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The Future of Fuel Diversity: Crisis or Euphoria?

The fragmented electric industry structure poses an obstacle to a more stable, diverse, and secure power supply.
Fortnightly Magazine - October 2004

The Future of Fuel Diversity

The fragmented electric industry structure poses an obstacle to a more stable, diverse, and secure power supply.

Daily news headlines have drawn attention to concerns about fuels, especially the rising prices of oil and natural gas. Fears of interruptions of oil exports from Iraq, Iran, Russia, and Venezuela (take your pick) roil the energy market. But coal is not exempt from bad news, as production declines reduce output from Eastern U.S. mines while rail transport bottlenecks limit deliveries of Western and Eastern coals. Meanwhile, state attorneys general seeking stiffer enforcement of environmental rules have brought lawsuits against owners of coal-fired power plants.

Amid all of these signs, the benefit of fuel diversity is clear. But the United States is not on course to maintain electric fuel diversity and avoid price shocks. The underlying public policy issue has been dormant since the oil shock of 1973-1974 and the subsequent oil and gas price deflation of 1982-1998. Structural changes in the power sector in the late 1990s have only added to the complexity of determining who, if anyone, is steering the ship.

The fragmented electric industry structure poses an obstacle to any focused public policy approach to promote a more stable and secure power supply. Some states have restructured investor-owned electric energy supply functions into a competitive market mode and other states have left power supply responsibility within an integrated investor-owned utility framework, while other consumers are served by an array of relatively small municipal utilities, public agencies, and cooperatives. Given this backdrop, it is not clear who will lead public policy: private enterprise, individual states, or the U.S. Congress or presidential administration, currently distracted in the run-up to a presidential election.

At issue is whether the public can rely on market forces to ensure adequate and stable fuels. The current industry structure, conflicting goals of different regulatory bodies with jurisdiction over the sector, and a history of inconsistent laws and regulations create a substantial bias against major capital investments in electricity power supply. Focused actions of individual states, the U.S. Congress, and federal agencies could mitigate that burden by reducing uncertainty and narrowing the risks facing investors. The U.S. public policy drift relating to power supply and diverse fuel sources, should it continue, does not bode well for consumers, the economy as a whole, or the credit prospects of the power sector.

Benefits of Diversity

Electricity consumers and the public in general benefit when electric power supply is secure and stable. Diverse fuel resources for power generation reduce the chance that embargoes, strikes, transportation constraints, or acts of war or unrest will disrupt power production. Fuel diversity and long-term supply contracts also reduce exposure to soaring costs of any single fuel.

Like buying insurance protection or hedging, fuel diversification entails an ongoing cost. In the short run, it will cost more to own and operate a portfolio of power resources that incorporates several fuels and technologies, including some that are not at the lowest short-run cost. But over the longer run, the added portfolio cost is an insurance

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