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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

is priced at $1.50 per million Btu at the start of the simulation, the variable cost would be only $10 per megawatt, and the total levelized cost would be around $26 per megawatt-hour (in '97 $). The total cost will increase over time with increases in the price of natural gas. With natural gas prices at $2.20 per million Btu in the year 2003, for example, the total levelized cost would be around $27.5 per megawatt-hour (in '97 $), matching the 1997 price forecast of the California Energy Commission. #

We assume that new CCCTs will be constructed based on investors' forecasts of the future PX price. If investors look into the future and "see" a price exceeding $27.5 per megawatt-hour, they will apply for construction permits and receive permission to build 12 months later. Investors will not apply for a construction permit until they "see" a profitable PX price in the future. Investors are continuously monitoring the PX price. If they believe that profitability has dropped during the 12 months required to obtain the construction permit, they may cancel the project. But if CCCTs still appear profitable, investors will initiate construction, and the new units will come on line 12 months later.

Feedback Mechanisms

This article focuses on the stability of construction over time, so it is important to appreciate the principal feedback mechanisms in the model. The figure below shows the two balancing loops that dominate the simulated system over time. The inner loop is highlighted with bold arrows. It represents the rapid adjustments in generation from existing gas-fired plants responding to changes in the PX price. This loop acts without delay to keep the supply and demand on the PX in balance. (The "seesaw" in the middle of the loop reminds us of the balancing function of the loop.) This loop can do its job as long as there is sufficient generating capacity in the region.

The upper portion of the figure shows the collection of assumptions on investors' behavior. To trace the cause and effect around the outer loop, suppose that growth in demand leads to higher PX prices over time. The increase in PX price leads to an increase in investors' forecast of future PX price, an increase in investors' forecast of profitability, and an increase in the number of CCCTs starting the permitting process. After a 12-month delay, there will be an increase in the number of CCCTs starting construction, and after another 12-month delay, an increase in the number of CCCTs coming on line. The increase in capacity will reduce the demand imposed on the PX and lead to a downward adjustment in the PX price. This example reveals that the closed chain of cause and effect acts to counter the increase in the PX price. Once again, we have negative feedback.

These feedback mechanisms may prove sufficient to maintain a relatively stable pattern of price changes over time. But there is no guarantee that this system will be stable just because we have negative feedback. It is certainly possible that delays in the actions