Why Peak Power Demand Is Softening

 | Jul 16, 2012 | 4:30 PM EDT
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When it comes to wholesale power, the summertime is the peak period of the year. But this summer, it appears that peak power prices are being shaved. Shaving prices lowers the market's average price, and that can mean lower margins for the nation's independent power producers (IPPs).

Price shaving can be caused by several factors. One is the normal market reaction to power supply and consumer demand. It appears there's plenty of supply, even in the face of new Environmental Protection Agency rules. It turns out that the EPA's rules do not require utilities to shutter non-compliant generators until 2014, at the earliest. So while there's adequate supply, it appears that demand is softening.

Don't blame the economy for softening demand. New energy policies, which were years in the making, are beginning to create economic value for energy efficiency. In some regions, large power consumers can earn revenue by simply reducing their energy consumption. Under a program required by the Federal Energy Regulatory commission, megawatt hours must equal "negawatt hours" -- the market value of energy must equal the market value of energy savings. So softening demand for energy may be coming from growing demand for energy efficiency.

We see energy efficiency in action when watching spot prices. During hot summer days, prices start to climb as demand grows. Prices continue to climb and then collapse.

While there are several reasons for a collapse, in all likelihood it's because demand suddenly disappeared. In markets that have maturing demand-response programs, large consumers monitor market prices and wait for prices to reach various thresholds. When wholesale power prices reach a target threshold, some consumers decide to take the energy-efficiency incentive offered by the grid, reduce their consumption and book a nice payment for not consuming. When marginal consumers exit, overall demand softens, and prices follow suit.

From the perspective of the IPP, it appears that market prices were shaved. This can really hurt pure IPP companies such as Calpine (CPN), GenOn Energy (GEN) and Atlantic Power (AT). It can also hurt integrated utilities such as Exelon (EXC), Entergy (ETR), Dominion Resources (D) and NextEra Energy (NEE), which own IPP assets. But it only hurts if the IPP is depending on the spot market.

Not all IPP production is sold into the spot or day-ahead markets. Many independent power generators enter into long-term power sales agreements with third parties, such as power marketers and energy service providers. These long-term agreements protect IPPs from spot pricing.

Energy service providers (ESPs) are deregulated companies that sell competitive electricity to consumers in state-approved markets. ESPs usually enter into long-term power purchase agreements with IPPs whereby purchase agreements are matched up with energy service agreements. These IPPs are financially hedged, have locked-in margins and are immune to day-to-day market fluctuations.

Sometimes the ESP is also the IPP. Exelon is an example. It owns one of the largest and most competitive ESP companies in the nation. It also owns a large fleet of independent power plants, including the largest nuclear fleet in the nation. With this powerful ESP-IPP combination, Exelon can offer incredibly valuable energy supply services, including energy-efficiency products, to deregulated consumers. Since Exelon has a large portion of the value chain under its control, it should be able to maintain margins, even as peak power prices are shaved.

Exelon is not alone. NextEra is also offering ESP services. Its competitive advantage is its ability to deliver low-cost renewable and carbon-free energy from its independent fleet of wind and solar facilities

Nevertheless, if sustained, lower average spot prices will erode margins for all generators. While cost leaders will remain in the market, marginal actors could be forced out. The marginal actors are relatively inefficient coal-fired plants. However, should natural gas prices inflate; the marginal actors will likely become the relatively inefficient gas-fired thermal power plants, followed by inefficient coal plants.

Should the nation's economy recover, consumers' reaction to demand-response price signals may become muted. Their response to energy-efficiency incentives may be delayed until prices float to higher levels. Higher levels mean higher average prices and higher margins for IPPs.

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