Historically low energy prices can’t last
To introduce myself, for the past several years I served as Director of the Illinois Power Agency (IPA). The IPA is the state agency created in 2007 by the Illinois General Assembly to purchase wholesale power for certain customers of Ameren and ComEd, the state’s investor-owned electric utilities. In October 2011, I started a consulting service and now advise communities on their energy purchasing options.
In my current capacity as an energy consultant, my job is price hedging. I identify risks, handicapping them for probability, and then explore what I can do to avoid those risks.
Prices for the electricity commodity have been driven lower largely by demand erosion due to the troubled economy. Since we entered into this recession in 2008, Illinois has seen about a 9 percent decline in industrial demand. The big question is how long will this low electricity commodity price market continue.
Conventional wisdom from the U.S. Department of Energy (DOE) indicates that the current price of 9.8¢ for a kWh of electricity will drop to 9.2¢ by 2019. Without meaning to sound too critical, I would suggest that the Energy Information Administration has perhaps overemphasized the role of low natural gas prices in making its projections. Their projected future electricity prices appear to me to be artificially low based on overly high expectations for new natural gas supplies.
The U.S. DOE claimed that 410 trillion cubic feet of recoverable shale gas was available in the Marcellus formation. The U.S. Geological Survey, the guys who know about dirt and rocks, claim that only about 84 trillion cubic feet are available. In addition, any increases in regulatory requirements on natural gas “fracking” will likely reduce supplies and increase prices.
Even if we get all of that supply to market, will prices stay low forever? The answer is no. In Europe and Asia, they will pay $12 to $15 a million btu for natural gas. We are paying $2 to $3 so there is a profit incentive to get it from here to there. We are turning liquefied natural gas import terminals into export terminals. I believe that retail electricity prices will likely rise by 75 percent by 2019. And, I also see natural gas above $6 – or roughly double the current spot price.
Electricity prices are driven by multiple elements including generation supply, transmission and distribution.
On the generation supply side there is significant potential for base load generation retirement, and the rate of public plant closure announcements is increasing.
Can the effects of these retirements be offset by new renewable generation? Likely not, because 50 megawatts of wind or solar generating capacity is not the same as 50 megawatts of dispatchable generation. Renewables may be the preferred policy option today, but they’re not the total solution to replacing lost base load generation.
So where will replacement generation come from? Frankly, I don’t know, because that’s a policy issue that has been ignored for the last 15 years in the deregulated states. We don’t have a mechanism in the deregulated world to build new base load power plants. There is not a 30-year contract model to support the capital necessary to build a new plant.
So, we have a situation where generating capacity is going off line but we don’t have new capacity coming on line. I think we can all agree that this will cause upward price pressure. More importantly, an economic recovery will drive up energy demand. At the first sign of true economic recovery I expect to see a lot of upward price pressure in electricity markets.
Transmission also has some upward price pressures. We’re starting to see some plans from regional transmission operators that predict higher costs. PJM, which manages transmission in the northern part of the state, estimates that about $14 billion in transmission system upgrades are necessary just to deal with plant closures. Additionally, PJM estimates that integrating new renewables into the system will cost around $60 billion.
Distribution costs are also likely to rise. The investor-owned utilities are spending significant sums of money to make long-overdue system reliability upgrades and all of this drives up distribution costs.
All of these items, and more, lead me to believe that electricity costs for consumers are going up.
Where does municipal aggregation fit into all of this? Municipal aggregation allows a county, city or village located in the ComEd or Ameren territories to step in and negotiate an electricity supply contract for their residents. Right now, municipalities are able to achieve significant discounts off the Ameren or ComEd energy rates for the short term. The ability to book those kinds of savings as a practical matter will basically end in May of 2013.
My suspicion is that more than half of the municipal aggregations that have been formed will probably go away within two years. Municipalities are generally not risk managers, and their residents can leave the aggregation if prices get too high.
First, it is important to remember that value is more than a low price. For example, electric co-ops are ahead of investor-owned utilities in terms of adding smart grid options. This new technology adds value in terms of reliability and pricing options. Co-ops are in many cases also providing rural broadband, or helping with rural water system expansion and other economic development projects. That’s added value.
Second, remember that price stability is also a value. The electric market prices change every 5 minutes. Electric co-ops have ownership in real generating assets that are going to protect members from rising prices over the long-term. While the municipal aggregation approach is yielding some short-term savings, we suspect that their prices will pop up when the economy recovers largely because they do not invest in generating assets.
Third, remember that today is not forever. We can all remember not long ago when they said we were running out of natural gas. I also remember something about nuclear plants making electricity too cheap to meter. We all know that the market changes, and that prices rise faster than they fall. Electric co-ops have taken crucial steps to prepare for the coming market changes.
Lastly, there will always be people who will question and criticize every decision any leader makes. When you look at the long term, someone will say you should’ve gone short. When you buy, someone will say that you could’ve sold. I see price pressures and instability in today’s electricity markets. My belief is that electric co-ops have laid out long-term plans and will be better positioned than the rest of the market when prices rise.
My Sunday school teacher used to ask, “When did Noah build the Ark? It was before the rain.” It was hard for Noah, with years and years of effort and everyone wondering why he did it. I personally believe that the state’s electric co-ops are doing the hard work necessary in the current challenging times to prepare for the long-term best interests of their members. And, I would suggest that co-op members are likely to be thankful in the future for the foresight that co-op leaders have demonstrated.