Fortnightly
Lifting Gas Over the Hump
January 15, 1995By Bruce W. Radford
"With market forces now taking aim at the power industry, natural gas is emerging as an increasingly important source for electric generation." That recent quote comes from Robert M. Spurck, a managing director and head of U.S. Fixed Income Research for Chase Securities Inc., New York. This emergence, according to Spurck, along with new gas discoveries, more efficient gas production, new power plant technologies, and "continued moderation" in gas prices will "create opportunities for increased demand."
Spurck then adds: "The gas industry has been swift to respond. [T]he name of the game is shifting more towards marketing of electricity.... Many gas companies believe that creating wholesale power marketing affiliates will allow them to cash in on gas production or transmission efficiencies." All of which brings us to the question at hand: Will natural gas profit from electric deregulation?
And that's a riddle that many people would like to solve, including the American Gas Association, which devoted a good portion of its 16th Annual Bankers Conference (New York City, November 16-18) to "The Impact of Electric Industry Deregulation on the Natural Gas Industry." But not everyone agrees that gas will prosper with electric deregulation.
John A. Gartman, who sat on one conference panel with Edward J. Tirello, Jr. to ponder electric restructuring's effect on gas, took a decidedly different tone. Gartman, who is vice president of gas supply and planning at Public Service Electric & Gas Co., predicts that electric deregulation will bring bad news for natural gas, at least in the short run. Why? First, says Gartman, electric restructuring has raised the ante on risk in power generation: "Things have ground to a halt." In other words, if no one is building new power plants, what good are all those advantages that gas offers for power generation?
In a world of competitive generation, Gartman predicts operating cutbacks at gas-fired cogeneration facilities \(em especially qualifying facilities (QFs) that serve base load: "When we have a pool with dispatch of the cheapest plants, those [QFs] will shut down. We could see a 50- to 70-percent reduction in consumption of gas at these gas-fired QFs." He also anticipates more competitive (downward) pressure on gas commodity prices, as electrics fight to cut their fuel costs.
Coal plays the wild card in this scenario. As Gartman notes, "If the coal industry loses the electric generation market, they're out of business. So coal will fight hard against gas." And if all these "PoolCos" that we hear about are intent on dispatching base load with the lowest marginal operating costs, it will be difficult indeed for gas to undercut coal. Or even nuclear! In this new restructured world, Ed Tirello envisions regional markets run by regional transmission groups \(em each with two to five power-generating companies operating "razor-thin margins," plus a single, separate nuclear operating company per region. By the way, Tirello still puts stock in that long ago prediction of "50 in 5." "We just need to extend our time frame," he says.
And that would be good advice for gas, too, says Gartman. Marginal operating costs alone won't always carry the day. In the long run, Gartman notes, when new plant construction gears up, gas-fired combined-cycle plants will reap competitive advantages from cheaper construction costs, shorter lead times, and a decided edge on environmental issues. The pendulum will swing back to favor natural gas. But not in the short run. And so the key, says Gartman, is getting gas over the hump.
On Vertical Hold
At this writing, the Federal Energy Regulatory Commission (FERC) is being flooded with comments on its notice of proposed rulemaking (NOPR) on stranded investment (Docket No. RM94-7-000). Editors get flooded too.
Sitting on top of my desk this week I've got copies of a couple of new papers on stranded investment. One is called "The Challenge for Federal and State Regulators: Transition from Regulation to Efficient Competition in Electric Power," by William J. Baumol, Paul L. Joskow, and Alfred E. Kahn. (Although the paper was funded by the Edison Electric Institute, the first page notes that the conclusions belong to the authors and do not necessarily represent the views of EEI.) The second carries the title, "Is Competition Here? A Preliminary Evaluation of Defects in the Market for Generation." It was produced for the Harvard Electricity Policy Group under the guidance of the National Independent Energy Producers (NIEP). The team of authors for the NIEP report included Merribel Ayres (NIEP executive director), Janet Gail Besser, Harrison Wellford, and private attorney Scott Hempling (who also helped author another study on stranded investment funded by the National Association of Regulatory Utility Commissioners).
One of the ironies of stranded investment has to do with operating efficiency. The same nuclear plants that carry high fixed costs and much of the blame for stranded investment can also offer some of the lowest marginal operating costs. Baumol, Joskow, and Kahn (BJK) allude to this in their EEI study:
[The] large gap between marginal costs [for nonutility generators] and the regulated rates of many franchised utilities [stems] not from differences in their respective marginal costs [but from the fact that] so many of the present costs of the utility companies, on which their rates are based, are sunk. [Thus] it provides no basis for the expectation that more competition offers significant immediate opportunities for improved productive efficiency in generation.
BJK also find room to defend vertical integration: "There is a danger that introducing more competition into electric generation will produce inefficiency if it results in loss or dilution of the economies of vertical integration between generation and transmission."
Of course, you won't hear that apology from independent power. Listen to what the NIEP said
in comments (taken from an executive summary) filed in response to the FERC NOPR on stranded investment:
Stranded costs are symptoms of larger structural problems rooted in the fact that utilities operate simultaneously in both the competitive and monopoly arenas.... As long as the competitive and monopoly elements ... remain affiliated under the same ownership and subject to the existing cost-of-service regulatory regime, incentives for anticompetitive practices and other inefficient behavior will remain, and intrusive government regulation will be required to combat them.
NIEP's Ellen Roy sounds another note for comparability: "IPP contract prices set 5 to 10 years ago are compared by some utilities to the cost of power today. [But] the typical utility project is not asked to pay refunds to customers if, years after the plant is in operation, it turns out that other alternatives would have been less expensive."
We'll have more on stranded investment in future issues. t
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