Aug

29

I rarely have erudite thoughts. Occasionally I have some pedestrian views.

First, oil has made a fool out of me. Nevertheless, I believe oil prices will revert to $80 and beyond. Unless there's a geopolitical event, oil prices should remain low for the next 24-36 months as the market rebalances and works down excessive inventories. However, I believe one or more geoplotical events will take place. It will likely take place within the 24-36 month timeframe. It could be severe enough to cause crude oil and LNG prices to spike.

Second, Mexico will become an important energy partner for US and Canada. Energy powerlines, pipelines, and unit trains will cross borders to facilitate trading, blending and shipping commodities. By merging Canadian, US, and Mexican resources, North America can become energy independent and energy secure.

Third, here are different views about North American electric and gas.

One trend underway today is for producers to exit from commodity markets and migrate towards regulatory assets. In some cases where the migration isn't possible, producers want to force consumers to pay above-market prices for electricity and natural gas. For example, nuclear power producers have convinced New York State, Georgia, and South Carolina regulators to force consumers to buy their electricity at above market prices. Coal producers argue that consumers should be paying above market prices and, at the same time, regulators should allow their customers to pollute air, land, and waters so the state can save mining companies and jobs. In addition, companies like Dominion, Duke, Exelon, PPL, and NextEra are dumping market assets and buying regulated assets (or hedged assets). It turns out, traditional utilities dislike free markets. These "conservative" companies prefer being regulated.

Industry leaders describe other trends. You may find some of these ideas interesting - or not:

1. America can no longer build large nuclear or coal-fired power plants. Yes, there are five nukes under construction. One is scheduled to reach commercial operations shortly. However, capital costs far exceed any financial benefits, and government subsidies are necessary to finance construction.

2. The only profitable option for those needing large-scale power producing assets is high technology gas turbines (combined cycle gas turbines). While capital costs are low, there are substantial [financial] risks in owning gas turbines. If fuel prices leap, generating assets depending on that fuel could become marginalized and unprofitable. Also, gas turbines need to be built near interstate gas pipelines with surplus capacities. Profitable locations are rare. As such, geographic limitations have become substantial barriers to widespread development.

3. Thermal coal consumption will continue to decline in North America. As more coal-burning power plants' production costs drift towards the markets' margins, owners will throw in the towel and retire uneconomic units. Like renewable energy, coal burners have been granted substantial government supports, which are slowly dissolving. Without government supports, coal burning costs increase and energy production becomes uneconomic.

4. Investors and regulators will continue to favor [new] wind and solar assets. Returns on these assets are substantial and financial risks are comparatively minimal. Compared to other alternatives, wind and solar are winners because they are frequently the markets' cost leaders.

5. The biggest winner is energy efficiency. It is the cost leader. It requires minimal investments in new infrastructure. Companies like Exelon are exploiting energy efficiency with success. Most expect energy efficiency programs will grow. As more technology is introduced and merged with energy infrastructure, investments in energy efficiency could explode.

6. You guys like might like one trend. It's called transactional energy. Instead of buyers and sellers transacting bulk power deals at the wholesale level, transactional energy will allow retail buyers and sellers trade electricity at the local level. Transactional energy is currently limited by policy. Those limits may change as regulators struggle with increasingly difficult choices.

7. A precursor to transactional energy is distributed energy, which is gaining traction. Distributed energy turns the current utility system upside down. Instead of spoke and wheel system centered around a single central power station, small generating assets are moved closer to consumers. High costs associated with spoke-and-wheel systems provides growing economic incentives for locally-owned fuel cells, batteries, solar panels, wind farms, and energy efficiency. It also eliminates the need for more transmission lines and associated costs.

8. Local electric and gas utilities will likely migrate to a different business model. They will keep their monopoly status, but they will likely change their core activities to the simple business of renting wires and pipes. After they change their model, they will likely allow customers to hang approved equipment off their distribution systems for a fee. Presently, California and New York State are heading in this direction; others will follow.

9. Motivation to change the current model will likely come about by consumer frustration. Today, wholesale regulators are piling on costs that reward power producers at the expense of consumers. At the same time, retail regulators are adding costs that must be borne by consumers. Taken together, the cost of electricity is substantially less than the cost of renting wires and related equipment to deliver that electricity. In some areas the ratio is 2-to-1. In other areas, it's 4-to-1. As the ratio grows, consumers will be motivated to self-generate or build distributed energy systems. The first to exit will likely be large business and government [military] consumers, followed by small consumer groups. In fact, the exodus has already begun. It will accelerate should natural gas prices jump above $5.00, because that price will be ripple through the value chain and amplify electricity prices.

Some trends are in progress and may accelerate in the near future. Others could take decades to gain traction. The underlying assumption is that all things will remain equal. Of course, all things will not remain equal. A recession will slow change. A recovery will accelerate change.


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3 Comments so far

  1. FTR on August 29, 2016 10:28 pm

    Conservative utilities dislike free markets when they have to compete against massively subsidized alternatives. When wind and solar gets handed billions from the ITC/PTC and wipe out wholesale margins, it’s not exactly unfair to cry foul.

    I’m not sure how you arrive at (4) unless 8% returns (with significant risk in most of the markets seeing large development) are considered substantial. Wind developers aren’t doing market deals, because, well, they can’t make money at the current curve. So yes, they make money if they can find a muppet or a regulator to require purchase but otherwise aren’t much better than a 30-year.

    Energy efficiency has been around what 30+ years? There is nothing new under the sun but coming out and saying that’s the cost leader is hardly a bold prediction.

    Distributed gen has some savings if it allows for reduced transmission and distribution charges (e.g. in ERCOT). As for rooftop solar? Laughably noncompetitive without the massive subsidy of net metering. Utility scale will almost always win a fair fight, even with transmission charges. Are you still debating the Insull point that there are economies of scale?

    As for number 9, the difference between wholesale and delivered costs is primarily driven by policy. It’s not a function of cheaper self-gen, therefore shifting to self-gen makes no sense as it is no more competitive. Complete auturky isn’t competitive unless someone can figure out how to install solar panels for free and build a 10X powerwall for nothing as well. While direct access may offer some benefits, regulators will stick departing load with large non-bypassable charges and prevent that arbitrage.

    $5+ natty will increase wholesale costs and reduce the capacity costs (and reduce the costs with all the underwater renewable PPAs). Net impact won’t be that dramatic. And the only way we’re staying there is if someone bans fracking.

    Seriously? This got through moderation?

  2. CD on August 30, 2016 9:31 pm

    >> Conservative utilities dislike free markets when they have
    >> to compete against massively subsidized alternatives. When
    >> wind and solar gets handed billions from the ITC/PTC and
    >> wipe out wholesale margins, it’s not exactly unfair to cry
    >> foul.

    Every oil, coal, nuclear, and gas-fired power plant by the nation’s electric utilities received 100% government guarantees (the two nuke plants under construction in Georgia have double guarantees and ALSO a PTC). The ITC for solar is limited and for only a fraction of the investment (there are no other guarantees). The PTC for wind is limited in time and scope (there are no other guarantees), which is not the case for the original owners of coal, nuclear or gas-fired power plants.

    >> I’m not sure how you arrive at (4)

    Capital costs for new wind and solar are far less than new nuclear and coal. Also, because construction timelines are so long, IRRs on project financing for new nuclear and coal is so horrendous that more government subsidies are needed just to construct the plant (reference: Construction Work In Progress - CWIP). Without government-mandated CWIP, new nuclear and coal plants are uneconomic before they produce their first watt of electricity.

    >> Energy efficiency has been around what 30+ years? There
    >> is nothing new under the sun

    Ah, no. There’s a new technology called Demand-Response. It created new tradable commodities called, negawatts. DR is a new competitor for independent power producers. IPPs are now competing against DR in RTO auctions. It’s had an impact on prices and profits. IPPs were so upset with the new competition; they raised a ruckus in the Supreme Court of the United States (see: FERC v. Electric Power Supply Association). IPPs lost.

    >> Distributed gen has some savings if it allows for reduced
    >> transmission and distribution charges (e.g. in ERCOT)

    First, RTOs like ERCOT only manage transmission. They have no involvement with distribution systems. That’s why there’s an issue regarding fee pancaking. That’s why there’s an opportunity for savings.

    >> As for rooftop solar? Laughably noncompetitive without the
    >> massive subsidy of net metering.

    In the wholesale power markets like ERCOT, solar has a production cost of almost zero. Nuclear has a production cost of ranging between $15-$20. Coal has a production cost ranging between $15 and $40. Natural gas has a production cost ranging between $18 and $45. Solr wins. Solar gets dispatched first.

    In most regions, there is no “massive subsidy” associated with net metering. In fact, if property owners design their systems correctly, there is no need for the added expense of a net meter.

    >> As for number 9, the difference between wholesale and delivered
    >> costs is primarily driven by policy.

    Uh, no. The difference between wholesale costs and retail costs is significant. Wholesale power is regulated by the federal government on a cost-plus basis. Retail electricity is regulated by individual states on a cost-plus basis. In each case, regulators allow a pass through of CAPACITY CHARGES for generation assets (in most regions), transmission wires, distribution wires, ancillary services and operational costs. Investors demand a return on investment for these assets and regulators provide those returns. Also, distribution systems are far more costly than transmission systems to build, operate, and maintain. To your point, states will add taxes and fees, but they are a fraction of the total costs (read a tariff book to understand line item costs).

    I’ll ignore the snarky comment at the end.

  3. FTR on August 31, 2016 11:40 pm

    1: Every nuke is backed by government subsidies, everyone agrees on this. Coal and gas are, sometimes at least, built merchant and only backed by RA payments so I don’t see how you can claim that 100% are government subsidized.30-50% of the value of wind and solar assets is subsidy, ~0% of the value of a new gas plant is resource-specific subsidy in most markets

    2: I fully agree: coal and nuke are dead. No one is going to argue on this.

    3: Demand response isn’t energy efficiency. I’m not sure why you’re conflating the two. Obviously demand response is a player, but why did you call it energy efficiency?

    4: Wind and solar clearly are dispatched first, they offer $-35 to 0. That’s obvious from the ERCOT bid data (see the 60-day SCED disclosure). That’s a marginal cost, not a levelized cost though so I’m not sure how it’s relevant to overall economic efficiency.

    5: In every region that I’m aware of, solar metering represents a massive wealth transfer. It’s why installers have been fighting to prevent tariff design that properly allocates costs. Every time the issue comes up, PUCs admit it’s a transfer (it’s the same if everyone was being able to sell apples to the grocer at retail in the summer and use that to offset purchases in the winter.)

    6: Many of the costs you mention — capacity, ancillaries, transmission — is a function of the RTO, i.e. federally regulated, not state regulated. Furthermore, the federal government doesn’t regulate wholesale prices as cost+. Without being overly technical, if prices are formed within a competitive market (and the entity has market based authority), the price is deemed reasonable and just. My point on the widening gap between wholesale and retail is that it’s largely a function of policy; e.g. California and NY have very high retail prices and low wholesale prices, ERCOT has high wholesale (sometimes) and relatively low retail prices.

    7: the snark will continue until we can get basic facts right, like calling demand response energy efficiency.

    At the end of the day the current structure appears to be subsidized renewables killing wholesale prices, so gas generators make it up in capacity markets. Demand response, depending on the market rules, helps around the edges from a reliability perspective but isn’t good for margins. No one is making great returns in this environment. Plenty of people are out there selling snake oil such as rooftop solar and making money getting PUCs to agree to underwrite the above market costs. No one is building coal. Nukes will either get shielded from the wholesale slaughter under the aegis of reducing carbon or will retire (they can’t compete in capacity markets against gas). There’s real economic plays here and there around distributed gen and the like depending on the location but it’s not a surefire winner.

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