Surprises From the Energy Front

 | Dec 06, 2013 | 4:00 PM EST
  • Comment
  • Print Print
  • Print
Stock quotes in this article:












Here is a surprise. Three of the nation's power grids announced they might not have enough power plants. As difficult as this could be for consumers, it could be the long-awaited news big-fleet generators such as Exelon (EXC), NRG Energy (NRG) and Calpine (CPN) and others have been waiting for.

Here is another surprise. While new U.S. Environmental Protection Agency (EPA) regulations are a factor, they are not the root cause for the nation's capacity shortfalls. The root cause is the markets. They are punishing power producers to the point that they must exit the business.

Thousands of megawatts worth of capacity are not clearing the markets. Keep in mind that, in order to bid, assets must be compliant with current and future regulations. That means thousands megawatts of compliant capacity is not clearing the auctions.

That is only half the story. Even if a generator clears, the auction delivers inadequate revenues. As a result, utilities are retiring marginal generators at unprecedented rates.

ICF International (ICFI) recently completed a study about New England's situation. It turns out grid operators were surprised by retirement requests. The grid went from surplus capacity to inadequate capacity in 12 months. Their ISO-NE's Turnaround in Supply/Demand Balance and Capacity Price Implications suggests, "Recent events in ISO-New England underscore the speed with which a seemingly oversupplied market can become short of capacity. This development is promising for remaining generators because capacity prices likely will be higher in the next auction, compared with industry expectations of very low prices for the upcoming capacity auction."

ICF reports 3,135 megawatts of capacity were retiring unexpectedly. NRG is retiring three oil-fired generators in Connecticut. Energy Capital Partners will shut down four coal-fired units in Massachusetts. Entergy (ETR) will shut down one unit nuclear plant in Vermont. In addition, hundreds of megawatts of energy efficiency (demand response) are disappearing. If New England's capacity markets do not improve, investors should expect more capacity to exit.

About the same time as ICF issued its report, McGraw Hill's (MHFI) Platts issued a warning about the Midcontinent Independent System Operator (MISO). According to Platts, "The survey projects about 7,900 MW of capacity will be retired or mothballed; leaving total resources about 7,500 MW short of the 109,900 MW needed to maintain the federal tariff."

MISO and New England shortfalls are in addition to the previously reported challenges faced by Texas. Texas is short capacity, and each year its shortage increases.

The problem is largely structural. Most of the nation's capacity markets fail to provide financial incentives for generators to remain in the market.

Some challenges are easier to resolve than others. As one colleague pointed out, all Texas has to do is tie its grid to adjacent grids, and neighboring capacity suddenly becomes available. However, Regional Transmission Organizations (grid operators) are reluctant to change policies that control their capacity markets, particularly for their base-loaded power plants.

The policy problem that prevents fixing the markets is a little more complex. It seems grid operators want capacity at no cost or low cost. Investors are being asked to commit billions of their dollars for 30 or 40 years with no assurance from regulators and grid operators that they will ever earn a return.

The other policy problem is unnecessary complexity. For example, New England's grid is willing to pay for capacity, but not too much. To make it more difficult, New England developed complex and seemingly illogical rules that purposely discriminate against classes of investors. Specifically, existing generators earn one price. New generators earn a better price. As ICF reports, the difference could be as high as 500%.

When the Federal Energy Regulatory Commission (FERC) set up its policies to create and operate Regional Transmission Organizations (RTO) markets, they had a goal of maintaining fair, free, open and non-discriminatory markets. It seems that in many of the nation's capacity markets, it is anything but.

The outcome is predicable. Investors of base load capacity are shunning RTO markets. The only deals that are being done are plant upgrades and the reselling of used generators (at a deep discount).

In the long term, this is good news for the larger fleets. Weaker players are exiting. New entrants cannot serve base load. RTOs are increasingly in a bind.

In the long term, companies such as Exelon, NRG Energy and Calpine should see stronger markets. RTOs will be forced to improve their capacity markets. Weaker players will not wait and they will exit. The result will be stronger capacity markets. Stronger capacity markets suggest stronger energy markets.

As time goes on, investors may learn of even more retirements. Keep in mind that retirements are good for capacity and energy markets and good for investors. In the meantime, ignore most of the rhetoric about how EPA is destroying the energy industry.

Columnist Conversations

volatility is quite low here, and we could see some downsides here in the short term. ...
View Chart »  View in New Window »
this chart is showing great bullish signs here, we like this to take out the old high shortly. ...



News Breaks

Powered by


Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.