Regulation vs. Deregulation Utilities
This subject matter can be as contentious as religion and political affiliation. Therefore let me start by saying I certainly would be willing to change my mind as I have already done over the past few years. I do like and live by Thomas Paine statement – “You will do me the justice to remember, that I have always strenuously supported the Right of every Man to his own opinion, however different that opinion might be to mine. He who denies to another this right, makes a slave of himself to his present opinion, because he precludes himself the right of changing it.”
What is regulation? Most people understand the need for police, roads, and fireman – hence the need for some tax. Electricity and water have become equal to those needs. A definition for utility can be functional rather than attractive. Society has chosen electricity and water to be utilities. They are a means to an end. However, the complexity of creating and delivering these utilities are not as easy as paving a road or having a fire station. These investments are much larger with much longer time frame of impact.
Natural evolution was to create a framework to allow these investments to occur for the greater good of society. The simple form was a Co-Op model. Local business and municipals come together and state everyone in this area will pay for this service at rate to make the product to support the local need. However, the cost was considered very prohibitive and greater scale could achieve greater cost reduction. The large utility model was created. The incentive structure for these investors to come together and supply such large volume of money was to create a guaranteed return for investment.
Regulation involves a return on investment. The incentive structure of utility in a regulated framework is investment. Without investments the utility would not make any return. Enter the public shareholder utility, the shareholder of these regulated utility makes a return on the investment piece. The cost of maintaining and operating the investments are cost based. There is no return for this part of the business. Balancing this cost pass through is the lack of competition, allowing the ability to recover investments with guaranteed returns even though the decision may have not been the best choice in hindsight.
With this model, if left unchecked inefficiencies will grow in two areas. One the cost structure to maintain and operate has the potential to grow beyond reasonable practice. This includes operating cost and compensation. Reliability becomes the goal over innovation and optimal decision making. Regulated model supports the themes if it is not broken don’t fix it. Economics 101 states rewards are typically commensurate with risk. For management teams in regulated utilities to make relative income to other sectors fails that. As a regulated entity, there is monopoly power with a relative less risk on return as compared to various other sectors. Hence one reason to drive for de-regulation not related to optimal market design was the executive suites desire to justify pay relative to other industry. Regulated utility should be considered similar to government – cost center with structured risk.
The other area of inefficiency comes from the desire of the shareholder and potentially management team to boost earnings. This earnings drive may cause non-optimal investment decision since returns are generated through investments. The higher the investments they can get approved, the higher the return. This does not necessarily bode well for promotion of efficiency and conservation.
The key solution to mitigate these inefficiencies is to have a strong regulatory body. The regulatory body should be compensated as highly as the utility to avoid any regulatory capture. Without this, abuses will likely to occur.
The de-regulation model, in theory, would bring more innovation as competition will necessitates that behavior. Competition in general leads to cycles (e.g. Operating Systems: DOS,Windows,Apple, Android, etc…) There are risk as your competitors can make you obsolete. Currently many of the de-regulated markets can claim they are successful and good for society. This is being masked by the long time frame generation assets offer, 40-60 years. Much of our generation capacity was decided in the 1970’s and 80’s. However, those assets are coming to their end of life. Now these large investments need to be made again, but now you have a competitive landscape with decisions requiring much larger returns due to the risk of making a wrong decision. There are no guarantees for these investments in a fully de-regulated world. Therefore decisions to limit the capital risk will occur. Most new generation build will likely be natural gas. Largely because it’s upfront cost is limited. You saw this even when gas prices were above $8/mmbtu. Future generation decisions will not be balanced nor focused on reliability, but based on the best way to maintain risk and extract as much profit as possible.
At this time, I believe as big of an error as Alan Greenspan suggestions that the bankers would police themselves, the belief that a competitive electric market will bring a more optimal solution than regulation may result in a similar fate. I have seen and do believe the regulated model can be abused as much as the de-regulated model can result in undesired results. The key question is which one of these can be more easily adjusted and remedied when they tend to stray from theoretical operations?
I contend the regulated markets are more likely to be maintained than the de-regulated markets. I only accept this premise under the same premise that I appreciate driving on roads and having a fire force take care of my neighbor’s house on fire before it spreads further. In general, I support free markets, but some things are utilities – purely functional and not attractive.
Please send me your comments or suggestions David K. Bellman [email protected] Perhaps I will change my mind if given more information. I have heard and thought of ways to make the de-regulated markets work, but each of those ways result in making it more regulated. One suggestion was to have the RTO pay for and permit greenfield development and allow participants to bid for those projects. This sounds promising, but I am not sure if it would do enough to offer baseload alternatives such as nuclear.
Given my experience in the power markets, I can help design and/or evaluate various market changes.
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Your Energy Consultant,
Solar Projects being approved in California
I am going to be a little critical with today’s reporting. More than once EnergyBiz will report on a deal , but they never delve into the deal. Yes EnergyBiz is free, but seriously it doesn’t take much work with the internet. For example, today’s article I came across on EnergyBiz involves the California Public Utility Commission (CPUC) approving PG&E solar deal with Sempra. In the article, they note how the commission approved the project, the dates, and the size. However, how come no discussion on the cost or expected performance of the project? Yes the project is a bilateral deal so the information is somewhat hidden. A little investigated journalism you can conclude the project is likely a 25 year commitment for under 0.10852 $/kWh with an expected capacity factor of 23%. First you go to the CPUC website. Do a simple search on “PG&E Sempra Nevada Solar “and you will get this link to the deal. In the deal you will note in the beginning “Generation from the 150 MW Project is expected to contribute an average of 303 gigawatt-hours (GWh) annually towards PG&E’s annual procurement target”. This would calculate to a 23% capacity factor. This is not the best capacity factor, but not the worst either.
In terms of cost the same link shows the statement “Based on 2012 commercial online date for the Copper Mountain 2 facility, the 25-year PPA is below the 2009 MPR and accordingly the PPA does not have above-market costs associated with it.” A little more investigative journalism would have you search on the website to see the 2009 MPR. The 2009 MPR can be seen on this link. From the link there is a table showing the 2012 25 year contract MPR is 0.10852 $/kWh. Interestingly if they had used the 2011 MPR, the limit was 0.09274$/kWh a drop of more than 10%.
The next level of investigated journalism is to see what type of cost Sempra is paying to build this facility. To do this I went to a publically available levelized costing calculator supplied by the very capable National Renewal Energy Laboratory (NREL) – note I served on the advisory panel for the technical review team. In addition to the calculator, if you click on the labels NREL will display the tables showing the range of cost. The lowest cost for solar is $5000/kW. For the remaining variables I used period 25, discount rate 4%, capacity factor 23%, FOM 10, VOM 0.002, HR 10000, and Fuel Cost 0. This produced a levelized cost of 0.166. I then changed the capital cost till the levelized cost was below 0.11. This occurs at $3200. If the investment tax credit is computed from the $5000 basis you do get around $3500. Applying a negative fuel cost (-1) from the $3500 capital cost you would produce 0.108. This implies likely the technology cost is still around $5000/kWh with a need for a 30% investment tax credit and some value of renewable credit around $10/MWh.
If you are of the very curious mind, you will be asking yourself how in the world is the MPR that high? Since you will note in the MPR link they state – “The MPR represents what it would cost to own and operate a baseload combined cycle gas turbine (CCGT) power plant over various time periods”. Well you see that’s not really a “true” statement on many fronts. Obviously there are forecast that need to be employed to calculate a CCGT cost in the future. They decided on using a NYMEX future curve for fuel which is understandable. The big driver pushing the MPR high is the assumption of CO2 price.
If this forecast became true, in the near future (in two weeks), Californians would be adding an extra 10 cpg on gasoline and by 2030 they will be paying almost a dollar extra on gasoline. This CO2 cost stream adds roughly $19/MWh on the levelized cost of CCGT– almost a 20% premium. Even removing the CO2 cost and comparing it with NREL levelized cost calculator the CPUC model shows an additional 0.01 $/kWh cost using the same inputs.
With simple investigative journalism the article EnergyBiz reported, which anyone could do scraping a company’s website, transforms into real value and knowledge.
At AEC we are committed to giving you knowledge not just information. Feel free to email me your comments or suggestions David K. Bellman [email protected]
Energy Independence Really?
Energy security is largely overstated and not understood. To secure energy is to have a reliable source of energy. The lack of reliable energy source typically comes from weather disruptions and political events. Therefore, the most reliable energy source usually limits the amount of transportation to obtain the energy source. More domestic use of fuel clearly achieves this objective.
I have always said the US could be energy independent, but we choose not to. The reason to not be energy independent can be explained for two reasons. The obvious reason is economic. If it is cheaper for someone else to supply a good than you could produce, you typically will import. The other reasons, a more philosophical reason, why plunder your resources now when you can let other plunder theirs. In the US, we choose not to plunder our resources; some of it is due to environmental concerns. We choose to have our natural beauty not obstructed by industrial devices and potential environmental spills. This increases the cost to the point we end up importing, versus using our domestic consumption. In the long run, perhaps by being less energy independent now, we will have more energy security later. By allowing others to plunder now, we may eventually use our resources later when we may truly need it.
Those who continually tout energy independence forget these simple points. They are aiming to say a political sound bite to get you to bite. We should not be striving for energy independent, but a smart balance energy plan which balances security, environment, and economics. I certainly enjoy the beaches and mountains without seeing industrial equipment, but I know for that, we must pay a premium and/or import more energy. Energy independence is not a goal one would want to achieve unless we are at war or will be going to war.
We can help developing thought-provoking reports. Please do keep All Energy Consulting in mind for your consulting needs and/or if you are thinking about funding a report. Let us write you a proposal.
Your Energy Consultant,
David K. Bellman
Shale Gas Production so now what?
The enormous potential for natural gas production is the essence of the shale gas revolution. Many people are still spending much of their time quantifying it. For those in the commodity trading, planning, or business development space, I think it’s time to move on and examine the opportunities. Shale gas production will not be small. Perhaps it could be medium with potential regulations limiting the development. It may be extra-large if knowledge is increased and the players involved act appropriately. The next important question is where will it all go? As with any product that is introduced, you need to do some market assessment. I can with some certainty pronounce that the bulk of the new gas supply will go to the power market.
Following that premise, the next question will be how it will go to the power sector? The answer to this will vary. As a producer you need to know your customer and how exactly best to market to this new sector. Given my vast oil & gas experience along with my power utility experience I can be that bridge for you to understand what is involved in this transition. Letting nature/market takes its course for you will produce a very rocky outcome. Approaching the transition in a more strategic approach will allow you to unlock more value and avoid significant on-hands learning moments.
Inversely, as a power/utility company, moving to gas will require much consideration as the dynamic of the gas industry is much different than the coal industry. The lingo and the business strategies are almost polar opposites in some cases. The power and gas industry are currently not aligned in the advocacy position of energy policy (or lack of). This will need to change if this transition will be smooth and productive.
At AEC we can act as the bridge for you. We can pull the two sides together to produce a win-win situation. Please call us to learn, reaffirm, and give you a unique perspective on the situation. 614-356-0484 email [email protected]
CSAPR – Cross State Air Pollution Rule – Trading Strategies
CSAPR – Cross State Air Pollution Rule – Trading Strategies
There are some clear winners and losers in the recent Cross State Air Pollution Rule (CSAPR). With the modified ruling of allowing the first two years of open trading among the groups, bring up some significant opportunity to maximize trade potentials for significant gains. At AEP, I have spent numerous hours learning and evaluating emissions trading strategy given our largest emitter standings in almost every category. I will tell you now CSAPR offers significant opportunity to make or lose significant sums of money.
Emissions trading require game theory analysis with some added inefficiencies in order to safely execute a successful trading strategy. Working with the Center for Energy Economics and simulating the recent CSAPR and reviewing the ruling there are some real opportunities for those in short position to minimize their losses significantly. As with most new trading rules/laws, they never account for potential maximization of individual actors.
If you are in a short position, please do call or email me I can help mitigate whether you are in Group 1 or Group 2. Likewise, if you are long call or email me, please don’t go selling away as you will likely be leaving money on the table. Since the beginning of emissions trading, there have always been significant losers and winners. Emission market trading requires a fundamental approach to ultimately be successful.
David K. Bellman
614-356-0484
CSAPR – Cross State Air Pollution Rule – 5 Steps to Solve / Gain Insights into the Impact on the Market
1. Understand the rule in terms of the number allowance and the limitations of trading
2. Evaluate existing generation emission rates (EPA)
3. Examine the choices to mitigate emissions
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-Retire
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-Install Pollution Control Technology – Cost and Effectiveness
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-Dispatch less – Competitive landscape with alternative plants
4. Simulate the various mitigation sources through pricing emission
- Emission price will lead to reduce emission
- High enough price will lead to retirement or incentivize the installation of control technology
5. Analyze competing fuel competition demand as a result of simulation
- Do the commodity assumptions make sense in lieu of the competitive landscape and underlying fundamentals? If not repeat step 4 with new commodity assumptions.
Call us to help you reaffirm your conclusions or help you through the process. We can identify hurdles and give you solutions to get you over them and also help you avoid the land mines of analytical paralysis.
David K. Bellman
614-356-0484
