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Benchmarks

Fortnightly Magazine - February 15 1999

The future contract for July delivery at cinergy remains at levels reminiscent of last year's prices. At one point the contract reached $170 per megawatt-hour, matching last year's actual average price during June and July. High forward contract prices such as this show that market traders believe that spot prices for electricity will again be sent to four-digit levels.

Three primary factors led to last year's price spikes. First, nearly 23 percent of the capacity in the Midwest was unavailable during June. Second, temperatures reached abnormally hot levels on consecutive days and loads were substantially higher than anticipated. Third, problems in one area of the transmission system quickly became problems in other areas as tight supply/demand conditions limited the ability of utilities to shift generation to meet load. These shifts caused overloads on the transmission system, which resulted in the need for line load relief.

Now it appears that market players are alleviating the first problem--the capacity shortage. First, a few generators in the region have undertaken significant forced outage rate improvement programs to ensure that their generators will not be one of the generators to miss the high next year. The economic incentives to undertake such initiatives are compelling. RDI calculates that a new combustion turbine installed in ECAR would have generated operating profits (revenue less fuel) of $106 per kilowatt if it had been available every day last year. A number of nuclear nits have also returned to service.

A second response has been the reactivation of generation in cold storage. RDI analysis indicates that in ECAR alone there is nearly 2,000 megawatts of generating capacity in cold storage that could be reactivated if price spikes persist.

A final response has come from the merchant plant industry. In the MAIN, new market entrants plan to have more than 600 MW of new capacity built by next summer. Similar activities are taking place in the Southeast.

These industry responses provide two insights into what type of trends may drive the industry in the future. First, electric generation supply is responsive to price. High prices will not go on forever as companies will build new capacity to profit from the high prices. Second, there may be more surplus capacity than industry analysts currently realize. The move to an asset-based management philosophy will induce companies to improve forced outage rates and reactivate assets that can generate additional profits, thus increasing the overall supply.

It is remarkable how much of this response has been stimulated primarily by a move to market-based pricing in wholesale markets. The impacts of retail competition in the region are likely to be even more dramatic.

Christopher Seiple is a principal with RDI.

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