Coal is taking a beating. As mining costs rise, coal reserves deplete, emission regulations strengthen, and inter-fuel competitive dynamics change, the allocation of coal in the electric...
U.S. utilities gain strategic insights by playing out a carbon-constraint scenario.
intended to predict future outcomes in the real world, but rather to identify likely future issues and to inform the strategic perspectives participants will bring to those issues when they arise.
A valuable game, or series of games, could be built around the effects of different types of climate regulation. Because the purpose of this particular game, however, was to illuminate industry strategy issues rather than public-policy issues, the game used a single set of regulatory assumptions, reflecting a rough mid-point among the more stringent carbon reduction proposals currently before Congress (see sidebar, “Regulatory Assumptions”) .
The players were five fictional power generators, mostly integrated utilities with a blend of regulated and unregulated generation portfolios. These players interacted with a regulatory team and (in the background) a control group. The aggregate portfolio of all players mirrored the U.S. national generation profile. Players operated in a closed system in the sense that their moves alone set power prices and determined industry emission levels. The object of play for each team was to maximize shareholder value, consistent with federal policy strictures and as permitted by state and federal regulators.
Play began in 2009, with the hypothesized enactment of a national scheme of carbon regulation. The game proceeded in three seven-year moves—the first spanning the period 2009 through 2015, the second 2016 through 2022, and the third 2023 through 2029. As players added or retired generation, market prices shifted. Meanwhile, emissions credits were bought, banked, or sold. Player balance sheets and income statements changed accordingly. At the end of each period of play the game-control group calculated net change in carbon emissions compared with 2009, and the annual total shareholder return (TSR) from 2009.
Move 1: Green Bandwagon
At the risk of over-simplifying a complex set of moves and strategies, the three stages of play seemed characterized by three different strategic impulses. In the first move (2009 to 2015), the main strategic impulse was a “rush to compliance.” The principal strategic actions were:
• Strong investment in demand-side management (DSM);
• Strong investment in renewable generation;
• Selective initiation of nuclear construction;
• Substantial retirement of coal facilities; and
• Major reliance on new gas-fired generation to meet near-term load needs.
While none of these moves is startling, the combined effect—an overall reduction of industry carbon emissions of nearly 20 percent (well in excess of mandated levels for that period), and an average annual real TSR exceeding 4 percent—was notable. As a consequence of this overall success in compliance, the industry finished the first move in a long position with respect to emissions credits.
The downside of this picture was that wholesale prices roughly doubled in real terms over the seven-year period, both in Coal Land and Gas Land. Notwithstanding substantial investment in renewables, capacity additions lagged demand growth. While retiring a number of coal facilities, companies remained cautious about large-scale investment in compensatory new capacity. As reserve margins tightened, unregulated assets yielded exceptionally strong returns. The stage was set for a correction.
Move 2: Capacity Correction
In the second move (2016 to 2022), that