For most population centers across the lower 48 states, consumers' prices for natural gas and electric power are set by the free markets. Energy wholesalers deliver their product to auctions, the lowest offers win, the highest offers are rejected, and everything in between shares margins.
Not only is energy auctioned, but the utility's right to use assets is also auctioned. In particular, reservations to use pipelines, transmission lines and power plants are also auctioned.
One of the more interesting auctions is for power plants. This auction is where generating utilities bid in power plant assets for the privilege of being paid to be one of the grid's resources. Winners earn a daily payment to be available, and that payment is beyond any revenues they may receive for power production. This availability payment is called a capacity payment.
For companies like Exelon (EXC), NRG Energy (NRG), Calpine (CPN) or Entergy (ETR) to bid for capacity payments, their generating assets must be up to date and meet all regulatory requirements. This includes approvals from the Environmental Protection Agency (EPA) and relevant state regulators.
Capacity auctions help pay the utility's mortgage. For grids like the PJM Interconnection (PJM), the capacity payment amounts to serious money. A typical 500-megawatt plant could expect to earn an extra $9,125,000 per year. That payment helps pay for generators capital expenses. Again, capacity payments do not include any revenues a generator may earn from energy production.
Capacity auctions provide interesting insights about the power market and about the industry. They also reveal three myths about energy in America.
Myth Number 1: The Future Is Bleak for Generating Utilities.
Wrong. When it comes to capacity payments, the worst times appear to be over in PJM. Auctions on forward capacity have already been completed and booked until 2017. Looking forward, the numbers are a huge improvement over 2012-2013. See chart:
A typical 500-megawatt plant will see their revenues jump from $5,060,725 per year in 2012 to $24,820,000 in energy year 2015-2016. Yes, there is a dip in 2016-2017, but it is nowhere near the lows experienced in 2012-2013.
Myth Number 2: EPA Is Forcing Coal Out of the Nation's Grid
Wrong. Since 2007, and every year until 2017, more EPA-approved coal-fired plants were offered at auction than were cleared. In the last auction, over 10,000-megawatts of EPA-approved coal-fired power plants were offered at auction but failed to clear. This result suggests these coal assets are uneconomic to maintain and uncompetitive in the marketplace.
Approximately the same time PJM announced their auction results, American Electric Power (AEP) announced plans to retire approximately 6,000-megawatts of coal-fired capacity. They warn the total might be as high as 10,000-megawatts. It is not an accident.
Keep in mind, capacity auctions have absolutely nothing to do with the price of coal or power prices. Capacity payments are about maintaining existing assets and keeping them available to operate if needed.
Auction results are public information. Yet, we hear industry executives and politicians complain continuously about EPA's impact on the coal industry as if emission regulations were the coal industry's only issue. It turns out, most of the EPA-approved coal plants cannot compete.
Myth Number 3: Renewable Energy Is Killing Nuclear Power
Wrong. Renewable energy's contribution in the capacity markets is relatively small. In addition, their capacity values are heavily discounted because their availability is limited. As such, renewable energy has almost zero impact on the open capacity markets. In particular, renewable energy has virtually no impact on nuclear power.
Nuclear generators like Exelon were gambling on massive amounts of coal exiting the market. They anticipated coal's exit would cause the grid to become capacity short. Exelon was right that large amounts of coal capacity would exit the market. They may be wrong about other competition in the capacity markets.
The threat to nuclear power's capacity comes from natural gas. As capacity markets force coal out, natural gas moves in. From energy year 2012 to 2013 to 2016 to 2017, approximately 15,000 megawatts of existing coal failed the auctions while 20,000 megawatts of new natural gas entered the market. This suggests that PJM and nearby Midwestern markets will not be short capacity for the near future.
It is true that nuclear power may be threatened in the other markets, specifically the energy markets. As Entergy's Q2 so plainly illustrates, with production costs floating above $29 per megawatt-hour, nuclear power is far from becoming a cost leader.
Coal, natural gas, nuclear and renewables rely on two separate forms of revenue. One is for the energy they produce. The other is for the capacity they offer the grid. For the last several auctions, it has been capacity that is first to separate the winners from the losers.