You've heard talk lately about the convergence of electricity and natural gas. That idea has grown as commodity markets have matured for gas and emerged for bulk power.
Genco Risk: "Location, Location, Location"Vinod Dar's recent article, "Competition, Convergence . . . and Cashflow? The Power Business in the Next 20 Years" (Apr. 1, 1996, p. 31), highlighted some of the risks inherent in investments in new power generation plants in a restructured electric industry. Dar discussed issues related to liquidity, credit quality, and foresight, but touched only briefly on the importance of "positioning" - perhaps the most critical issue in determining the financial viability of a new power generating unit.
Now that the California Public Utilities Commission has encouraged California's three major investor-owned utilities (IOUs) to divest themselves of a sizable portion of their existing fossil plant - to avoid a concentration of market power in generation - certain questions arise: What is an old generating unit worth? Which plants will the IOUs offer up?
These questions call to my mind the three basic tenets of the real-estate market: location, location, location. A gas-fired unit's
installation cost, fuel-price risk, and the market price for its "product" are all related to its location.
A new unit, particularly in California, must meet a variety of siting and permitting requirements that add to the overall cost of installation. These costs rise dramatically as the site moves closer to a major load center. Existing units may even require expensive retrofits to make them environmentally acceptable. Thus, some investors may find it more profitable to locate a new generating unit farther from a load center, since the cost of transporting the unit's power to the load may more than offset the installation premium at a closer locale.
Similarly, the price of natural gas delivered to the burnertip will also affect a unit's profitability. While natural gas "choke points" may not prove troublesome in the near term, given existing gas pipeline capacity, power plant owners still must consider appropriate fuel-risk strategies for 20 years out, when natural gas curtailments may reappear. Will easy access to storage or backup fuel supply provide a sufficient hedge to allow a generating unit to make only spot-market purchases of gas? Investors may find certain fuel-risk strategies less expensive if a unit is located closer to the gas production fields in Canada and the Midwest.
Finally, the location of the unit will impose a tremendous impact on the revenues received for its generated power. Is the unit located downstream or upstream of an electric transmission "choke point"? Can the unit provide needed voltage support and, more important, get paid to do so? The prices paid for unit ancillary services will affect the viability of older units located near load centers. By contrast, revenues from ancillary services for a unit located far from a load center may be negligible. This fact, when combined with a higher electric transportation cost, may undo a proposed project.
Here's another point to consider: How will the owners of the gas and electric transportation systems respond to existing and future choke points? If a generating unit located downstream from an electric transmission constraint receives a premium for its power, the owner of the electric grid could end