This week, the Environmental Protection Agency proposed another rule for power plants. It focuses on a greenhouse gas, an industry and fossil fuels (coal, natural gas and fuel oil). This rifle shot of a rule will mean higher electricity bills for consumers, and the economic pain will show up faster than regulators expect.
In short, the proposed rule limits carbon dioxide emissions to 1,000 pounds per megawatt-hour, independent of fuel type. The 1,000-pound number appears to come from the utility industry's best available technology, combined cycle gas turbines.
It's not clear whether the EPA is aware that its beloved combined cycle gas turbine is really two turbines. One is a gas turbine and the other is a steam turbine; each has its own generator (this is why combined cycle gas turbines cost much more than gas turbines). Using the EPA's logic, perhaps utilities could pair a nuclear plant with a coal plant and achieve the same result.
The EPA is only partially right when it argues that the nation has a fleet of combined cycle gas turbines. Calpine's (CPN) fleet, for instance, is dominated by combined cycle gas turbines, but many utilities own combined cycle gas turbines that cannot meet the EPA's proposed regulations of 1,000 pounds per megawatt-hour.
To be clear, current fleets do not have to meet the standards described in the proposed rule, they are grandfathered. The proposed rule only addresses new power plants greater than 25 megawatts. Nevertheless, there are consequences to the EPA's proposed rule. Some are costly for utilities and consumers alike.
One consequence affects new peaking power plants, which are typically fuelled by natural gas and operated for short periods. They provide extra power to cover the grid's daily peak periods of high demand. Peakers typically have high production costs and low capital costs. They can be turned on and off as needed. Because they are relatively inefficient, they emit more carbon than allowed by the proposed rule. Therefore, under the proposed rule, utilities cannot acquire these types of plants, or even replacement plants.
High-performance combined cycle gas turbines and new nuclear power plants are the only practical options remaining for grid planners. Both options are designed to serve a constant load for long periods. They cannot be switched off and on quickly or respond to customer peak load demands. Both plant designs have high capital costs and low production costs.
Assets with high capital costs need to operate at high capacity factors or investors will see low returns. Nuclear power plants have capacity factors in the low 90% range. Combined cycle gas turbines have lower capital costs but need capacity factors in the 80% range.
With peaking and intermediate resources declining, Regional Transmission Organizations and private grids will resort to forcing combined cycle gas turbines and nuclear plants to "follow the load," which forces lower capacity factors and decreases efficiencies. Lower efficiencies or higher production costs will lower gross margins.
Advanced combined cycle gas turbines manufactured by General Electric (GE) and Siemens (SI) can maintain high degrees of efficiency while load-following. But the capacity factor remains the economic challenge for owners; it's a return on assets issue.
The grid's challenge is amplified if the volatility of natural gas returns as consumer prices will explode. This is a concern raised by experienced companies such as Dominion Resources (D), Southern Co. (SO), American Electric Power (AEP) and other generating utilities.
By eliminating options, the EPA's proposed rule violates a fundamental law of the electric power industry: diversity provides safety and economy. The EPA's proposed rule clearly reduces diversity, and the lack of diversity will likely cause price volatilities for wholesale power prices.
The Obama administration agrees with the utility industry's argument for diversity. The administration's consistent message is that everything is on the table. That is clearly an argument for diversity.
Yet the EPA's proposed rule takes almost everything off the table. If the EPA's proposed rule becomes a federal regulation, grid planners, developers and policymakers will have only two options left for their base-load customers: nuclear power or combined cycle gas turbines.
For all practical purposes, it's not even an option between two resources. For the next decade, new nuclear power is not an option -- most utility boards will not risk investing in new power plants that cost more than their utilities are worth.
Thus, the EPA's proposed rule is a rifle shot that effectively eliminates all practical options except combined cycle gas turbines. In its proposed rule, the EPA is effectively defining diversity as one.
If approved, this regulation is bad policy for those needing safe, economical and reliable power. It's not even good environmental policy.