Saturday, December 22, 2012

Update on Energy

In the US, our energy policies have been transformed by fracking, which has led to an abundance of natural gas and re-invigorated our domestic oil industry, to boot. When I first worked in the energy business they still talked about how the natural gas industry was forced to curtail new hookups of houses in the 1970's because we believed that we were about to run out of the fuel, and the costs in the 1990's were about $2 / unit. After a spike up to $14 / unit (which contributed to the bankruptcy of California), economic forces and not government intervention led to the innovation and today's low prices in the $2 - $4 / unit range.

When natural gas first fell into this low price range, industry participants were basically "waiting it out" to see if prices would rise. The price of natural gas plays a huge part of the overall energy pricing market, since natural gas "peaking" plants are turned on during spikes and they set the marginal cost of power during those peak events. During times of peak usage coal, nuclear and hydro plants reap a windfall since their costs are (comparatively) fixed if the price spikes are set by high natural gas prices. These price spikes have been significantly lessened and now natural gas is used not only for peak plants but for base-unit capacity. If the price of natural gas ever rose near those peaks in the $10+ / unit range all those investments would be un-economical, but price spikes in those ranges don't seem to be coming in the near future.

Last Hurrah For Wind Subsidies

The wind industry is basically a creation of government incentives worldwide. The Spanish market collapsed completely instantly when incentives evaporated. The US turbine market is about to collapse as well as soon as a governmental program providing subsidies in the form of tax credits to all wind installations in service by year end, as described in this Bloomberg article.
Wind-turbine installations are exceeding natural gas plants in the U.S. for the first time this year as developers rush to complete projects before the expiration of a tax credit for renewable energy. New wind capacity reached 6,519 megawatts by Nov. 30, beating the 6,335 megawatts of natural gas additions and more than double those of coal.
It isn't known whether or not this tax credit will be renewed; if it isn't the US turbine industry will likely grind to a halt since wind isn't competitive in the US without large subsidies. Unlike natural gas, which can be found in areas connected to the gas pipeline grid, most of the best wind locations are not connected to the electricity transmission grid and the costs and barriers to installing these transmission lines are insurmountable under the current regulatory regime, dooming wind to a niche tax subsidized role. Our existing wind infrastructure will sit in place, earning the tax credit, with little or nothing added going forward without new incentives.

Impact on Coal Plants

The dominos now are falling. Midwest Generation, which operates coal plants in the US, has gone into bankruptcy protection. Per the article:
Midwest Generation and Edison Mission Energy (EME) have been hit hard by cheap natural gas prices, falling energy demand, increased energy efficiency and mandates for expensive pollution controls that have all made the power from their aging coal-fired plants uncompetitive on the open market where they sell their electricity.

Ultimately the bankruptcy court and owners that could take possession of Midwest Generation’s assets in the future could continue to run the coal plants – three in the Chicago area and one in Pekin in central Illinois...But if the coal plants were unprofitable under Midwest Generation, there is no reason to expect they could turn a profit under new ownership, sources say, particularly as new sulfur dioxide controls are still needed at every plant, for a total cost of $628 million. A July filing by Midwest Generation indicated that financing from EME would be needed to make the pollution control upgrades; now such financing appears highly unlikely, if not impossible.
Other large coal plant operators are under severe financial strain. They have been partially insulated by the large drop in the price of US coal, which has even led to record exports of coal overseas to Europe (it is almost the definition of irony that the US is sending coal for generation to Europe, the continent that pushed all these climate mandates so hard), as shown in this article:
U.S. coal exports to Europe increased by 29% YoY in the first quarter of 2012, as power companies in the continent switch from natural gas to coal for power generation. Power generating companies in Europe are taking advantage of the lower prices of coal and the fall in carbon emission fees. Natural gas prices are currently at high levels in Europe because they are associated with oil prices. U.S. coal exports have been increasing. Total U.S. exports stood at 28.6MMST in the first quarter of 2012. Almost half of U.S. coal exports are to Europe.
Financial Stress on Nuclear Plant Operators

The nuclear renaissance promised by the current administration never happened; it was a pipe dream to begin with and the death knell was the tsunami in Japan. However, while nuclear plant expansion was a mirage, it wasn't expected how long the low natural gas prices would stay and the financial impact on nuclear plant owners.

Exelon, the largest nuclear fleet owner in the US, has come under financial pressure and seen their stock price decline due to fears that they may have to reduce their dividend. Since utility stocks are often propped up by their dividend (or almost solely valued based on their dividend), dividend reductions are desperately avoided for not only do they reduce current payouts to shareholders, they fundamentally change expectations for future dividend growth which hits the long term stock valuation. Over the last year their stock dropped from $44 / share to less than $30 / share, and their current dividend yield is over 7%. Per this article, they are paying out 165% of their earnings in dividends, and generally payout ratios of > 70% (as a rule of thumb) are unsustainable.

Cross posted at Chicago Boyz

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