Energy Update

In the US, our energy policies have been transformed by fracking, which has led to an abundance of natural gas and re-invigorated our domestic oil industry, to boot. When I first worked in the energy business they still talked about how the natural gas industry was forced to curtail new hookups of houses in the 1970’s because we believed that we were about to run out of the fuel, and the costs in the 1990’s were about $2 / unit. After a spike up to $14 / unit (which contributed to the bankruptcy of California), economic forces and not government intervention led to the innovation and today’s low prices in the $2 – $4 / unit range.

When natural gas first fell into this low price range, industry participants were basically “waiting it out” to see if prices would rise. The price of natural gas plays a huge part of the overall energy pricing market, since natural gas “peaking” plants are turned on during spikes and they set the marginal cost of power during those peak events. During times of peak usage coal, nuclear and hydro plants reap a windfall since their costs are (comparatively) fixed if the price spikes are set by high natural gas prices. These price spikes have been significantly lessened and now natural gas is used not only for peak plants but for base-unit capacity. If the price of natural gas ever rose near those peaks in the $10+ / unit range all those investments would be un-economical, but price spikes in those ranges don’t seem to be coming in the near future.

Last Hurrah For Wind Subsidies

The wind industry is basically a creation of government incentives worldwide. The Spanish market collapsed completely instantly when incentives evaporated. The US turbine market is about to collapse as well as soon as a governmental program providing subsidies in the form of tax credits to all wind installations in service by year end, as described in this Bloomberg article.

Wind-turbine installations are exceeding natural gas plants in the U.S. for the first time this year as developers rush to complete projects before the expiration of a tax credit for renewable energy. New wind capacity reached 6,519 megawatts by Nov. 30, beating the 6,335 megawatts of natural gas additions and more than double those of coal.

It isn’t known whether or not this tax credit will be renewed; if it isn’t the US turbine industry will likely grind to a halt since wind isn’t competitive in the US without large subsidies. Unlike natural gas, which can be found in areas connected to the gas pipeline grid, most of the best wind locations are not connected to the electricity transmission grid and the costs and barriers to installing these transmission lines are insurmountable under the current regulatory regime, dooming wind to a niche tax subsidized role. Our existing wind infrastructure will sit in place, earning the tax credit, with little or nothing added going forward without new incentives.

Impact on Coal Plants

The dominos now are falling. Midwest Generation, which operates coal plants in the US, has gone into bankruptcy protection. Per the article:

Midwest Generation and Edison Mission Energy (EME) have been hit hard by cheap natural gas prices, falling energy demand, increased energy efficiency and mandates for expensive pollution controls that have all made the power from their aging coal-fired plants uncompetitive on the open market where they sell their electricity.

Ultimately the bankruptcy court and owners that could take possession of Midwest Generation’s assets in the future could continue to run the coal plants – three in the Chicago area and one in Pekin in central Illinois…But if the coal plants were unprofitable under Midwest Generation, there is no reason to expect they could turn a profit under new ownership, sources say, particularly as new sulfur dioxide controls are still needed at every plant, for a total cost of $628 million. A July filing by Midwest Generation indicated that financing from EME would be needed to make the pollution control upgrades; now such financing appears highly unlikely, if not impossible.

Other large coal plant operators are under severe financial strain. They have been partially insulated by the large drop in the price of US coal, which has even led to record exports of coal overseas to Europe (it is almost the definition of irony that the US is sending coal for generation to Europe, the continent that pushed all these climate mandates so hard), as shown in this article:

U.S. coal exports to Europe increased by 29% YoY in the first quarter of 2012, as power companies in the continent switch from natural gas to coal for power generation. Power generating companies in Europe are taking advantage of the lower prices of coal and the fall in carbon emission fees. Natural gas prices are currently at high levels in Europe because they are associated with oil prices. U.S. coal exports have been increasing. Total U.S. exports stood at 28.6MMST in the first quarter of 2012. Almost half of U.S. coal exports are to Europe.

Financial Stress on Nuclear Plant Operators

The nuclear renaissance promised by the current administration never happened; it was a pipe dream to begin with and the death knell was the tsunami in Japan. However, while nuclear plant expansion was a mirage, it wasn’t expected how long the low natural gas prices would stay and the financial impact on nuclear plant owners.

Exelon, the largest nuclear fleet owner in the US, has come under financial pressure and seen their stock price decline due to fears that they may have to reduce their dividend. Since utility stocks are often propped up by their dividend (or almost solely valued based on their dividend), dividend reductions are desperately avoided for not only do they reduce current payouts to shareholders, they fundamentally change expectations for future dividend growth which hits the long term stock valuation. Over the last year their stock dropped from $44 / share to less than $30 / share, and their current dividend yield is over 7%. Per this article, they are paying out 165% of their earnings in dividends, and generally payout ratios of > 70% (as a rule of thumb) are unsustainable.

Cross posted at LITGM

7 thoughts on “Energy Update”

  1. I would disagree on a minor point – if gas prices surged again, existing gas turbines would not be obsolete overnight. Yes, some of the demand would shift to any spare non-gas capacity that had lower cost of production. But changes in the installed capital stock move much more slowly than commodity prices like natural gas. Profit margins would shift from owners of natural gas generation to those forms of generation not directly coupled to the price of gas…but those will have little spare capacity anyway. The end result is higher electricity prices over the short to intermediate run (0 to 5 years say.)

    Exelon owns 17 reactors in the US. The nuclear industry scuttlebutt estimates between $50 to $100 million per reactor for post-Fukushima modifications – figure another $1 billion in capital outlays for Exelon over the next 3 years. Looks like they’ll have to borrow the money to do so or slash their dividend.

    As to natural gas prices staying so low, I’m skeptical. Looks like we’re seeing a bubble burst where initial fracked wells investment blew out the market leaving gas prices below current cost of production for now. This can’t go on and we’re seeing some industry leaders like Cheasapeake having financial difficulties.

    I expect the price of gas to recover significantly. Add in export of US gas via LNG terminals, and we’ll see gas approach global LNG prices of about $6/mmBTU. That will take a few years though – the terminals need to built and licensed although the economic life of a fracked well is only about 2 years. On the downside, domestic demand for gas and electricity will stay low for 4 years at least as demand tracks economic activity and Democrat policies continue to suppress growth.

    Obama done screwed coal but good. He’s been no supporter of nuclear either. Worst, he’s a wet blanket economically for all.

  2. Agreed that capital stock doesn’t move immediately in response to fuel price changes. In the post I basically say everyone waited years to see if natural gas prices would move before throwing in the towel (whether that means go bankrupt or cut their dividend, which Exelon hasn’t done yet).

    I don’t know about natural gas prices rising. They have a lot of existing wells and infrastructure in place. They also are linked to oil since you often find them together and there is little talk of oil prospecting slowing in the short, medium or long term. But I certainly am not a prognosticator either way.

    The fact that low gas prices reduced the price of coal and bought the coal plant operators a bit more time is interesting.

    Low gas prices will push out the older coal and nuclear units.

    Basically by the time gas prices rise we will be so desperate maybe we will just start up our own coal plants. They will be damn efficient by then, we can just copy the Chinese designs since we won’t know how to build them anymore, 10 years from now.

    The fight is going to move to our decaying infrastructure for delivery and the impending fuel switching from electric centrally burned to gas powered home generation. They will co exist but this is going to be an interesting fight. People are going to get pissed paying 2x – once for electrical infrastructure (through their bill) and once for a reliable, backup natural gas generator.

    Like cable which is under threat from the internet (although of course often they are provided by the same company), electricity is going to be a less dominant monopoly in the future. Land line phones are now virtually dead.

  3. Gas wells, particularly fracked wells with horizontal runs, are very productive but only for a couple of years before they peter out. Therefore, drilling must resume when price reflects production costs.

    Home generation moves the delivery problem from wires to pipes. Gas transmission and distribution systems are in even worst shape than our electric systems. Plus, applying the same emissions standards to home generators from central station units will drive up the cost and hassle of installing and running a home generator – and that’s only for those who can afford the up-front capital investment.

    “Trains” magazine had a piece on how the jump in coal exports to Europe was stressing rail systems on the East coast and causing big investment in more coal shipping terminal investment at our ports.

  4. I was looking at the latest Exelon earnings presentation in November and they were predicting natural gas costs in the $4 – $5 / unit range in 2013-5 so they are in line with your expectations for increases.

    I am not much at predicting prices as I note above.

  5. }}} The nuclear renaissance promised by the current administration never happened; it was a pipe dream to begin with and the death knell was the tsunami in Japan.

    I don’t agree that the notion was a pipe dream, but certainly am in accord with the notion that the stupid tsunami dealt nuclear power development another massive setback akin to that of TMI. As with recent Gun Control exhortations in response to Denver, Oregon, and Connecticut, the response is stupid and utterly senseless, but it certainly is the public’s idiotic view that a 40 year old design hit by a triple whammy that killed no one off the property of the plant is indicative of the inadequate safety properties of modern nuclear power… :-S

  6. I’m designing post-Fukushima modifications. The plant I’m lead engineer on will be tsunami-proof!

    And it’s on Lake Erie.

    Carl and I have had exchanges in the past about new nuclear build. Low gas prices and Depression Era negative demand growth for electricity certainly didn’t help but the Obama Administration took great pains to dive a stake through the heart of new nuclear in this country.

    Here’s a summary of the war on nuclear:

  7. Joe Somsel has been writing about these issues for years but nobody in the political world seems to be listening. Peggy Noonan seems to believe that the Republicans are going the way of the Whigs and she might be right. She links to this piece which poses the problem that he describes:

    We begin our discussion by noting the three distinct dimensions that have always defined American conservatism. The original and traditional American conservatism of the nineteenth and early twentieth centuries collapsed in a great debacle during the Great Depression of the 1930s, but this was followed by a creative reinvention of American conservatism during the Great Stagflation of the 1970s. This reinvented conservatism experienced its own debacle during the current Great Recession, which began in 2007 and which continues into the 2010s. We conclude with a review of the current condition of what was once a reinvented, but now seems to be YET another collapsed conservatism, in the light of the elections of 2012.

    He poses this theory:

    It is the business elite that, over the long run, has proven to be the most powerful component of the conservative coalition; it has gotten its way on more issues than either the religious or the security conservatives, and it has done so not only within the conservative coalition itself, but with actual government policies. Calvin Coolidge may have exaggerated somewhat when, in the 1920s, he said that “the business of America is business,” but it has been no exaggeration that the business of American conservatism has been business.

    However, business is by no means limited to the financial services area.

    Traditional American conservatism and its political vehicle, the Republican Party, largely dominated American society and politics after the Civil War down through the 1920s. However, they were unable to provide satisfactory responses to the challenges posed by the Great Depression during the 1930s and the Second World War during the 1940s. The result was a great debacle for this kind of American conservatism in each of the three policy arenas, and this in turn resulted in a long period when American progressivism and its political vehicle, the Democratic Party, largely dominated American society and politics.

    The Depression was a failure, not of the conservatism of Calvin Coolidge but a failure of the progressive policies of Herbert Hoover and Franklin Roosevelt. The essay linked here is worth reading in full but Peggy Noonan seems to think that the only hope for the Republican party is a return to social conservatism.

    He is right about the policy dominance of “Wall Street”, and the need for the party to kick away from policies that have left it looking like the handmaiden of the economic elite. In the foreign policy section, something should be added to his references to the Cold War, something that has been largely lost to history. Americans for half a century opposed the Soviet Union and stood in support of US efforts in the Cold War for many reasons — the Soviets were totalitarian, a dictatorship, and dangerous. But one of the biggest reasons Americans resisted the Soviet Union, and made sacrifices to oppose it, was that the Soviet Union was atheistic — and expansionist.

    Americans saw that wherever the Soviets went they oppressed the church and the religious. And Americans were a church going people.

    I don’t believe that social conservatism will save the Republican party as it tends to missteps like Akin and Mourdock, both sincere men but inept at politics. There is no question that we are suffering from a debased culture but nuclear power and molecular biology do not seem the natural home of social conservatives.

    The crony capitalism of Goldman Sachs does not add to the economy. Invention, like that of Craig Venter, and energy progress like fracking does.

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