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Defining the New Policy Conflicts

Failing to address and adapt to the new ratemaking realities could result in increased costs for the economy.

Fortnightly Magazine - July 2006

cake and eat it, too. That is, we could have low electricity prices and shift risk from consumers to investors. Moreover, we could have more environmentally friendly electricity generation and provide financial incentives for renewable energy resources without much of an increase in rates. We could have all of this without worrying about the security of supply issues that dogged the energy industry in the 1970s.

It seemed as if the two conflicts endemic to the industry—cost/price vs. environment, and the total level of acceptable risk vs. the burden of the risk—had been solved, while the security of supply simply was ignored or forgotten.

Reality and Unfulfilled Promises

Unfortunately, current realities show that the conflicts were not resolved, but simply postponed. While wholesale markets and competition have taken root and continue to survive and expand in the Northeast, Mid-Atlantic, and the Midwest, one could argue that the promise of competition has been stymied by poor market design, market power and manipulation, high fuel prices, and a lack of the necessary energy infrastructure in electricity transmission, natural-gas pipelines, storage, and LNG facilities. 18

Retail consumers are facing the real price for power after having been shielded for several years under rate freezes. The industry is just now recovering from the financial and structural meltdown of extended periods of high prices in Western markets. 19

Natural-gas prices, on a yearly average, have risen from around $2/MMBtu in the mid-1990s to almost $8/MMBtu in 2005 and are projected over the long term to be in the $6/MMBtu to $7/MMBtu range. 20

Additionally, the traditional natural-gas production basins are projected to continue experiencing declining production, and there will be a greater reliance on production from new regions as well as on imports of LNG to meet demand. 21

Finally, natural-gas markets have become far more volatile in recent years in response to the changing realities in our production basins, but also to disasters such as hurricanes affecting both transport and production. In contrast, North America is well endowed with coal resources that dwarf the remaining gas reserves, and coal prices relative to natural-gas prices have been quite stable over time. 22

These new realities make coal-fired generation more attractive due to the price of coal relative to natural gas as fuel, which more than offsets the higher capital costs of a new coal facility, including the costs associated with the more stringent Clean Air Interstate Rule (CAIR) and the Clean Air Mercury Rule (CAMR). Furthermore, coal-fired generation is forecasted to be less expensive going forward than all viable renewable resource options for Florida and the Southeast. 23

Often overlooked in the above discussion is the idea that we have been living on high levels of investment and capacity in electricity transmission and generating capacity from the previous generation. 24 Many areas of the United States are at a point where new generating capacity and new transmission capacity are needed. The costs of not having new baseload capacity can be seen in the increased use of natural-gas facilities and the increased costs of generation. The costs of