A block buster deal by Consol along with my continuing blogs with the ScottMadden Energy Industry update in the section on rates, regulation, and policy, is inspiring this insight. As noted in the industry update, several policies are set to minimize coal generation. However, the biggest harm to coal did not come from the government, but the natural gas industry. Shale gas revolution is causing the big harm. If gas prices were to be in the $4-7+/mmbtu range, many decisions to install control equipment at these power plants would have been easily made. However, prices are now at the point that it does not make too much economic sense to invest in a several decade old plant when a brand new gas plant can be built at roughly the same cost. The benefit of added capital cost in the past was made up by the lower fuel price over time.
Shale gas has placed a big question mark on the long-term price of natural gas in the US on the market participants. If prices were to sustain around $3/mmbtu, there is no doubt that a significant amount of coal retirements would occur, including possibly fully control plants, as low power prices are not covering existing fixed cost. Eventually the coal industry would be left with barely a shell from the past. However, before we all jump on that trajectory, I will be willing, as I have been in the past to be the counter forecaster to the rest of the market.
On the bearish side of gas, there is quite a bit of evidence that production cost may actually be coming down for shale. Also, producers have a strong zeal to continue to post strong production numbers in face of relatively poor economics, as share prices are being rewarded. The btu in the ground will still be there for a few years later, but money now is the key for many publically traded companies. Long-term thinking may be pushed to the wayside as management teams have options, and shareholders want dividends now.
On the bullish side, what is not discussed more is the demand response that is likely to occur, but just takes time. As noted in several post, the demand for natural gas in the industrial sector is very binary. There is not ramping of natural gas demand as a brand new chemical plant, power generator, or LNG export terminal comes online. All these investments take time and large amount s of capital. No one places a $1+billion dollar investment for a price move which occurred in a one or two year period. A sustained belief that prices will be relatively low allows investments to be made. As noted in the ScottMadden energy update over 35 Bcf/d are looking for export license. We have at least 5-10Bcf/d already approved and very likely. To put that into some perspective, total US demand in 2012 was around 70 Bcf/d. If around 40GW of coal retire plus the addition of the LNG exports, the total demand from those two activities can surpass the entire US residential demand in natural gas. This is not insignificant.
Note: Expect in the coming months a long-term gas price projection from All Energy Consulting.
With world markets natural gas price north of $7/mmbtu, the US natural gas prices will likely move in that direction, as LNG exports try to capitalize on the market differences. IF coal producers and generators can believe over the next few years, we will see prices north of $4/mmbtu, on a consistent basis coal retrofit decisions become more likely. The coal market participants must realize there will likely be no more coal builds with the number one reason, not being the EPA or natural gas prices directly, but the plain fact the cost of building a coal plant is very high as seen in the recent Turk Coal plant built by AEP. The article is honoring the plant, but that honor comes with a high price tag of $3000/kW, almost twice expensive as the state of the art gas plant. For this very reason, new coal plants will be limited. Therefore, the only coal demand in the US will be from the existing coal plants. Coal producers and generators need to realize this fact. If the units retire, there is no coming back for that demand. Therefore, it is of the greatest need to figure out a way to keep the units economical to the point they do not retire.
My strategy for the survival of the US coal industry is to be creative with coal contracts. Go back to the old fashion way of creating coal contracts which are plant specific and less commodity like (non-homogenous). Both the producer and generator need to do the analysis and/or hire third party like myself to evaluate the economics at each plant. A spread should be produce based on the local natural gas benchmark. This spread should be to the point that it enables the plant to economically run in the current poor gas price. For the shared suffering in today’s price, the producer will then get the upside when the market recovers. If the market does not recover it does not matter anyway. The industry needs to save what they can or it will be lost forever.
As noted in the article, I would be glad to facilitate and produce a contract which produces a win-win situation for both the coal producer and coal plant. I have the ability to produce unique solutions which can benefit both parties. Please do consider All Energy Consulting.
Stay tuned for the Long-term Natural Gas price outlook.
Your Energy Consultant,
Continuing with the insights inspired by the ScottMadden Energy Industry update, the slide on GRID resilience offers some insights on planning related issues. GRID resilience is essential in resource planning. The layman needs to know that electricity must be balanced at all times, that means supply/demand must be in sync. A surge in demand must automatically be met with a surge in supply or vice versa, no room for delay is allowed. If there is a delay, there will be a potential for an equipment failure and a prolong outage. During storms, the failure of equipment down in the distribution level causes demand losses which can then trigger imbalances in the system and lead to wider disruptions beyond the initial storm damage.
The graph on Weather Related Outages is very telling of the impact on storms. However, before we account for the increase in outage to just climate change, let me note causation and correlation issue. As noted in my previous posting Power Industry Challenges, the age of the distribution system is worse off than the generation resources. Given that knowledge, it is very possible to have increasing outages without a significant increase trend in weather related storms. A storm ten years ago will not be impactful in terms of electricity outage as a storm now given the aging of the poles, transformer, etc.. Investment in Transmission (T) &Distribution (D) is no doubt needed – more so in D than in T.
In terms of a utility, the level of investment is a function of the level of reliability that society wants to pay for. For the individuals who want more reliability, they can either install back up or self-generate on-site. I suspect the answer is to see more distributed generation only in the fact that the average consumer level of reliability would not be cost effective enough for various applications. If the utility were to set the standard of reliability too high, it would be a very regressive policy.
A utility operation is more of a society tool to offer benefits of basic essentials to society which would be out of the reach for many individuals. If utilities started offering Rolls Royce systems, it would cause a regressive rate structure and thereby, negating their very existence of being the tool to enable the mass of society to obtain a basic essential. The commissions need to examine very closely the cost benefits of these items in the T & D filings, and make sure they are balanced with the need of the AVERAGE consumer. With this insight and the business model change we discussed in the beginning of the examination of ScottMadden update, many utilities will likely be much smaller than they were before.
Stay tune for more insights derived from ScottMadden review. Please do consider All Energy Consulting for your consulting needs as I can help giving you a different look into the challenges that lay ahead in the energy world.
Your Energy Consultant,
Taking a break on the various issues of utilities from my previous blogs, I was inspired by this article to take on a macro issues of energy involving Shale gas and carbon issues – Is shale gas our future or should we look at other sources of energy? (Molten Consulting).
The title is opened ended… how far is future? And whose future? Shale gas does not and will not make up the majority of energy usage worldwide. It is a substantial portion for the US oil and gas balance. Before there were shale expectations, the theme to balance the energy market was to use all sources of energy including improvement in efficiencies. Supply and demand always meet, it is just a matter of convergence with price as the critical variable to impact supply and demand.
- LNG imports were going to save the US from sustained $8+/mmbtu prices.
- Imports of crude with a large dependency from Canadian tar sands were going to fill in to maintain oil markets while we slowly convert the US auto fleet to alternative fuels.
- Advance coal would even play a part.
- Nuclear plants were going to easily be relicensed.
- Wind and solar cost would come down in cost and the cross intersection with gas prices at $8+/mmbtu would allow the elimination of subsidies in a few years.
However, shale has allowed this delay as it came with a bonus of liquids production. Middle East LNG and Canadian heavy oil are still there. Both coal and nuclear are actually being hampered because of the shale gas producing poor economics, therefore a significant decline is likely in the US. Renewables will likely continue to require subsidies, and the ability to transform quickly is hampered by the fact that there are physically known recoverable sources of energy to be used if shale gas drops off whether heavy oil, LNG, or even coal.
Technology breakthrough in energy is extremely tough given the capital intensity in the industry. New technology cannot plan or wish for peak oil to produce higher prices to enable their technology. Shale gas has pushed the peak curve much farther out than any of these peak oil theorists would ever imagined. Mr. Shaw brings up the carbon issue as a critical path. Once again, as much new technology cannot plan for peak oil, they probably should not plan on significant carbon prices to make their technology viable. Carbon is not going away, but when countries and individuals cannot even balance their check books, can we really plan beyond 10 years much less 100 years which many of the impacts of climate change will be felt? Debt is no different than carbon, it is kicking the can for the next generation. Therefore, to see any government put in a sustained economic penalty for benefits not seen in decades does not seem likely.
The stretch goal for all new technology in the energy space try to compete with prices now, not on a dependence on something in the future. Just as shale gas came into the picture, other sources of technology have the same opportunity.
Your Optimistic Energy Consultant,
Demand Response (DR) & Demand Side Management (DSM) are very hot topics that are interrelated however was broken apart in the ScottMadden Energy Industry Update. The ScottMadden Energy Industry Update addresses the DR and DSM discussion,albeit with an unexpected slide on the nuclear power sector in between. There are not many insights to offer on nuclear, other than nuclear waste being very expensive for taxpayers and gas prices are impacting renewal of existing plants. I can offer insights on DSM, particularly as it relates to the utility industry. I believe utilities can be, as effective if not more effective in DSM roles than third parties. It is just a matter of aligning the incentives for the utilities similar to the third parties. If this happens, I suspect many will be crying wolf.
I have spent time working in the DSM (DR and efficiency) space for utilities. Similar to the insights derived in my previous ScottMadden Energy Industry Update executive summary, the utilities need to change business model. This includes their approach to demand related options. Society and the commissions and are siding with the capability of efficiency programs due in part to some results coming from the western states energy intensity over time, but I believe that may be overly optimistic. I cautioned the extent of the results from the western states being translated to the rest of the country, as western states saw a migration of industry on which the rest are more dependent. In addition, the climate is more temperate in the west, which leads to the ability to be easily more efficient. Energy intensity is not the best metric as it covers up the underlying changes and issues. DSM is a detailed process since it focuses in on what your customer uses energy for. If your customer uses heat pumps to stay warm as their primary energy usage, implementing a large light bulb program will only get you so far compare to places like California. Besides all that caution, DSM does have a place and the utilities can create a win-win situation. They just need to change the model.
All Energy Consulting has experience facilitating such a change to the model in the following roles:
- Developing management understanding of the issues and the various strategies that could create a win-win situation
- Working with the regulatory team and the commissions to make sure all parties understand that the win-win situation is being created
- Assisting the modeling and planning groups to treat the DSM, not as a top layer input, rather more akin to a resource option
Third party facilitation has the following advantages:
- Removes the emotional attachment of keeping the status quo
- Allows people to take comfort in having someone to blame if something goes wrong
- Removes fears that prevent many organizations from changing.
Stay tuned for more insights derived from ScottMadden review.
Please do consider All Energy Consulting for your consulting needs as I can help being the facilitator to change.
Your Energy DSM/DR Consultant,
In this blog, I am moving forward into the ScottMadden Energy Industry update from the previous posting on the Executive Summary. As I noted many times, the real meat of the discussion is in the details. ScottMadden brings up much meat to generate insights.
Coal & Capacity Markets
In terms of the coal retirement story, two fascinating things bring to mind that were not discussed in the update. The first one is the PJM capacity auction which is and should be in serious flux, given the required must run (RMR) status put on First Energy Hatfields Ferry Power Station. A moral hazard has been created probably without intention.
In July, after the capacity auctions dropped from the last auction, First Energy announces the retirement of the plant. In theory, the capacity auction should be high enough to keep the necessary units running. Hatsfield Ferry already has SO2 controls and some mercury mitigation which they recently spent $650 million. It is quite peculiar they announce a retirement for such a plant. Nonetheless, with an RMR designation, First Energy is in the driver seat for this plant. They can in effect “guarantee” a return for the plant regardless of the market condition – low load or low gas prices. This may be quite unintentional but perhaps other utilities should follow and announce retirements.
There is no real mandate one has to follow through with an announcement – similar to announcing a new power plant. (Tidbit of fact if you look at new power plant announcement only around 10-20% get built). One could at least see if they can get their plant to be guaranteed for some time. If not decide later to retire or not retire.
Another point worth discussing, coal in areas of significant wind development (e.g. MISO), how can you not mention the interplay with wind. The big debate is how much wind can be attributed to capacity. When you need capacity in times of high load typically wind is not blowing. The most obvious occasions are the very hot days. However, even on very cold days there is a good chance there is too much ice buildup on the blades to obtain any electricity. Therefore, the wind capacity is generally discounted for capacity value. At the same time a trend you can see to the angst of coal units in markets with large wind is the intermittent availability. The coal plants cannot cycle without significant risk of increase maintenance. This has led some coal units to just turn off versus trying to chase the wind.
To capacity market or to not is the question of many market organizers. ScottMadden presents the grand experiment in ERCOT with an energy only market. Discussing capacity markets are as contentious as religion as noted in my Regulation vs. De-regulation blog. In hopes of taking out some of the religious fever on the topic I like to discuss it on a math basis. A market with regulation typically gets a return on investment between 8-12%. If the market is free to compete, the risk is increased. Therefore, the reward needs to increase above the regulated return requirements. This increase leads to boom bust cycles as rewards are large and eventually attract many suppliers.
Not all the suppliers are smart and so herd mentality is likely leading to a market bust when in a boom and market boom when in bust. A boom bust cycle is okay for goods such as beanie babies to cars to cell phones etc… However, power and water have become essentials for society and producing boom and bust cycles will likely lead to very instable society. The spread between the current regulated framework of 8-12% return to now 15+% rate of return, I contend is too great for society. I do agree the potential for a more efficient market is very possible with an open market, but society is not willing to take the means needed to achieve the ends of a more efficient market.
Outside ERCOT, many are trying to rectify the de-regulation imbalance with the security of regulation by offering a capacity value to incentive build before the energy only market induces a build. I believe that there needs to be a more creative way to reduce risk, thereby reduces rewards requirements. As an example, one source of reducing risk is to offer pre-designated projects with permitting and locational issues cleared by the RTO. The RTO can then auction off these locations.
We are now at the half way point of the ScottMadden Energy Update. As you can see the update is more valuable in not just the facts they present, but from those facts the ability to stimulate alternative ideas and potential concerns – insights as like to call it. I will continue on with this in my next blog.
In the meantime, please do consider All Energy Consulting for your consulting needs as I can help you see beyond the facts to find issues impacting your business directly.
Your Energy Consultant,
ScottMadden Energy Industry update offers much knowledge and points to ponder. I want to thank ScottMadden in making the report publically available.
Executive Summary Thoughts
I couldn’t agree more with the Executive summary theme – Times are Changing. However, what is not addressed is the root of the utility business involves the status quo. Not because of the lack of understanding, but the very nature of their business design and incentive. The root of utility business without elaborating too much involves a regulatory return on investments and minimizing cost to allow more returns on investment. The risk-reward paradigm does not offer enough or any reward for change. If you happened to guess right, your rewards are limited, and if you guess wrong, the punishment could be severe particularly on a personal level not necessarily the company level. In addition, because uncertainty in the sector and revolving commissions doing what was done in the past, has been viewed as not being wrong, even if that is the case.
The mergers & acquisitions noted in the report continue to follow the root of the utility business which ignores that changing landscape. I believe that getting larger in the face of the customer getting more knowledge and involvement in the electric sector goes against the desire of the customer. The business model needs to change and find a way to get back to serving customers, not just by class, but by individual needs and requirement. This would have been impossible in 1970’s, but we have come a long way now, in terms of technical capabilities.
You will note many of the themes in investment, ScottMadden notes goes right back to following the old business model. A “No-regrets” activity in the T&D space is the perfect lingo of doing what one did before. The T&D space is really the only no-regret activity, since it still falls under regulatory paradigm. Anything involving generation can now be considered outside that no-regret policy.
ScottMadden concludes in the executive summary section accurately that new business models are needed. However, I feel they offer quite a bit of optimism that change can happen in time. One may consider many utilities as big and clunky as the Titanic, but the positive thing is, even if one see the iceberg ahead, yet refuse to alter course; they will not likely sink as the Titanic, given the broad need and still some regulatory format, but they will be altered. The real decisions is whether they want to prosper by the change or be left in a much smaller, less active role, similar to the newspaper industry. Print is here to stay and there will be returns for some, but nothing like the good ole days.
Let me break my reporting of the ScottMadden, given the abundance of topics covered in the next sections. I want to close with thanking ScottMadden in sharing this very enlightening document. Business decisions are made by – Information turning into Knowledge turning into Action – the consultant part in the process is not hoarding the information or knowledge but helping you with the turning.
Your Energy Consultant Focused on Helping You Turn,