distributed generation (DG) company owner said RealEnergy's failure has had devastating impacts on the industry, leaving venture capitalists and potential clients distrustful of the distributed generation technologies and companies still in the business.
As Steve Mueller, president of DG Energy Solutions, says, RealEnergy "did things that defied gravity ... It raised $75 million and the money's gone; we raised $40 million and have 71 megawatts in the ground."
Cashdan admits to the loss. "By the time we were done with it, we went through $80 million." he says. The experience has left him angry. "The real estate community proved very receptive to trying these technologies," he reflects, referring to the gas-fired internal combustion engines and microturbine systems RealEnergy installed. But in his opinion the company failed for three reasons endemic to the industry, and not with RealEnergy's performance, which others dispute.
The technologies RealEnergy used—primarily Hess Microgen and Waukesha engines along with two Capstone turbines—in Cashdan's opinion never lived up to expectations. He thinks these problems are at the heart of an industry that has never worked. "I thought the cogeneration business would be different," he says. The company's ability to build and deliver energy according to its promises to the underwriters was off by 50%, equivalent to a bond promising a 10% return but delivering 5%, notes Cashdan.
The second reason Cashdan cites for the company's failure was the rising cost of natural gas, which RealEnergy failed to predict, coupled with engineering and construction problems that did not allow the projects to operate at the specified thermal efficiencies, which at times were as much as 80% off. This equation caused the overall cost of power to be noncompetitive with utility power. "It is cheaper as we sit here today to buy power from the grid," Cashdan argues. To add insult to injury, utility demand charges for one 15-minute period could wipe out half a month's revenues. "As a result, the cost of running the system can be more than its revenues," he adds.
The third reason for the sorry state of the industry, Cashdan believes, is ultimately the lack of political will at the federal level to make distributed generation successful. "The government does not have time to look at a half-cent industry compared to a vastly larger utility industry," he says.
In the end, Cashdan reflects, GFI Energy Ventures, the lead venture capital company that first invested $50 million in RealEnergy, could not have been a more patient and professional partner, as were all the people who put money into the company. Arden Realty, the Los Angeles–based office building owner with 142 properties, was a tremendous client and very patient. "We thought having the client and the money would make it work," says Cashdan.
RealEnergy's business model was to produce onsite electric and thermal energy that it then sold into its clients' buildings. Systems ranged in size from 200 kW to 1 MW. It leased space from the client in the building where the generation system was installed. The system was sized to produce about 50% of the building's peak load and to displace peak demand that would otherwise place stress on an already constrained grid system. The systems were run, in most cases, 12 hours a day, Monday through Friday, most Saturdays, and on occasion on Sundays.
In his 2001 interview with Wall Street Reporter, Cashdan emphasized that the demand was enormous, but that there were no players in the distributed cogeneration market that owned anything that approximated 100 MW. (That is not true today; at the time of this writing DG Energy Solutions said it would have almost 100 MW by the end of 2004.) Cashdan was being realistic keeping the company's goal simple: At the time it had 20 systems in various stages of construction. Apparently, it was a real struggle getting those constructed and operating, because it never got beyond 18 operating systems—32 discretely interconnected plants—that in 2004 were sold to DG Energy Solutions.
RealEnergy Reborn
Kevin Best, RealEnergy's current CEO and one of the founders—and director of sales and marketing in 2001—picks up the technology story. He agrees that many of the plants RealEnergy installed had difficulty holding to standards. It chose to buy Hess Microgen engine packages because of the backing of the parent company, Amerada Hess, a highly regarded East Coast petroleum company, which moved into manufacturing. The company trusted the name, Best says, but ultimately it trusted the experts.
Best still supports the Hess Microgen packaged system. The company purchased about 75 engines at $200,000 each because of the high level of confidence it had in the manufacturing process. The company is now evaluating Ingersoll-Rand's 250-kW microturbine for future applications because of its ability to meet emissions regulations.
Best says the company is now requiring that equipment suppliers meet performance standards through branding mechanisms and that they perform rigorous testing. Engine service hours must be realistic or the suppliers will pay significant penalties. Emissions standards, which have become much more stringent in recent years, are the biggest bugaboo, Best notes, because the older equipment has had to adapt to much higher standards.
Gas prices escalated from $3.50/MMBtu to $6.50/MMBtu in the four years RealEnergy built its systems. That was not on anyone's radar, Best confirms. "Now … we'll plan for volatile prices," he says. Best argues that electric tariffs are needed to reflect wholesale/real-time gas prices so that the industry can more equitably compete with utilities that buy their fuel in October like everyone else and roll their costs into rates a year later.
While Cashdan accuses utilities of monopolistic behavior with the use of demand charges, Best thinks strategically. Tariffs don't conform to distributed generation and in fact are disincentives. "The utilities need us for half of a day—the noon to eight peak period—and are competitors for the rest of the time," he points out. If the electrical and thermal load in a building requires that the system shut down at 6:00 p.m., the customer will be hit with a $10/kW demand charge. He discussed this issue in a meeting with California Energy Commission commissioners. "We got a sympathetic ear; they loved it," Best says.
Lessons Learned
Steven Greenberg, another partner who left RealEnergy a year ago to form Distributed Energy Strategies (DES), says he is taking another approach, based on what he learned while at RealEnergy. "We look at energy facilities as though we are mining," he says.
DES offers customers one or more of three choices: It can teach them how to extract the energy resource; it can mine the energy resource on a pay-as-you-go basis, allowing the customer to benefit from the dollar savings; or DES can pay for a license to mine the resource and keep the savings for itself. This third option means the customer spends no money. It is designed for those not comfortable getting into the business of acquiring and maintaining energy assets, says Greenberg.
Greenberg and other DG company owners explain that the economics of the business depends on aggregating customer relationships to create a pool of demand. It takes time to educate one customer. The solution is to strike a deal with an industry association or with one customer that has multiple sites.
For example, one of RealEnergy's original investors was Arden Realty, the largest publicly traded real estate company in southern California. RealEnergy installed an acre of solar panels on the roof of Arden's 110,000-square-foot City Centre office building in Fountain Valley. It went on to install cogeneration systems in seven other Arden commercial properties.
While at RealEnergy, Greenberg learned the importance of having a consortium of vendors so as to not become dependent on one supplier. The DG market is not a cohesive one, and no one vendor can provide the equipment for all sizes and fits, says Greenberg.
A Study in Contrasts
DG Energy Solutions, the two-year-old company that acquired RealEnergy's 13 MW of operating DG systems, plus 9 MW from Hess Microgen soon after, offers an insightful contrast: At its height, RealEnergy employed 80 people in three offices. DG Energy, with less money and more assets, has 55 employees in California, New Jersey, Florida, and Oregon. DG Energy's president, Steve Mueller, has 25 years of experience installing cogeneration systems, which none of RealEnergy's principals had.
DG Energy has a different philosophy—it has chosen to diversify its assets. It has 27 MW of operating DG systems in hotels, office buildings, big-box retail, and campuses; 8 MW of cogeneration plants in industrial facilities; a 22-MW equivalent in district heating and cooling systems; and 14 MW of biomass and other specialty generation facilities.
The company expected to close on another 18 to 22 MW of assets by the end of 2004. And in 2005, it will start installing critical energy systems to provide baseload power in data centers and telecom facilities. DG Energy systems vary in size from 500 kW to 2 MW, although a few supermarket systems the company installed were as small as 140 kW.
Mueller says cogeneration technology has not changed in 25 years. It's all about economics, he observes, the effective utilization of waste thermal energy. When a system is designed with no effective round-the-clock, 24/7 thermal load and operates—on the average—only 16 hours a day, five days a week, as the RealEnergy systems did, it is tough to make the system cost-effective. And it is 10 times more difficult to make the units operate reliably due to the on/off nature of the loads, he adds.
Instead, Mueller says, the company is restructuring the contracts and re-tooling the RealEnergy systems it now owns to be more baseload-oriented and to serve the 24/7 critical loads. He likes the larger office building market and office parks where the company can find 24-hour loads for both power and cooling, such as the district heating systems he confesses he really likes.
Regarding its difficulty with Hess Microgen and the poor reliability of its packages, Mueller claims RealEnergy did not have the packaging and engineering right. Furthermore, communication with the servicing arm became contentious. DG Energy has not had the same problem—it owns 96 Hess Microgen units along with some Solar turbines.
The design should be kept simple and easy to maintain, Mueller stresses. When the units are operated 24/7, maintenance is decreased. Turning them on and off daily only increases problems. Maintenance is key and will lead to better reliability and more profit, he says. Demand charges—the problem that plagued Cashdan—disappear when the units serve the load 24 hours a day.
Three Views From Afar
Garrett Smith, president of Portland, OR–based Cogentech, founded in 1999, says RealEnergy's implosion represents the Achilles heel of the industry. RealEnergy attracted capital and clients but its choice of technologies was poor, Smith says. The result is DG companies have gotten a bad rap. The general investment community is asking, "If this industry is so good, why aren't the utilities interested?" Smith reports. Furthermore, potential clients are telling him, "We've heard about RealEnergy; we're not talking." He says four or five projects were ready to be built, and when the customers heard about RealEnergy and its problems with Hess Microgen packages, they decided not to go ahead.
"If we could have hooked up with the financial backing and the corporate alliances [that RealEnergy had] there would be no stopping us," Smith contends. He believes the utilities will drive the industry once they rid themselves of the view that DG is a threat. He cites Arizona Public Service as the only utility in the country that has become involved in and supports DG.
Compounding the economic difficulties most DG companies face, many investment houses aren't interested in funding anything less than $100 million, because the cost of capital is identical even if they are funding much smaller amounts of $1 million or $2 million typical of DG installations like Cogentech's. At the end of the day, it's the scale, says Smith. Even if the company has 6 or 10 projects, it's still not large enough to attract venture capital funding, he argues.
Without that funding, DG companies the size of Cogentech—its core staff is 8 to 10 employees—cannot attract large corporations. The result is that Cogentech is installing projects exclusively for private entities willing to put up the funding, making it a feast-or-famine business and dependent on getting new projects, Smith says.
Smith also suggests that venture capitalists are putting their money into new technologies like fuel cells and new solar technologies, precisely because they are new and sexy and popular. When he talks of GE Jenbacher technology, for example, "The VC guys fall asleep," he says.
Smith argues that had RealEnergy honestly evaluated the DG technologies being used around the globe, the company would have discovered that Jenbacher, with 40 years of experience in Europe, had already proven out the technology Americans are just now doing.
Furthermore, Smith says, Jenbacher is dedicated to its support and maintenance. He said most packaging and service companies have come out of the standby diesel generation industry. It is very different from the DG industry where the natural gas–fired cogeneration systems operate 8,760 hours and have much more complex control systems, such as utility grid interconnections. The typical generation repair shop is clueless, Smith says.
Smith has seen the number of DG projects go down in the past two years, and with the bad stories out there, he doesn't know what the future holds for gas-fired combined heat and power projects. Cogentech, an engineering and construction firm, is now turning to renewable and biogas projects, he explains. This includes anaerobic digesters for farmers, where it will be easy to do 50 to 100 projects. In addition to state incentives in both Oregon and California, Smith is in negotiations with venture capital firms for funding for these projects.
Maintenance Is the Key
Len Beyea, a senior energy engineer and certified cogeneration specialist at NORESCO in Santa Cruz, CA, with almost 20 years of experience in the field, explained that maintenance of cogeneration systems is important but expensive. NORESCO does not maintain the cogeneration systems it installs and instead requires customers to sign long-term agreements with an approved service company.
Beyea says once the unit is installed operation is rough for the first two to three months, primarily with control problems. Once the bugs are worked out, the unit can be expected to be trouble-free for two to three years, with 96% reliability the first year and 86% reliability by the second year. "If you don't realize this, you're headed for trouble, he says.
Telecommunications has made a big difference in the development of the industry. As opposed to 20 years ago, now when a unit goes down it can often be diagnosed online, from across town or across country.
As with Cogentech, Beyea says cogeneration units are being sold because customers are requesting them. The systems have long paybacks, 8 to 10 years even when California's self-generation incentives are included. This works financially, but always on the margin, he says. The reasons are the high cost of fuel and construction costs. Furthermore, maintenance costs are equal to or slightly higher than thermal savings. Add in time to push the project through the permitting process, and this size project—500 kW to 1 MW—becomes quite expensive, increasing its payback time.
Beyea admits he is generalizing and there are exceptions. It will take gas prices going down or electricity prices going up to make DG profitable, he argues, adding that a DG system using a waste fuel, such as landfill gas, will look terrific.
Larry Tengel is vice president and general manager of Enercon Engineering in East Peoria, IL, and chairman of the US Combined Heat and Power Association. He describes RealEnergy's business model as unique and describes the company as having grown too fast. But the poor quality of the technology it chose created many problems for it, in particular major backpressure and overheating problems.
Tengel, who knows the team at RealEnergy, confirms the other major problem facing the company was an underappreciation for maintenance. Without these problems, its business model would have succeeded, he says.
Enercon manufactures electrical systems and controls, and packages cogeneration units from 100 kW to 5 MW for installers such as Stewart & Stevenson, which no longer packages the units. With installations in 90 countries, it has experience handling maintenance issues.
The competency of field service technicians is an issue, says Tengel, and more expertise is required than typical electrical contractors have. Engines are a standard item, fairly easy to maintain, while the control system and "balance-of-plant"—the valves, thermostats, heat, etc.—require highly trained technicians to maintain. But in the past seven years, Tengel says, engines have gotten more complex. For example, a Caterpillar technician cannot do much without his laptop. Diagnostics now require computer analysis.
Furthermore, it's difficult to train field people how to make repairs following troubleshooting in the office. The solutions are costly, Tengel admits.