Pulling the Plug on Oil

 | Jul 08, 2013 | 6:00 PM EDT
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It seems incredible, but residents of New England are finding that they need oil to keep their lights on. In an era when most of the nation has removed oil from electric grids, New England's grid continues to rely on oil-fired power plants. While this may be a big win for power producers such as NRG Energy (NRG), Exelon (EXC) and others, it should be an embarrassment to advocates of renewable energy, and it will hurt consumers. In the end, consumers will pay, or they will be disconnected.

First, some context.

If you own a power plant, any type of power plant, including a wind-powered plant, oil is your friend. When a regional grid such as ISO New England runs out of conventional power plants, it is forced to turn on its oil burners. When those oil burners produce power, they set astronomical market-clearing prices.

It is simple math. If natural gas costs $4.00 per million British thermal units (MMBtu) and fuel oil costs $20.00 per MMBtu, any electricity flowing from oil-fired power plants will be more costly to produce than most electricity produced by natural-gas-fired power plants. If plants are equally efficient, the differences in production costs between oil and natural gas are about to 5 to 1.

However, the efficiencies are not the same. Many oil burners that remain in the nation's fleet are boilers, and they are relatively inefficient. Compared with a combined cycle gas turbine, the difference in efficiencies can be 2 to 1, or worse.

Here is the kicker. The wholesale price for all generators is set by the most expensive unit. If oil clears the power market, every generator wins, including producers that deliver energy from efficiency, wind, solar, biomass, nuclear, coal and natural gas sources. However, there is a big loser, and that is the consumer.

Over the last several days, New England has been under a heat wave. It happens every year, so it is not a surprise. To cope with the heat, New England's expected demand for the next few days is somewhere between 22,650 and 23,360 megawatts.

New England is short power plants. The region has enough power plant capacity to meet system-wide demand. However, its incremental assets are oil.

For the last several days, New England was forced to dispatch about 400 megawatts worth of power from oil-fired power plants. While that may not seem like much, it was enough to cause power prices to shoot from $40 per megawatt-hour to about $400 per megawatt-hour.

Here is another kicker. Over the last several days in New England, more power was produced from oil than was produced from solar, wind and landfill gas combined.

It appears that New Englanders ignored the principle of "all of the above" and cast their lot with "some of the above." Unfortunately, they are disposing of perfectly good nuclear, coal and other plants well before building enough renewable energy sources.

New England needs to fix three problems. First, it must educate consumers about the free markets. Many consumers have an oversimplified notion about how energy works.

You can hear it in their arguments. When they advocate shuttering a power plant, some will say, "When I put the plug in the wall, I still get electricity. What's the problem?"

The problem, of course, is economics -- specifically supply, demand and price. To get enough electricity delivered to consumers' walls means that somebody with bodyguards must go shopping for more oil in the Middle East. The price of that oil will be paid by New England's consumers.

Second, New Englanders need to understand that their grid is a regional asset, not a state asset. If a state wants to force a power plant into early retirement, it needs to seek the advice and consent of their neighboring states.

An example is Entergy's (ETR) Vermont Yankee Nuclear Power Station. Some folks in Vermont do not like nuclear power. However, Vermont is trying to destroy a low-cost producer. Citizens of nearby states should be protesting. A loss of a low-cost power producer means higher electric bills for everyone else.

Third, New Englanders should learn that the perfect is the enemy of the good. Before they throw away too many good assets, they need to be sure they have enough of their perfect assets.

For the rest of the nation, very little oil is used in their electricity. Nationally, the average number is somewhere under 1%, including Hawaii. New England remains addicted. Its economy is paying the price.

In the meantime, regional independent power producers are seeing several days of high margin production. NRG, Exelon, Dominion Resources (D) and Entergy (ETR) will finally earn some margin.

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