Steve Mitnick's response ("Overbuilding? Fuhgeddaboutit!", , Jan. 15) to my Nov. 15 article extended the great industry debate over whether the recent power plant construction boom would result in near-term over-supply. The only problem is, the industry has moved on. The debate is over, at least in the near-term. Even taking into account the recent acceleration of cancellation notices, most markets will face some level of excess capacity as a result of the current power plant construction boom. That does not mean that new plant developers are doomed. It just means it's going to be harder going than they had hoped.
Mr. Mitnick's response had two themes. First, he claimed that forecasts of over-supply (like RDI's) fail to take into account developer's ability to respond to forecasts and cancel projects. Second, he points out that new plants will likely chase older, less-efficient capacity from the market. But, RDI's forecast takes both of these dynamics into account.
In our recent study, , a study providing wholesale power market forecasts for each region in the country, RDI projects significant oversupply in many regions even though we assume that less than half of all announced capacity additions will be brought on-line. Less than half. While in recent weeks, cancellation notices have accelerated, there are enough projects currently under construction-meaning they've already broken ground-to ensure some period of over-supply in regions like the Midwest, Texas, and New England. Those projects are moving forward. Other regions may have more flexibility to avoid over-supply if cancellations continue to mount, but as of this writing, projects slated to begin construction in 2002 are by and large still on.
Included in RDI's forecast is the assumption that over 18,000 MW will be retired or pulled into long-term standby as a result of the construction boom. So, we've taken into account the signs that Mr. Mitnick's "clunkers" should be replaced. Problem is, the retirements really aren't happening yet. He cites one anecdotal example of a utility deciding to retire one of its plants. But, by and large, that trend has not taken hold. We've got a long way to go before the market retires 18,000 MW.
Mr. Mitnick also operates under the assumption that "merchant plant development ramps up and down fairly well now in accordance with the market." If so, wholesale power markets will be the first commodity market to not be plagued by boom and bust cycles.
Contrary to Mr. Mitnick's assertions, developers haven't been particularly nimble in ramping up and ramping back project development. Developers make decisions based on market signals-price signals in particular. There are often lags between market events and prices changes. Also, there's imperfect information regarding new supplies coming to market. One developer often doesn't know he is building into a market facing over-supply until it's too late. RDI believes this recent boom in development will have repercussions in the power markets in the near term, based on simple supply-demand economics. Demand for electricity between 2000 and 2003 will likely grow at somewhere around 2 percent annually-in a good year. Yet, total generating capacity will grow by over 20.6 percent, 2.5 times as fast as demand. The end result in the short-term is too much capacity chasing too little load, which will likely drive down electricity and capacity prices.
Mr. Mitnick also asserts that forecasts like RDI's are based on "outdated notions about reserve margins" and states that new power plants will be fine because they will dispatch before the older "clunkers" in their region. We agree with that. But, how will they do against the 10 other new combined-cycle plants in a 100-mile radius that are all competing for the same load and are all taking gas off the same pipeline? Therein lies the rub. That's the challenge that new power plant developers face. They don't have to beat the existing plants, in the short-run; they have to beat all the other plants that are basically exactly like theirs. We agree with Mr. Mitnick that the most successful developers will get through "the windows of opportunities as they open and before they shut." It's just that we're guessing many developers are wishing the windows weren't opening and shutting so fast these days.
It has happened many times in U.S. history-development booms and busts. It happened in the railroad industry, in commercial real estate, and most recently in the telecom industry. And electricity generators are not proving to be immune. Utilities saw their first development boom in the 1970s, when population and industrial growth were reaching their peaks and the need for reliable generating capacity was strong. While development tapered off in the 1980s and 1990s, the industry charged forward with a second construction boom in the first decade of the 2000s. In fact, generating capacity additions scheduled to come online from 2000 to 2003 are on pace to match generating capacity additions for all of the 1990s combined. RDI Consulting projects that-as a result of the current construction boom-almost 160,000 MW of new electric generating capacity will be added to the grid by the end of 2003. Over 73,000 MW has already been brought into service in 2000 and 2001.
RDI believes that many new plants will succeed and that there are opportunities for future development. The boom and bust cycle will repeat. While the first development wave is coming to an end, the next wave will begin in the latter part of this decade. To be successful in the generation marketplace, companies will have to have several characteristics. First, they must be low-cost producers focused on profit capture. Companies must be technologically savvy to maximize plant operations and must take full advantage of risk management tools. Most importantly, they will have to time their strategies for building, buying, or selling assets to correspond with cyclical trends.
Betsy Vaninetti is Senior Consultant with RDI Consulting, a unit of Platts, in Boulder, Colorado. Will Dailey and Steve Piper, also Senior Consultants with RDI, assisted in the development of this piece. Platts is the energy information, research, consulting and marketing services business of The McGraw-Hill Companies.
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