Navigant Research Blog

Facing Change, Utilities Change Course

— June 16, 2014

Minutes after details of the proposed new U.S. Environmental Protection Agency (EPA) regulations on emissions from power plants were released, the coal industry made its reaction clear.

“If these rules are allowed to go into effect, the [Obama] administration for all intents and purposes is creating America’s next energy crisis,” declared Mike Duncan, the CEO of the American Coalition for Clean Coal Electricity, a trade group that represents suppliers, such as Caterpillar; mining companies like Peabody Energy and Arch Coal; and big operators of coal-fired plants, including American Electric Power (AEP) and Southern Company.

The responses echoed what some utility officials have been saying for years: limiting emissions of greenhouse gases from existing power plants will unravel the already beleaguered utility industry, send electricity rates soaring, and kill the shaky economic recovery.

“Under Attack”

“Electricity is under attack in our country,” said Tony Alexander, CEO of Ohio-based utility FirstEnergy, in a speech last April at the U.S. Chamber of Commerce, “and this battle is being waged through largely untested policies that will ultimately impact the reliability and affordability of electric service, and the choices customers now enjoy.”

Utilities and industry associations have spent millions trying, with limited success, to influence the EPA’s rulemaking decisions.  Utilities’ tactics, however, do not always match their rhetoric.  The umbrage of officials like Duncan and Alexander masks the industry’s more nuanced and responsive adaptations – not only to the EPA’s aggressive regulations, but also to the market forces that are driving power generation away from coal and toward cleaner sources like renewables and natural gas.  In fact, the EPA is only giving a shove to a battleship that’s already turning, however gradually, toward uncharted waters.

“The rule is going to speed the transition away from coal into natural gas and renewables and potentially increase the role nuclear electricity plays in the U.S.,” Christopher Knittel, director of the Center for Energy & Environmental Policy Research at MIT, told Bloomberg News.

Diversify, Already

AEP, for example, is the biggest owner of coal-fired power plants in the United States, and the Columbus, Ohio-based utility “could be among the most affected by the new rules,” according to Columbus Business First.  CEO Nick Akins has warned of plant shutdowns and the associated job losses because of the proposed regulations.  AEP is also, however, among the utilities that have already taken dramatic steps to reduce its carbon emissions and shift its generation fleet off of coal.  According to AEP’s 2014 Corporate Sustainability Report, the company’s generation fleet is “increasingly diverse,” and the company already had plans to retire 6,600 MW of coal-fired capacity before the new regulations were announced.

AEP’s 2013 environmental performance was “the best in company history,” a release summarizing the Sustainability Report said.  “AEP has invested about $10 billion in environmental controls and new generation over the past decade. Between 2005 and 2013, AEP reduced its carbon dioxide emissions by 21 percent.”

These reductions have hardly ruined AEP’s financial performance: the company earned $3.23 per share in 2013, comfortably within analysts’ projections, and its share price has nearly doubled since 2009.  “AEP’s total shareholder return for [2013] was 14.2%, compared with an average of 7.8% for the S&P 500 Electric Utilities Index,” the release noted.

Like newspaper publishers a decade ago, industry executives are watching a business that has persisted in more or less its current form for a century or so transform, virtually overnight.  Some of them are proving to be surprisingly nimble.

 

Russia-China Gas Deal Narrows Window for U.S. Exports

— May 30, 2014

Russia and China’s grand bargain on energy, a 30-year, $400 billion deal to pipe natural gas from Russia’s Far East to China, has prompted much commentary on the agreement’s potential to reshape global energy markets and tilt the balance of influence in Ukraine and, more broadly, in Europe.  The deal has “upped the ante for Europeans to diversify their gas imports away from Russia,” said Erica Downs of the Brookings Institution; it means producers of liquefied natural gas (LNG) “may face more competitive markets in Japan and South Korea, which together bought more than half of the world’s supply in 2013,” wrote Chou Hui Hong, a Singapore-based reporter for Bloomberg News; “the implications are potentially huge for Russia, for China and much of Asia, and also for Europe,” declared Keith Johnson, covering all the bases in Foreign Policy.

All the bases, that is, except one: the United States.  The shale gas revolution in the States has led natural gas producers to envision an export boom in which U.S. companies become key suppliers to East Asia while countering Russian influence by shipping large amounts of LNG to Europe.  President Obama said in 2012 that the U.S. is becoming “the Saudia Arabia of natural gas.”

Better Hurry

Indeed, U.S. petroleum exports reached 3.5 million barrels a day in 2013, roughly double the level of 5 years ago, according to the Energy Information Administration.  Proponents of increased LNG exports argue that the gas export boom will bring in billions in profits for American companies, create thousands of high-paying jobs, and reduce the influence of undesirable LNG suppliers, i.e., Vladimir Putin’s Russia.

All of that is, potentially, true.  But there are signals that, even before the Russo-Chinese gas deal, natural gas advocates were overstating the potential market.  And with China building pipelines to ship LNG across Central Asia, the market opportunity is dwindling fast.

The United States has been slow off the mark in building export capacity.  Thirty-one applications for LNG export licenses have been approved since 2011; only seven have been approved, six conditionally.

In 2012, on assignment for Fortune, I visited the Sabine Pass natural gas terminal on Texas’ Gulf Coast.  Built by Cheniere Energy in the 2000s as an import facility, the port had been retooled to load LNG on big tankers for export to Europe and Asia.  Cheniere is the only producer that has won full DOE approval to export gas; and the window for an export boom may already be closing.

The Shrinking Spread

U.S. supremacy in international gas markets depends largely on the wide spread between the cost of producing natural gas in this country and the prices that countries like Japan, South Korea, and Germany are accustomed to paying.  As Karim Rahemtulla, the chief investment strategist at Oil & Energy Daily, points out, that spread narrows rapidly once you liquefy the gas and ship it, via tanker, overseas.

Competition in the international gas markets is bound to heat up, and the United States may have already missed its opportunity for an LNG export bonanza.  Expanding pipelines, more export terminals, and better technology for liquefying and shipping natural gas will all help globalize the natural market, in the way the crude oil market is already globalized.  Already, the relatively low price that China will pay for Russian gas (around $350 per thousand cubic meters, analysts estimate) is putting downward pressure on higher prices for Japan and South Korea.

Earlier this month Dominion Resources won approval from the U.S. Federal Energy Regulatory Commission to build an LNG export facility at Cove Point on Maryland’s Chesapeake Bay.  The company said the $3.8 billion terminal could begin shipping gas as early as 2017.

That could be too late.

 

Inaction on Energy, Climate Change Risks Global Chaos

— May 16, 2014

The crisis in Ukraine has provided the West with a stark reminder of an inconvenient fact: Many of Europe’s liberal democracies are heavily dependent on Russia for their energy supplies.  The latest move by Vladimir Putin in his campaign to destabilize the fragile elected government of Ukraine came this week, as he announced that supplies of natural gas to the country would be cut off at the end of May unless Ukraine pays for them in advance.

Ukraine owes Russian gas giant Gazprom $3.5 billion, Putin said in a May 15 letter to European leaders.  In April, Gazprom responded to the ouster of former Ukrainian president Viktor Yanukovych with a sharp hike in the price of the gas it sells to Ukraine, going from $268 per 1,000 cubic meters to $385.  Russia has throttled its gas pipelines into Ukraine twice before, in 2006 and 2009.

Russia supplies around 27% of Europe’s natural gas, according to Emergingmarkets.org – much more in the case of former Soviet Bloc countries like Bulgaria (85% of its gas comes from Russia) and the Czech Republic (80%).  Nearly half of the gas headed west to European markets flows through Ukraine.

The Law of Possession

Russia’s takeover of the Crimean peninsula has also thrown into turmoil plans for developing offshore oil & gas resources in the Sea of Azov and the northern Black Sea, where Chornomornaftogaz, Ukraine’s state-owned oil & gas producer, controlled rich oil & gas fields and at least a dozen offshore drilling platforms.  Since the annexation of Crimea, Russia has laid claim to those resources.  “If this is a part of Russia,” declared Denis Khramov, Russia’s deputy natural resources and ecology minister, “then it is subject to Russian law.”

Energy chaos on the edge of Eastern Europe has already prompted Fitch Ratings to warn that cutting off Russian gas supplies to Europe could derail the fragile economic recovery on the continent.

All of this points to a further sobering truth, of which Western democracies must be forcefully reminded at least once a decade: There is no national security without energy security.  This fact will be less and less escapable as the effects of climate change accelerate, according to a major new report from CNA Corp., a strategic risk analysis firm in Arlington, Virginia.  Written by the company’s Military Advisory Board, a panel of former high-ranking military officers, the report warns that inaction on climate change is seriously undermining the post-Soviet world order, destabilizing critical regions, fomenting terrorism, and endangering irreplaceable supplies of water and energy.

No Security without Energy Security

“The volatile mixture of population growth, instability due to the growing influence of nonstate actors, and the inevitable competition over scarce resources will be multiplied and exaggerated by climate change,” the report says.

That conclusion was echoed by Helge Lund, CEO of the Norwegian oil & gas major Statoil, in an address at Columbia University’s Center on Global Energy Policy Spring Conference.  “Energy policy is economic policy,” Lund remarked, adding that “Now is the time to support investments that spur carbon reduction.  In that perspective, we at Statoil are strong believers in a high carbon price.”

What a growing chorus of top generals and admirals and senior business executives is saying is this: The proliferation of renewable energy sources, the spread of energy efficiency and conservation measures, and the reduction of reliance on fossil fuel imports from volatile (or hostile) states aren’t just feel-good green policies; they’re critical strategic responses to the harsh realities of climate change and growing resource conflicts.  The world leaders who would resist a price on carbon include Vladimir Putin, whose expansionist tendencies and contempt for the censure of Western democracies is based on his country’s energy might.

If the world fails to act, wrote retired Rear Admiral David Titley, former head of the Navy’s task force on climate change, in the CNA report, “I am afraid we will soon start getting into varsity-level instability.”

 

In Reinvention, TVA Wrestles with Uncertainty

— May 9, 2014

This week’s release of the Third National Climate Assessment – which demonstrates that the effects of climate change today are much more widespread, pervasive, and destructive than previously understood – and the decision by Stanford University to cleanse its endowment of $18 billion in investments in the coal industry have increased the pressure on U.S. utilities to reform their business models, restructure their fuel mixes toward cleaner fuels and away from coal, and embrace the distributed energy model that is gradually replacing the centralized grid.  Nowhere are those pressures more apparent than at the TVA Towers, the Knoxville, Tennessee headquarters of the Tennessee Valley Authority (TVA).

TVA is being forced to remake itself at a more rapid pace than other utilities, thanks to the settlement of a historic lawsuit filed by the state of North Carolina and the U.S. Environmental Protection Agency in 2011.  The agreement called for a drastic reduction in TVA’s coal-fired power generation capacity and a variety of clean-up measures at the remaining plants.  In essence, TVA – which is one of the nation’s largest operators of both coal and nuclear plants and is attempting to complete and fire up the second nuclear power reactor at its Watts Bar Plant in central Tennessee – is being shoved out of the business of burning coal.

Time to Go

In fact it is time, according to a new report from the conservative Heritage Foundation, for TVA to go the way of the Works Progress Administration and the Rural Electrification Administration – other New Deal federal agencies created to create jobs, spur economic development, and bring light and power to America in the depths of the Depression – and shut its doors.

Unique among U.S. utilities, TVA is a quasi-federal agency that was created with an explicit socioeconomic mission beyond the business of supplying electricity to its customers: to develop the Tennessee River into a navigable waterway, to bring prosperity to some of America’s least developed regions, and to be a steward of the region’s resources.

“The navigation waterway is built, though lightly used,” writes Ken Glozer, author of the Heritage report.  “Electricity is widely available, though rates are among the highest in the Southeast; and the people of Tennessee enjoy a good standard of living.  The most effective way to restore efficiency to the TVA system and to relieve federal taxpayers of a significant liability is to sell the Authority’s assets in a competitive auction.”

End of the Coal Era

Going fully private is hardly what TVA CEO Bill Johnson had in mind when he told shareholders and audience members at the Authority’s May 8 board meeting in Memphis that the 81-year-old organization is cutting expenses and refashioning its power generation business in order to meet the region’s power demands with rates below the U.S. average, while replacing coal with more renewable sources of power generation and instituting far-reaching conservation and efficiency measures.  TVA has already shut down its John Sevier coal plant near Rogersville, replacing it with a state-of-the-art combined cycle natural gas plant, and plans to shut down several more, including the massive Johnsonville plant, the largest coal plant in its fleet.

Johnson also said that TVA’s debt, which in recent years has edged closer to the $30 billion limit imposed by Congress, is coming down.  Debt reduction, he argues, will help the authority in its plans to open new co-generation plants that would use biomass in combination with coal to produce both heat and steam.  The co-generation project “is a perfect example of how our improved financial condition has put us in a condition to take the steps to do this,” said finance chairman Peter Mahurin at the board meeting.

The steps TVA is taking to remake itself for the 21st century are ambitious and could provide a model for other large utilities – unencumbered by TVA’s ties to the federal government, its complicated history, and its high debt load – to follow.  Whether they’ll be enough to enable the Authority to survive and prosper remains to be seen.

 

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