The EPA Shifts Utilities' Energy Incentives

 | Jun 09, 2014 | 5:00 PM EDT
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The government has two tools it can use to incentivize energy production. One is to offer tax and financial incentives to motivate investments in favored technologies. The other is to punish competitors so that favored technologies can win.

The Environmental Protection Agency (EPA) is using the second tool. It appears that the agency is punishing coal and natural gas. As a result, states may reward nuclear power. However, nuclear's success may come at a price.

It is about cost leadership. Cost leaders always win in power markets. For decades, Harvard Business School's Michael Porter argued that cost leaders have the competitive advantage.

In the wholesale markets, energy efficiency, solar and wind are the cost leaders. The reason is simple: Their production costs are zero or near zero.

On the other end of the spectrum is petroleum, which has been and will remain in last place. Because petroleum-fueled power plants cannot compete, these units rarely operate. They are useful only to provide grids with reserve margins. That is, oil-fired power plants are idle until there is rare enough demand for the market to pay outrageously high prices for their power.

This leaves the middle ground. Porter warned that the middle ground is a tough position for competitors. It is the domain of nuclear power, natural gas and coal. When natural gas was cheap, gas-fired power plants led this group. When gas prices jumped, coal became the leader. Mixed in were nuclear power plants.

After the EPA announced its new carbon regulations, the dynamics within this middle group changed. Now, state regulators will likely seek methods to punish oil and gas. Some states may join Florida, Georgia and South Carolina and reward nuclear power, which is carbon-free.

Because nuclear power displaces carbon, a nuclear plant suddenly becomes a strategic option for state policymakers. Its presence means that the state has reliable sources of power without the usual air emissions. Its loss means the state must authorize more carbon production, hope demand drops or watch the system lose reliability.

For the middle ground, it appears that nuclear has become a leader. States will realize that nuclear power offers them some environmental attributes they had previously ignored. This is better news for companies such as Exelon (EXC), Entergy (ETR) First Energy (FE) and other nuclear owners. All of a sudden, their nuclear assets are repositioned into the leadership position, at least within the middle ground.

The only question is timing. Will states implement the EPA's new rules in time to save the 10 or 20 nuclear units that are on the precipice of retirement?

In all likelihood, the answer is both no and yes. It will be a no for units that are already retired. It will also be a no for Entergy's Vermont Yankee and Exelon's Oyster Creek, which already have firm commitments to retire early. It also may be a no for Entergy's Indian Point, which New York State is trying to close because it is too close to New York City.

It may be yes for other units. Illinois may try to save its nuclear plants in order to assure reliability, jobs and tax base. The EPA's new regulations give states added incentives to motivate Exelon and other nuclear utilities to keep nuclear plants operating. By keeping nuclear plants operating, states push carbon out of the power markets and out of their states.

Illinois appears to be a bellwether. Exelon is asking state policymakers for economic incentives to prevent early retirement of several units. Since new rules are on the horizon, Illinois may need the nuclear option to help it attain the EPA's new air quality standards.

Illinois may not be alone. Other states may join in. New Jersey and Maryland may attempt to modify their restructuring policies and keep nuclear power as an option.

Yes, it is a reach. Restructuring is an all-or-nothing proposition. If nuclear power is allowed back into the rate base, or if it is provided financial guarantees, other independent power producers will want similar incentives. States will have to walk a fine line by incentivizing one form of energy while punishing another form.

Nevertheless, the facts changed. States' response to those facts will also change. Nuclear power may get a second wind. Nuclear utilities may be in a stronger position than previously thought.

Natural gas may not be the silver bullet that many expected for the power industry. In addition, coal may exit the power markets much faster than many expected..

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