According to a new study we have conducted at Resource Data International, the continuing transformation from a regulated industry to a fully competitive industry will create substantial opportunities for new generating companies. With the implementation of the Energy Policy Act of 1992 and the FERC's Orders 888 and 889, competition has been introduced into wholesale power markets. It is limited in scope, however, as utilities are still able to recover their fixed generation costs and embedded cost of capital from their captive retail markets. The guaranteed recovery of fixed costs gives utilities a competitive advantage over new market entrants and creates distorted competition in wholesale power markets. When each generator must recover all of its costs from market-based revenues, new opportunities will be created for merchant power plants.
Most regions of the U.S. currently have excess capacity. At RDI we expect that reserve margins will shrink rapidly when full competition is introduced into the industry. Experience in already deregulated generation markets provides insight into trends one can expect to see in the U.S. In 1993 the National Grid Company in Britain forecast a reserve margin of more than 30 percent for the 1995/96 year. By 1995, the reserve margin fell to 16 percent. In short, the opening of markets in Britain forced the closure of 26 percent of the capacity in the market in a five-year span. At the same time, 10.4 gW (or 15 percent of the capacity in the market) of new capacity entered the market. If the British experience applies to U.S. markets, then clearly, many of the highest cost generation facilities will be eliminated from the grid, shrinking reserve margins.
A second reason for shrinking reserve margins will be higher-than-anticipated demand growth in certain regions of the country. For instance, it costs Niagara Mohawk approximately 5.5¢/kWh to produce electricity. If this component of a customer's rate were to drop to 2.5¢/kWh, the overall price would fall by 33 percent. Over the long term, this price decrease should affect electricity demand. The current forecast demand growth rate for the New York Power Pool is only 0.89 percent per year. In part, the extent to which this price decrease can be achieved will depend on stranded cost recovery.
Rapidly shrinking margins will create an attractive environment for adding new capacity to the grid. Existing efficient plants will provide the first wave of capacity additions through uprates (em i.e. capital investments below the cost of building new generation that increase the capacity at existing plants. RDI estimates that roughly 70 percent of all nuclear units can increase their capacity by 3 percent to 5 percent through uprates. An average uprate of 5 percent at nuclear plants would add 3,780 MW of capacity to the grid at a very low cost. Many coal-fired utilities also will be able to add incremental capacity through uprates. For instance, in 1994 PacifiCorp added a total of 80 MW of capacity to existing coal-fired plants by making small design changes at the plants. PacifiCorp has identified another 150 MW of capacity it can add at existing units (em at one-third the cost of building a new plant. Improved availability factors and forced outage rates at existing plants also will provide an additional source of new capacity.
Another source of "new capacity" is likely to come from changing customer demand profiles. In many regions of the country, as much as 10 percent of the capacity in the system is needed during only 1 percent of the hours in the year. In the past, customers paid based upon the average cost of serving their demand. As real-time pricing technology becomes more widespread, the high cost of a utility's inventory will be reflected during these peak hours. This increase in prices may reduce demand during the peak demand hours. Such a change could delay some of the need for new generating capacity.
Because the total uprate potential and changes in demand profiles are limited, there will be a new breed of merchant plants that will need to be developed. Merchant power plants are built without the security of long-term power sales contracts. The primary obstacle to developing these new plants is securing financing for the projects. However, project developers have shown that the financing obstacles can be overcome with innovative financing strategies. RDI has identified more than 25 new merchant plants (em totaling about 5,500 MW of capacity (em that are either under development or already in operation in the U.S. RDI estimates that at least another 5,000 to 10,000 MW are being developed but have not yet been publicly announced. Most of this development activity is concentrated in the Northeast U.S. and the Western U.S. t
Christopher Seiple is principal of the Power Consulting group at Resource Data Internationa Inc. an energy industry consulting and information management firm specializing in fuels and electricity market analysis.
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