[BETA] Fortnightly

LAST YEAR, RESOURCE DATA INTERNATIONAL PREDICTED THAT merchant plant activity was poised for explosive growth as deregulation created opportunities for a new breed of highly efficient generators. (See "Merchant Plant Activity Set to Explode," April 15, 1997, p. 14.) This prediction has proved true, with nearly 30,000 megawatts of publicly announced merchant plants under development.

More than 50 percent of this development is concentrated in New England, a particularly attractive market for merchant plant development. About 60 percent of existing generation in this region was built more than 25 years ago. These older, inefficient oil- and gas-fired plants cause high market prices. Closure of Maine Yankee and Haddam Neck nuclear plants removed excess capacity from the market; additional closures could create a need for more capacity.

New England is relatively isolated from other power markets due to limited transmission interconnections. Finally, most states in this region are moving rapidly to introduce retail competition, increasing the pool of potential buyers for merchant plant power.

Yet power plant developers seem to have overcompensated for any expected capacity shortages. About 25,000 MW of generating capacity exists in the region. If all publicly announced merchant plants were built, another 15,000 MW of capacity would be added to the grid. Too much new capacity could lead to low market prices; it also would push reserve margins in the region to 100 percent. Clearly, not all of this proposed capacity will get built. Some capacity, however, is already past the permitting stage.

Companies such as FPL Group and Sithe Energy will face considerable pressure to build their proposed capacity. These two companies recently purchased generating assets from utilities in New England. Implicit in their bids was the increased value that could be achieved by adding more capacity at existing sites (4,300 MW total).

RDI used its electricity price forecasting model to examine the sensitivity of market prices to new capacity additions. The model added 9,215 MW to the New England market. The results indicate that this amount of capacity additions would drive prices to a level that reflects short-run marginal costs ($20 to $25 per MWh) rather than long-run marginal costs ($32 to $36 per MWh). During peak hours, prices could drop by half.

New capacity additions could create intense competition among individual generating units. Although the most efficient merchant plants could achieve capacity factors close to full output, a plant only 10 percent less efficient than the most efficient plants would achieve utilization factors of less than 40 percent. This dynamic will give a competitive advantage to developers of larger plants that have increased efficiencies.

If even half the proposed merchant plants are built, the profits of developers likely will vanish. Developers who get started early may have an edge over others as the market absorbs capacity and prices decline to levels unable to support additional plants.

Christopher Seiple is principal and Christopher Neil is senior consultant with Resource Data International Inc.

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