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Boom and Bust? Understanding the Power Plant Construction Cycle

Rising energy demand could spur investment in waves, but a fixed capacity charge might flatten the curve.
Fortnightly Magazine - July 15 2000

capacity payment in the range of 5-8 mills per kilowatt-hour could stabilize the market in the long run. The "price of stability" turns out to be only slightly higher wholesale rates in the short run.

Moreover, this strategy of adding capacity price incentives would seem to have minimal effects on consumers in retail markets. Based on the ratemaking rules in California, retail customers would be shielded from the short-run increase in wholesale rates.

Reliance on Energy Prices: Cyclical Behavior in the Long Run

The figures that follow each assume a particular rate of demand growth and then show the effects on (1) the PX energy price, (2) investment in power plant permitting and construction, and (3) new plants coming on line, which are assumed to be gas-fired, combined-cycle combustion turbines (CCCTs).

They also show how the energy price compares with the total, levelized cost of new CCCTs.

Short-Term Reaction. Figure 1 begins with just two variables, the cost of CCCTs and the PX energy price, and considers the reaction of the construction cycle only over the short term, for the eight years from 1998 to 2006. It assumes the simulation with base case assumptions as explained in the Technical Appendix. In Figure 1, both the PX energy price and the levelized cost of a new CCCT are measured in dollars per megawatt-hour, in constant 1997 dollars. The PX price begins the simulation at $20 per megawatt-hour, around the same result obtained in a detailed analysis by the Northwest Power Planning Council (NPPC 1998). The growth in demand forces the PX to increase the price to bring more of the existing gas units into operation. The price of natural gas escalates at 1.0 percent per year, which also contributes to the upward trend in both the PX price and the levelized cost of a new CCCT. By the end of eight years, the PX price has increased to exactly the levelized cost of a new CCCT.

Three Predictions on Market Price Effects

Northwest Power Planning Council

The staff of the NPPC warned in 1998 that most commodities go through cycles of over- and under-supply, and that electricity is not likely to be different. They repeated the warning in their 1999 report on adequacy of power supply in the Northwest.

Brattle Group

This consulting firm took a similar position in its 1999 report on electricity markets in "exuberant regions" like Texas and New England. Analysts observed that New England was the leading market for gas-fired, combined-cycle projects, where the capacity planned on the drawing board appeared sufficient to double the installed capacity base.

Brattle also warned that electricity prices in the future would no longer reflect average total costs, but would likely be highly volatile, with unpredictable price spikes in the short run and boom-bust cycles over the long run.

California Energy Commission

A third example comes from market price scenarios issued by the California Energy Commission in February 2000.

The commission staff warned that additions of new generating capacity would not occur in a smooth, even manner, but would more likely follow a