Competitive Power Markets
Put Capacity at Risk
Generation markets in the U.S. are about to go through a period of radical transformation as full competition is introduced to the industry. One of the largest impacts of this transformation will be the creation of a more efficient generation industry. According to a new study by Resource Data International, the drive towards increased efficiency will result in the premature shutdown of some high-cost, inefficient power plants.
Our analysis starts by analyzing the costs of every utility owned power plant in the country. The cost portion of our analysis distinguishes between two different types of costs: sunk costs and on-going costs. Sunk costs include the depreciation, capital and tax expense associated with existing facilities and some portion of long-term fuel supply commitments. On-going costs include the future fuel expenses, operation and maintenance expenses, and the replacement capital costs required to keep the plant operating or to extend the plants life. On-going costs are the basis for efficient competition in markets. In an open market, a generator would shutdown its plant if the potential revenue generated by the plant is less than its avoided costs. To do otherwise would result in additional losses, regardless of the initial investment in the plant.
After determining the costs of every plant, we next looked at the potential revenue generation of each unit from a competitive market. Two types of revenue streams were considered. The first revenue stream is the value created by the generator from selling kilowatt hours in the economy energy market. This first revenue stream does not take into account the value created by supply capacity, or reliable supply, to customers. This revenue stream was compared to the plant's historic generation and its on-going costs. The degree to which a plant is at risk is determined by the amount of revenue the plant needs to generate from "capacity payments" to recoup its on-going costs.
Our analysis reveals that as much as 10-15 percent of existing capacity is at risk of being shutdown in a competitive power market. This is especially true in regions where reserve margins are high and operational costs, particularly fuel, are low.
To better understand the implications, take for example the Mid-American Interconnected Network (MAIN) NERC region. Coal-fired and nuclear capacity account for more than 84 percent of the region's operating capacity. Peak demand in the MAIN region is expected to grow at an average annual growth rate of 1.3 percent during the next ten years. Today, MAIN utilities maintain about a 19 percent reserve margin. Considering a 15 percent cushion for reliability, new capacity additions may not be needed until after 2001. This high reserve margin is likely to create an extremely competitive market where power is traded at short-term marginal cost at the inception of full competition in generation.
RDI identified more than 12,064 MW of capacity as being at risk in MAIN. Of this total, approximately 8,000 MW are coal-fired units and 4,000 MW are nuclear units. The at risk generating units account for 23.5 percent of the regions operating capacity and 21.6 percent (49,627 gWh) of the regions electric output. The list includes 20 coal-fired steam units, 3 nuclear plants and 3 small gas-fired facilities (em seven of these generating plants recorded capacity factors of over 60 percent in 1995. This capacity is operating today because utilities are capable of recovering all of their costs from their existing ratepayers. Unless the utilities are able to significantly reduce operating costs or restructure fuel contracts, it is likely that the reserve margin in the region will shrink more rapidly than forecasted and opportunities may be created for new merchant power plants.
Other regions identified with capacity at risk include the Arizona/New Mexico (30.6 percent), Florida (18.4 percent), Northeast Power Pool (16.7 percent) and the New York Power Pool (15.8 percent).
Coal and nuclear plants account for more than 87 percent of the capacity at risk nationally. The majority of at risk plants are coal-fired - 56 percent. However, the plants with the highest on-going costs tend to be nuclear. Ten nuclear plants would need to generate nearly $100/kW-yr from capacity markets just to recover their on-going costs.
Though capacity is considered at risk in some regions based on projected market conditions, the opportunity to develop new projects depends more readily on a combination of existing high cost capacity, thin reserve margins and the availability of competitively priced fuel. Whatever the final shape of the electric industry, it is paramount that generators compete on the basis of on-going costs. t
Kent Knutson is senior vice president and Chris Seiple a senior consultant at Resource Data International, Inc. an energy industry consulting and information management firm specializing in market and competitor analysis.
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