California's Power Gamble: Long-Term Contracts, Locked-In Risk
on equity for a typical plant, and how it varies with the gas price and the debt-equity ratio (percentage of equity included in capital structure), given a particular heat rate and a certain prevailing wholesale market price.
In the base case in Table 4, illustrating a plant with a heat rate of 7000 Btu/kWh, plus a market price for power of $250/MWh, we can see that return on equity for a 50-50 debt-equity ratio runs anywhere from 24 to 280 percent, for natural gas prices ranging from as high $30 per MMBtu down to $5 per MMBtu. For a more highly leveraged capital structure, with 25 percent equity and 75 percent debt, the returns run even higher. We could perform the same calculations for different wholesale power prices and plants with different heat rates. For instance, for the same plant (heat rate = 7000), but a higher power price ($450/MWh), returns on equity (50-50 capital ratio) would run 316 percent to 572 percent, over the same range of natural gas cost figures.
By contrast, a less-efficient plant placed in service years ago (heat rate = 11,000) would earn returns on equity (50-50 capital ratio) running from 141 percent to 542 percent, at a high power price of $450/MWh. However, at a lower power price of $250/MWh, that same older, inefficient plant would still earn returns on equity (50-50 capital ratio) as high as 250 percent, 170 percent, and 190 percent, respectively, at gas prices of $5.00, $10.00, and $15.00 per MMBtu. Returns for this older plant would fall in the negative range only as gas prices grew higher than $20 per MMBtu. (This older plant would record a negative 151 percent return on equity, at a 50-50 capital ratio, at a gas price of $30 per MMBtu.)
The Profitable Conclusion
These examples show that existing power-generating investments are more than sufficiently profitable, even at relatively high heat rates and relatively high natural gas prices. Only when the price of natural gas reaches astronomical levels, coupled to relatively high heat rates and moderating prices for electricity, does the profitability picture change.
These results lead one to conclude that investment will be attracted to California in spite of the state's inherent risks. In fact, they indicate that environmental constraints and/or local opposition to power plant siting are the only serious impediments to new power plant construction in California.
In short, prices for wholesale electric power will likely come down when sufficient additional capacity is built and natural gas prices return to historical levels. A long-term power price of $70/MWh, appearing in three years or so, would be a reasonably generous estimate.
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