If you needed additional proof that the power industry is changing, the ELECTRIC POWER keynote and panel discussions over the past few years have provided it—top-of-mind issues have been significantly different each year. For the 2011 keynote speaker and panelists, the challenges of reliability, regulatory compliance, financing, and getting the fuel mix right took center stage. In the wake of Japan’s nuclear crisis, safety also featured prominently.
What a difference a year makes. At the 13th Annual ELECTRIC POWER Conference Keynote session, smart grid and nuclear (which figured prominently last year) were the equivalent of footnotes. What the speakers converged on instead, without actually confronting it directly, is that the industry is headed for significant consolidation.
Opening remarks were given by John Shelk, president and CEO of the Electric Power Supply Association (EPSA), which has probably done more to pry open wholesale electricity markets over the past 20 years than any other organization. His comments were followed by an industry executive panel, moderated by POWER Editor-in-Chief Dr. Robert Peltier (Figure 1).
|1. Keynote speaker John Shelk. Shelk is the president and CEO of the Electric Power Supply Association. Source: POWER|
Shelk began by noting a key attribute of this industry: Reliability “is an input,” a requirement to maintain a surplus of capacity; no other “competitive” industry operates with such a regulatory mandate. One might think that, after 30 years of “deregulation,” 20 years of competition programs at the state level, and numerous initiatives at the federal level, mandated reserve margins would be coming down. Not so, at least not in Texas.
That point was underlined in the panel discussion by Doyle Beneby, president and CEO, CPS Energy. He reported that the Electric Reliability Council of Texas, which runs the Texas electricity market, increased its reserve margin from 12% to 13.5%. And this is a market that, according to many observers, “got [competition] right.”
The Fuel Conundrum
A second challenge Shelk noted was the perennial cost of environmental compliance. No one needs to be reminded that environmental mandates have essentially made the industry’s No. 1 power plant fuel, coal, uncompetitive economically. Carbon cap and trade legislation is off the federal government’s agenda, at least for now; the Republican-dominated House is trying to rein in the Environmental Protection Agency (EPA) on myriad other compliance initiatives; and, reported Shelk, Congress is requesting economic impact analyses of compliance rules from the EPA, the Federal Energy Regulatory Commission, and the Department of Energy (DOE).
Despite this shift at the federal level, announcements of coal plant retirements keep growing. Tennessee Valley Authority (TVA), one of the country’s most significant coal burners, is “throttling back the coal fleet,” said Robert Fisher, TVA’s senior VP, fossil generation. “Eliminating today’s carbon footprint includes closing coal plants,” said Ruth Ann M. Gillis, executive VP and chief administrative and diversity officer, Exelon Corp. (Figure 2).
|2. 2011 Power Industry Executive Roundtable panelists. From left to right: Robert Fisher, senior VP, fossil generation, Tennessee Valley Authority, a federally owned corporation; Ruth Ann M. Gillis, executive VP and chief administrative and diversity officer, Exelon Corp., which in May announced a plan to acquire Constellation Energy, to become the largest electric utility in the country, and certainly one with a huge footprint in PJM; Doyle Beneby, president and CEO, CPS Energy, a municipal utility, one of the nation’s largest, with a protected service territory and charter; Stephen M. Carter, VP, regulated generation, Cleco Power, which, according to Carter, is “totally focused on the regulated utility”; Dan Foley, CEO, ACCIONA Energy North America, which is developing renewable energy projects to take advantage of renewable portfolio standard mandates imposed by at least 30 states; and Dr. Robert Peltier, PE, editor-in-chief of POWER, moderator. Source: POWER|
From a market perspective, it’s hard to imagine a cheaper source of electricity than a fully paid-off, amortized coal-fired plant—unless you heap enough environmental compliance costs on it to kill it.
Beneby noted that you can buy an idled combined-cycle plant for less than the cost of the flue gas desulfurization system that would be required on a coal unit—forget about the boiler, turbine/generator, and other major components. What’s more, the financial models show gas prices low “as far as the eye can see.”
Then there were financing concerns. Dan Foley, CEO of ACCIONA Energy North America, observed that wind plants will be “exceptionally difficult” to finance in the 2011–2012 time frame because of low gas prices and the disappearance of merchant banks, disgraced during the financial crisis, which financed half of the wind projects in recent years. They were able to protect their huge profits in other aspects of their business by taking advantage of tax-incentive financing available through federal production tax credits (PTC).
Stephen Carter, vice president of regulated generation at Cleco Power, also noted that merchant generators can’t get bank financing.
The result of low gas prices and restricted financing options is obvious. Fisher said TVA was growing its gas fleet, while Gillis crowned natural gas “queen,” one that will “reign for a long time.”
Despite the disaster at Japan’s Fukushima nuclear facility, the panel discussion revealed that the industry isn’t necessarily running away from nuclear, but the near-term hurdles have been raised. Exelon owns and operates the nation’s largest nuclear fleet, but it is only committed to continuing its uprate program on existing units; it’s not planning any new builds. The new units at South Texas Project, which CPS was once part of as one of several off-takers, are now history (except for completion of the license). This is especially notable because they were some of the only U.S. units that looked like they could be developed outside of rate base. TVA’s Fisher talked about completing facilities begun decades ago. Even though TVA isn’t “scared of the Japanese situation,” according to Fisher, the agency isn’t planning any new “big units” and instead is eyeing the smaller modular technology.
And, as Beneby suggested, nuclear becomes cost-prohibitive without the federal government’s loan guarantees and may be further burdened by new compliance regulations following review of current design standards in light of the Fukushima disaster. Getting carbon legislation off of the current congressional agenda has also taken the urgency out of new nuclear units.
Thus, although Shelk implored that “we need it all,” every fuel and technology, it seems there’s little “competition” today on the supply side. Most generating companies will approach their banks and/or public utility commissions only with some type of a gas-fired plant or participation in a renewable facility. It isn’t competition, but multiple layers of government intervention that is causing the industry to converge.
The third challenge Shelk identified is the so-called shale gas revolution. Anyone whose eyeballs are glued to a computer, television, or digital device screen knows about the political battle over shale gas. Both sides seek to win the hearts and minds of the American public. When Shelk mentioned that the natural gas industry had spent $100 million on an advertising campaign, it seemed clear industry had won round one. However, environmental groups are now focused on gas instead of coal, he stressed. Thus, when the environmental lobby’s troops make the full transition from the coal theatre of political operations to shale gas, it probably won’t seem as one-sided as it does now. And gas probably won’t be as cheap as it is now either.
Cleco, for one, isn’t just burning shale gas in its power plants. According to Carter, the company also plans to invest with exploration and production companies in “upstream integration.” This way, the utility won’t be “exposed to [pricing] volatility.” But there are potential risks with gas. Beneby, for example, believes future EPA regulations will force the price of shale gas up.
Is Solar the New Kid on the Block?
Shelk mentioned that recent Electric Power Research Institute studies show solar beginning to be economic. Other positive sentiments about solar were echoed by the panel. Beneby sees photovoltaic prices declining and the prices of “big solar,” sized north of 250 MW, coming in just under gas when considered on a 30-year life-cycle cost basis. Solar also potentially avoids transmission risk and costs, so Beneby thinks it is “worthwhile to look at big solar in Texas.”
Foley believes that concentrated solar plants sited adjacent to a gas-fired plant can lead to a “green peaker.” (See this issue’s cover story and cover photo.) Unlike wind, solar energy is generally available, barring cloud cover, when electricity demand peaks.
But although solar may give wind a run for the money over the next few years, Foley stressed that new wind turbine technology will be more competitive. Wind facilities incorporating the latest turbine designs have exhibited 20% higher capacity factors in Oklahoma and Iowa, increasing yield and lowering prices. Foley’s “not worried about gas” because “technology changes will drive the business.”
Beneby isn’t as sure. He noted that in Texas, intermittent sources like wind will soon be penalized for non-delivery if Texas Senate Bill 15 becomes law.
The Buildout, Pushed Out
In recent years, topics for impassioned discussion at this forum have been new capacity additions, transmission expansion, carbon legislation, and smart grid programs. None of these topics got much air time at ELECTRIC POWER 2011. Cleco’s Carter mentioned transmission investment as “what’s next.” He also acknowledged what others have been reading in the press about so-called smart meter programs. That is, customers don’t perceive their value. In Cleco’s case, that meant the utility was unable to rate base the DOE cost-shared program; instead, it had to fund it through operation and maintenance savings. The program also resulted in layoffs for all of the company’s meter readers.
The drop in demand over the past three years, accompanied by electricity price declines, has led to surplus capacity, stressed Shelk. As a follow-up to that comment, Peltier asked the panel about the impact of low electricity prices on their businesses. Both Gillis and Fisher noted that demand certainly took a hit but that manufacturing and commercial and industrial accounts were rebounding. The hit on earnings made nuclear unattractive, Beneby conceded.
The Value of Fuel Flexibility
Carter talked at length about Cleco’s new $1 billion circulating fluidized bed (CFB) boiler power plant completed last February, which “burns anything,” including petroleum coke, biomass, and Illinois coal. (See “Cleco’s Madison Unit 3 Uses CFB Technology to Burn Petcoke and Balance the Fleet’s Fuel Portfolio,” August 2010 in POWER’ s archives at https://www.powermag.com.) Among other things, the CFB allows the utility to burn woodchips to help meet its renewable portfolio standard (RPS) obligations. Of course, if that plant started up last year, it went through permitting in the middle of the last decade, when natural gas prices were high and escalating, and carbon management was a bigger threat. Things have changed, which evidently is why Cleco also recently purchased a combined-cycle facility.
Other panelists saw biomass as problematic when an audience member asked about alternative fuels. Foley noted that biomass was “impossible to finance” because of fuel suppliers’ lack of credit-worthiness. Even Carter conceded that care had to be exercised so as not to compete with your customers, such as pulp and paper plants, and drive up wood prices. Beneby noted that the radius of supply/delivery on alternative fuels kills you.
It was heartening to know that four of the five executives, when asked by Peltier what keeps them up at night, responded with workforce safety. Fukushima obviously is on the industry’s collective mind. But two of the executives also mentioned recent fatalities. Fisher opened his remarks by reminding the audience that “weather is a significant challenge.” TVA’s system had just been devastated by more than 300 tornadoes in the span of a few days.
Recent pipeline, mining, and plant accidents with multiple fatalities across the nation, along with a greater incidence of severe weather, have not only brought safety to the forefront, but also the need for an experienced workforce. Although Peltier pointed to the experience gap—there are few workers in the 35 to 50 age bracket—these executives expressed confidence in their preemptive hiring strategies, part-time and remote worker programs, and cross-training. Fisher, for example, noted that workers from the retired coal plants at John Sevier station moved seamlessly over to the John Sevier combined-cycle plant. For the most part, the recession has at least punted the workforce problem—which was at the top of the utility executives’ agenda only three years ago—down the field.
The Hidden Cost of Shutting Down
Foley made an excellent point that is probably underappreciated by the industry, and certainly those outside of it. You have to be really careful about retiring capacity, he said, if for no other reason than the difficulty of building replacement capacity. As just one example, he noted that his firm has been trying to permit a wind facility for 10 years—in a state, California, that is pursuing a 33% RPS!
When officials threaten to shut down nuclear units because of Fukushima, and coal plants are retired because of compliance costs (and let’s face it, to take excess capacity out of the market), what replaces that capacity? Carter noted that “it takes five to seven years to do anything.” If, as Shelk says, reliability is an input, then it pays to not be cavalier about retirements or shutdowns.
The Big Asset Shuffle
Cleco isn’t alone in buying gas-fired assets. Beneby said CPS is also looking to acquire combined-cycle facilities that are “cheap” because the mandates around wind and the PTC have knocked them out of the dispatch queue in Texas. TVA seeks to “grow its gas fleet,” noted Fisher. Indeed, throughout the country, gas-fired plants once owned by merchant generators are being acquired by regulated entities.
The Exelon-Constellation merger proposal is only one of several. Earlier this year, Duke Energy announced that it seeks to merge with Progress Energy, First Energy consummated its merger with Allegheny Energy, and AES Corp. announced it is acquiring DPL Energy. Others are clearly in the works. Divestitures to prevent “market power” will likely accompany these mergers as they move forward. In an era of low gas prices as far as the eye can see, resistance to raising rates at the retail level, and less infrastructure expansion for earning a regulated rate of return on capital investment, what’s a utility CEO to do? The “urge to merge,” as Peltier put it, is strong because companies can eliminate redundancies and leverage costs across larger fixed asset and customer bases (see “The Urge to Merge” in the June 2011 issue of POWER).
Consolidation isn’t just happening through utility mergers and plant acquisitions. Shale gas players are being consolidated into the major oil and gas companies. Wind industry suppliers are consolidating, now that business has contracted from the recent boom years. The federal government is even encouraging larger balancing areas so that intermittent renewable resources can be integrated into the grid with less cost impact. As Fisher noted, larger service territories lead to larger control areas.
Shelk mentioned “relying on market forces to do the best job for consumers.” Market forces are certainly driving consolidation. But that generally gives greater pricing power to suppliers. The low gas prices that currently have executives’ attention are based on supply that hasn’t yet been extracted from the ground, an environmental compliance framework that hasn’t yet gotten the full attention of the opposition lobby, and a fragmented supply industry.
Myriad government mandates have clearly limited choice in supply and, barring more demand destruction, will drive electricity prices upward. It is common knowledge that few, if any, projects will get financed today outside of rate base without a long-term power purchase agreement with a regulated entity and fixed operating costs guaranteed through a contractual service agreement with the equipment vendors, at least during the debt service period. There’s little competition in that situation, at least as the industry has come to know the term.
Market forces are certainly at work, but regulatory distortions are even clearer. What’s not clear is who is watching out for ratepayers.
— Jason Makansi (jmakansi@ pearlstreetinc.com) is president, Pearl Street Inc.; principal of Pearl Street Liquidity Advisors LLC; and executive director of the Coalition to Advance Renewable Energy through Bulk Storage (CAREBS).