Impending Electric Shock? Consumers And Investors Should Brace Themselves

By Ed Hirs, Energy Economist

What happens when governmental regulation dictates that producers charge less for something than the cost of creating it?  Shortages, of course:  no sane producer is going to make something just to lose money in the process.

That is the road we appear to be headed down with electricity in the United States.  Costs are increasing partly because of increased environmental regulation, but the principal factor is that the cost of building new generating plants has in many cases outstripped the price at which generators can sell their product.

The industry is in a transitional phase.  Gas-fired plants can operate cheaply, but there aren’t enough of them to go around. Renewable sources, such as wind and water, continue to increase, but not quickly enough to make up for the increasing closures of older coal and nuclear plants, and they still cannot come close to competing on cost with gas-fired ones.

The result is that grid managers and utility regulators are worried that capacity will diminish to the point where scarcity will result in dramatic price spikes.

In 2016, no region of the country has an average wholesale price of electricity greater than $32 per megawatt hour. (One megawatt hour is equal to the amount of electricity used in about 330 homes during one hour.) This does not compare well with the costs of new generation as compiled by the Energy Information Agency. These levelized costs then provide us a way to compare the all-in costs of producing one megawatt per hour of power as summarized in this chart.

Gas is the winner by a mile on its current low price, and gas is also attractive because generation facilities can be built in less than two years, less than half the time of a coal plant of the same size, and for less than half the capital investment to boot.

Unlike the old days, when utilities were highly regulated and regulators made sure they were profitable, in today’s world utilities are subject to free market competitive forces.  The Supreme Court has ruled that utilities are not guaranteed to recover their costs or investments.

How did we get here?

In the past, electric utilities were generally monopolies and limited to a regulated return on invested capital — for example, a $1 billion power plant would be limited to electricity rates no higher than those that would generate a 16 percent return on invested capital.

The incentive for utilities, then, was to build larger plants in the guise of ever increasing reliability. The overbuild included generators, transmission lines and local distribution lines. There were obviously cross-subsidies built into this system, because running one line to a rural area would not pay for itself with that one customer at the end of the line, but with every customer on the system paying to string the line to until it reached the last customer in the boondocks, utilities always had the incentive to keep stringing the line. This led to an overbuild of generation capacity, and sharp operators including Enron and other energy traders convinced governors, legislators and regulatory bodies that by unbundling the various services provided by the industry — “deregulation” — they could open up wholesale power markets and provide lower costs to consumers. That is, generators would have to offer their electricity for sale into a market under strict rules and regulations. Wholesale purchasers would then bundle purchases and resell the electricity to consumers. Generators would be separate from transmission companies and vice versa.

The transmission companies generally remain under old regulations as common carriers; think of them as toll highways for electricity supplied to the consumer. Access and exit are controlled. Payments and profits are guaranteed. Consumers collectively still pay for the last mile of transmission lines.

For the companies that generate electricity, however, it’s a brave new world.  Deregulation began when natural gas was scarce and therefore expensive, making it noncompetitive versus coal and nuclear. However, because natural gas plants were relatively quick and cheap to bring online, they became the go-to solution for short term power supplies necessary to balance the grid during peak periods. These peaker plants extracted monopoly prices from the grid operator simply because they could, and these high costs were spread across all consumers in the market.

Shale gas – and the resulting bonanza of cheap natural gas – upended the old order of electricity generation economics. Beginning with the shale gas revolution, utilities could consider using gas-fired plants not just to manage peak demand, but to compete directly with coal and nuclear for all levels of business. Peaker plants have now been repurposed to also provide continuous electricity supply when required.

Today, nuclear facilities Diablo Canyon (PG&E), Pilgrim (Entergy), Fitzpatrick (Entergy), Clinton (Exelon) and Quad Cities (Exelon) are slated to close.  Dominion Resources has requested that the state of Connecticut consider economic incentives to keep open the Millstone nuclear power plants, which can provide more than one-half Connecticut’s daily electricity requirements. Nuclear power plant operators cannot cut costs any more. They are acutely aware of Northeast Utilities’ 25 felony convictions for unsafe reactor operations due to zealous cost cutting.

Nuclear operators had expected salvation from the Obama administration’s promises to impose a cap-and-trade scheme or carbon tax on fossil fuels. But the Great Recession interfered, and no congressman could vote to increase electricity prices and expect to be re-elected.

Coal-fired plants received a temporary reprieve when Supreme Court stayed the implementation of EPA’s Clean Power Plan, but the future for coal still looks dim.

Grid operators are in the unique position of managing electricity supplies and distribution, but they cannot force utilities to continue to operate at a loss. Utilities know the history of the state of California forcing Pacific Gas & Electric to sell electricity below costs and driving the company into bankruptcy.

The challenge for grid operators in regulated and “deregulated” markets will come when their grids come up short on hot or cold days. Eventually, costs to consumers will begin to increase and be realized either at the meter or by consumers turning to their own solutions, such as rooftop solar, battery storage, backup diesel and gasoline generators. Come up one megawatt hour short at a data or medical center on a hot summer day and prices will skyrocket. One grid manager for a “deregulated” market that has experienced such shortfalls has imposed an old-fashioned regulated price cap of $9,000 per megawatt hour on generators in those circumstances, or about 300 times the average price across the grid. Prudence dictates planning ahead, but grid operators and regulators can only encourage new generation sources. Rising prices will make new generation capacity happen.

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