After spending 32 years in the traditional electric utility business interfacing with customers large and small, I have come to conclude that American consumers generally hold a view that energy prices are too high. This view, fueled by decades of consumer activism and regulatory treatment is predicated upon a skewed perhaps narcissistic view of the world and the operation of energy markets. The facts suggest otherwise! According to the US Energy Information Agency (US EIA), the REAL price of delivered electric energy at the end of 2007 was the same as it was in 1960.
As figure 1 suggests, the price in real terms for electricity in the United States has been indexed to GDP growth since at least 1960’s. True, there have been years where the trend was disrupted by supply/demand imbalance or major policy initiatives but in general the trend is very clear. What is true for electricity, not surprisingly, is generally true with all forms of energy and I would assert that it is because all traditional energy forms are indexed to oil. Again at a fine enough granularity, it is possible to see divergence in these prices for short periods of time but over the long haul, the trend is clear and can be seen in the US EIA data base covering that period.
What this means, as a practical matter, is that energy prices have been kept artificially low, albeit stable, over a very long time. This relative stability in energy prices has been the engine which has driven our economic prosperity during that period of time. This has been achieved through economies of scale and scope in the industry sectors and in the consumer sector through dramatic improvements in productivity –i.e. Energy Intensity. In the 50’s and 60’s for example the vertically integrated electric utilities took advantage of materials technology improvements to increase voltage levels for generation, transmission and distribution equipment. Generating plant designers took similar advantage of the capability to run hotter boilers at higher pressures to get more energy conversion per unit of coal input.
Over decades, regulators and policy makers relied on the ability to keep consumer prices low by taking advantage of these improvements. Our economy flourished as industrial processes were mechanized and electrified. All the while though we were creating unintended consequences that we now need to confront. The US accounts for 25% of the world-wide consumption of energy—to support 6% of the world’s population. Many have suggested that situation is not sustainable in the long run as other economies seek to expand and grow and improve the quality of life for their citizens.
We have built an economy that relies on cheap energy to fuel its expansion. I, along with many others believe those days are numbered and this presentation will attempt to explain what is coming and how we might deal with it. Consumers in the mass market have come to expect and indeed demand access to cheap energy. Industrial and large commercial consumers led the charge across the country over three decades to deregulate natural gas and electricity in the misguided reliance on cheaper energy as the solution to their problems.
Looming ahead of us in terms of traditional energy pricing and availability is what can best be described as a train wreck---In A Tunnel!
I would argue that the first train has already entered the tunnel and we are incapable of stopping it. That train is the rapid growth in energy demand by the remainder of the non-OECD nations (Organization for Economic Cooperation and Development-i.e. US, Canada and Western European nations). According to the International Energy Agency (IEA) “World Energy Report 2009” released at the end of last year, total consumption of non-OECD nations will increase by 93% by 2030. Most startling is the consumption growth in China and India which are expected to increase Ten Fold during the next 20 years. That might not seem so startling without a benchmark of comparison. China has just recently surpassed the US in terms of total energy consumption and its per capita consumption is still less than 1/3 that of the US. Do the math. If China and the US collectively account for 1/2 of the world’s energy consumption and China and India are growing by ten-fold between now and 2030, someone has got to lose ground or significant sources of new production must be found.
This same IEA report declares that Oil consumption world- wide will require 105M barrels/day (b/d) of production-up from today’s 85M b/d. Again we might be tempted to exclaim that is only a modest 23% increase from today’s levels. But here is the tunnel where the wreck will occur—75M b/d, of that production and consumption will have to come from new, currently undeveloped sources of production. Do we really believe that we can replace over 90% of the world’s oil production capacity and grow it another 25% in the next 20 years? Admittedly, I am only an electrical engineer, not a petroleum geologist but I am betting that scenario is highly unlikely if only because we live on a finite piece of real estate where it took millions of years to create those fossil oil reservoirs we are currently tapping-and have been for less than 100 years.
As the emerging economies of the world compete for increasingly scarce fossil fuels, you don’t have to be an economist to predict significant increases in prices and potential availability problems. I would expect that reliance on oil to put upward pressure on the price of all fossil fuels. As competition for ever more scarce oil causes people to shift to alternatives like natural gas and coal they too will feel significant price pressure and any supply disruption in any of those fuels is likely to manifest in scarcity of supply for the other substitutes as well. Finally, to the extent that these fuels are used in electricity generation, expect those issues to be reflected in the price-and perhaps even availability for at least some hours of the year- of electric energy.
That brings us to the “domestic” train in our metaphorical train wreck. Our current economic recession has resulted in what appears to be an Oversupply situation. Prices have become soft, even fallen in electricity, natural gas, coal and oil markets domestically. Focusing on the electricity market specifically, a reduction between 30 and 35% in consumption in 2009 is directly attributable to the recession. We first saw the impact in the spring of 2008 at a time when consumption generally should have been picking up, it was actually falling. As we now know, by the fall of that year it was clear we were in a full-blown recession that continues today.
This falloff in consumption by the way has not been matched with a similar reduction in instantaneous demand. Driven by sustained hot weather this season, many delivery systems haves seen peak summer loads that match or exceed their all-time system peaks. Since those peaks exist for only about 100 hours each year, we might get lulled into a sense that all is well. I assure you, as any utility engineer or operator will tell you, the instant demand outstrips supply, the interconnected electrical system will automatically shed load and shutdown to protect itself from catastrophic equipment overloads. These actions occur in milliseconds-far faster than any human intervention can control. The only way to assure that it does not occur is to always have an available reserve capable of picking up the next instantaneous change in the system. Until we have viable electrical energy storage technology available to perform that task we rely on the inertial capability of all the generators that are on and producing energy at the time the event occurs. If they are all loaded to their maximum capability, we are only one light switch away from a blackout.
The reduction in economic activity and falling energy consumption has led to an excess of electrical generating capacity and falling electricity prices. This trend would appear to contradict the picture painted by the IEA report. What has happened in recessions/economic slumps past is that the “excess capacity” quickly turns into under capacity as the economy turns around. This can be understood in the context of consumption growth. Normal electrical consumption growth shown in figure 2 has been less than 2% CAGR for decades. But when economic recovery does occur consumption will not grow as it originally did, it will step back. Certainly not 100% but a significant 60-75% step back in a relatively short period of time will occur if history is any predictor of future. This occurs because office space that was vacant may become only partially occupied but will require most of the HVAC and lighting of the previously fully occupied building. An assembly process totally shutdown right now might resume production for only one shift 5 days per week but the equipment will all be on for those hours of use.
Couple the step- back in energy consumption with the loss of capacity that is occurring and it is not a stretch to understand that a very real under capacity scenario can emerge fairly rapidly with an economic recovery. The loss of capacity is happening all around us and for well understood, if not noticed reasons. A casual search of the industry media covering just 2010 announcements of plant closures revealed a total of 36 units producing nearly 7,000 MW of electrical energy slated for closure or already mothballed in the region east of the Mississippi.
First and foremost, older units heat rates and electric energy production costs prevent the units from clearing their costs in this soft market causing operators to shut them down and/or mothball them. This is a trend we will continue to see according to the Forbes Magazine article titled Why Small Coal-Fired Plants Are Going Away” by Jonathan Fahey, July 1, 2010. If those older units go into cold shutdown or mothballed status very long-more than a few months-it is highly unlikely that they will ever restart even after a rebound in the economy requires more electricity production because of the practical limitations imposed by periods of disuse and potential for new requirements once restarted.
This situation is being exacerbated by the lack of new construction of base load generating plants. In fact, according to the National Energy Technology Lab Report “Tracking New Coal Fired Power Plants” released in January 2010, 34% of all announced coal plants have been cancelled or deferred. Recognize that these are assets that take a long time to permit, site, construct and place into operation. So, even if the picture cleared up tomorrow and decisions were made to begin the process, we are a decade at least away from significant new base load generating assets. Given the cloudy picture regarding potential carbon legislation it is highly doubtful that the picture is going to clear up anytime soon.
Finally, for those units still in operation but sneaking up on their design life there are other forces at work to reduce capacity and life. The US EPA, under the current Clean Air Act 1977 authority began several years ago to challenge the upgrading and life extension work that has been at the heart of keeping old units economically viable many times for decades past their initial 40-50 year design life. Those few plants that did upgrade have, either voluntarily or under consent decrees, agreed to install new environmental controls. Those additions consume a portion of the unit output thus decreasing available capacity and of course making energy produced more expensive from those units. For the remainder of the plants across the country, owners are holding off doing life extension or upgrades that might trigger New Source Review (NSR) requirements. That will ultimately result in those units not being available for another 30 to 40 years of operation. As they eventually come out of the market-due to economic factors described above, that capacity hole created by the dearth of new power production capacity will only get deeper.
By the way, this trend has not gone unnoticed by some in the Independent Power Production (IPP) segment of the industry. Since July, two major consolidations involving three major companies have been announced. GDF-Suez has announced a planned acquisition of International Power which will make it the largest IPP in the world-nearly double the size of its next competitor AES. The Blackstone Group just weeks later announced the acquisition of all of the generation assets of Dynergy and a simultaneous sell off of the gas fired generation to NRG. The announcements summed up the situation very clearly: the assets were tremendously undervalued in today’s market conditions, but are expected to return handsomely on the investment once the economy turns around. I’m betting with the folks making the $5B bets that they are right and history will repeat itself!
The cumulative effect of these decisions made or delayed will be that electric energy prices will cease the declines experienced during this recession and will begin to rapidly increase. Of course, the biggest unanswered question is -at what rate will energy prices increase. I cannot predict the future with any more clarity than anyone else but I would point to history in New Jersey to give us a clue as to the likely magnitude.
Figure 3 shows three scenarios of electricity prices for the future. The lowest- blue curve- assumes no carbon cost ever and a price growth of 2.5%. This growth scenario is only provided for relative comparison since it is unlikely that future growth will be below the historic CPI trend of 3%. The red curve assumes the historic CPI at 3% and a carbon cost at only the voluntary $20/t equivalent price kicking in after the next presidential election cycle.
The Green curve demonstrates the historical cost of energy in New Jersey since 1990. Notice that in 2000, as a result of the deregulation of power production in NJ, there was an artificial reduction in price of about 10%. Also notice that the price for 2010 was held at the 2009 level to reflect both the BGS auction price decline and the time averaging impacts for this year. Since deregulation, and including the effects of that decrease, we have experienced a +6% CAGR in price over the decade. Obviously, if we only looked at the last 5 years that growth rate would have been higher. We used the time averaged rate for purposes of conservancy and added a Carbon cost at the voluntary level in 2016, but I for one will be surprised if future prices grow this slowly for all of the reason enumerated before.
The ancient Chinese Proverb declares, “prediction, especially with regard to the future, is very difficult” but the weight of momentous forces both internally as well as external to the US suggest that the real growth rate may substantially exceed the rate experienced over the last decade in New Jersey. My thesis is simple. The forces on the market over the several years that led to double digit increases in electricity rates in NJ will all be exacerbated by the forces I have described above. If there was sufficient market justification pre-recession to sustain those price growth rates then it is likely that we can expect at least that much from the confluence of forces that will lead to shortages in capacity as we begin to emerge from the recession and consumption steps back to some level below the pre-recession levels. Couple that with some level of carbon cost flow though and I expect all of us to be in for a significant and long term increase in electric energy pricing and a possibility, at least for peak hours of the year, scarcity of supply.
Some have argued that we have been through this cycle before and we can and will solve it the same way-with gas fired combustion turbines. They are after all easily deployable and natural gas is cheap. To that faction I would just note that even the Federal Energy Regulatory Commission (FERC) predicts natural gas prices forward are not going to stay at the current low of $4/MMBTU. FERC predicts a 36% price increase this year and 50% by next year. That projection does not include the effects of likely regulation of the Hydro-fracing processing that proponents say will give us ready supply of gas. Nor does the projection include the impact on gas prices that inevitably occur when we burn gas for electricity production in large quantities such as we experienced in the early to mid1990’s.
There are those who would point to offshore wind generation as the cure. Even its proponents admit that there is a 7 year siting and construction period in the most optimistic view. For those that think the next generation nuclear unit will be the savior, I would just point to the fact that the projected costs are quoted to be on the order of 15 to 20 Billion dollars for a single 1,000 MW unit. That is a number for a single power plant that is larger than the market cap for most power plant owners. It is unlikely, even if someone figures out a way to fund it, that the first unit will be designed, approved and constructed in the next 15 years considering the experiences with the last of the first generation units that went online in the 90’s.
So, we are left with a quandary. Our economy has grown in the past at the expense of, and some would say upon the backs of, the underdeveloped world economies. There is no way, short of seizing resources from others and quashing those emerging economies’ growth aspirations that we can effectively stop that train from entering the tunnel. It would appear that we are going to be hard pressed to stop the domestic energy train from entering the tunnel.
There is good news though. We have the capacity to stop our train and eventually, at least over the longer term, to return to a period of relatively cheap energy. The solution lies in the achievement of the New Jersey Renewable Portfolio Standard (RPS). The RPS requires 22 ½% of the electric energy consumed in NJ by 2020 to come from renewable sources of energy production. A minimum of 2 ½ points must be from solar generation. Solar Photovoltaic generation is time tested and effective as a source of environmentally sustainable energy production. The difficulty in implementation relates not to the technology but to the financial construct necessary to incent the construction of this solution.
One of the perversities of the situation we now find ourselves in as a result of artificially cheap traditional energy sources is that it holds off the adoption of alternatives in the market place. The only way we have to overcome this difficulty is through policy initiatives at the State and Federal levels. Currently we rely on a 30% Federal Investment Tax Credit (currently payable as a cash grant expiring at the end of the year) coupled with accelerated depreciation (5 year MACRS) credits and New Jersey’s pseudo market based Solar Renewable Energy Certificate (SRECs) requirements. The financial construct requires the owner of the solar PV array to be in a position to take advantage of tax credits in order to amortize the cost of the installation and to be in the SREC trading business-activities that won’t work for everybody.
That problem will eventually be resolved as traditional energy prices soar and alternatives continue to gain from scale and scope economies. In fact, figure 3 shows that, at least on a Levelized Cost of Energy (LCOE) basis-that is the average cost over the life time of the solar array, we can expect solar PV to be equivalent to traditional electricity production within the next 3 to 5 years. Beyond that point, fueled by the predicted price increases in traditional electricity production, I would expect solar PV and in fact all alternatives to stop their current price declines. Once price parity is achieved, there will be no rationale for prices to decline further until energy consumption growth and supply are balanced.
There will a window of opportunity over the next several years for companies to adopt solar PV as a viable long term price hedge against the future increases in traditional electrical energy prices. As demand ramps up, driven by further declines in solar prices and increases in traditional energy prices, that window will begin to partially close simply driven by supply and demand realities. For those with capital to invest and a tax bill to offset, a turnkey installation on their roof or grounds might fill the bill. In exchange for their investment dollars, they keep the tax credits (or grant), depreciation credits, SRECs generated, and of course get the benefit of all kilowatt-hours generated as a direct offset to their electricity bills.
Those with limited capital or desiring to keep their capital working in their core business can obtain the benefits from a third party developer such as American Clean Energy through a Power Purchase Agreement (PPA). In exchange for an easement for the term-usually 15 to 20 years, the host gets paid usually in the form of reductions in electricity pricing for energy produced by the array. The PPA provider uses the tax credits and SRECs and electricity sales to the host to amortize the cost of the investment and earn a return for the investor(s).
Both approaches can and do work in New Jersey. Anyone interested in the topic can find more information on-line at the Office of Clean Energy www.cleanenergy.com , the NJ Board of Public Utilities at www.state.nj.us/bpu or from any of the companies represented at this conference.
- United States Energy Information Agency (US EIA) –www.eia.doe.gov/emeu/steo/pub/special/pdf/2010_sp_02.pdf
- International Energy Agency (IEA)- World Energy Outlook 2009 www.iea.org/speech/2009/birol_moscow.pdf
- US Federal Energy Regulatory Commission (FERC)- NYMEX Natural Gas Forward Price Curve www.ferc.gov/market-oversight/mkt-gas/trading/ngas-tr-fwd-pr.pdf
- National Energy Technology Lab- “Tracking New Coal-Fired Power Plants, Jan 8 2010” www.netl.doe.gov/coal/refshelf/ncp.pdf
- US Environmental Protection Agency (US EPA) -Reconsideration of Interpretation of Regulations that Determine Pollutants Covered by Clean Air Act Permitting Programs www.epa.gov/air/nsr/documents/psd_memo_recon_fs_032910.pdf
- United States Energy Information Agency (US EIA) –www.eia.doe.gov/fuelelectric.html
- Forbes Magazine – Why Small Coal-Fired Plants Are Going Away, Jonathan Fahey, July Issue 7/1/2010