One of the best sources of information about how the U.S. produces, moves, stores and consumes energy is the Department of Energy's Energy Information Administration (EIA). This agency has been tracking primary and secondary energy for decades and regulators, banking, academia and government rely on its reports as a primary source of information.
There is an exception, however. While EIA may serve as a reliable source on how energy was used, its attempts to forecast energy fall short. Its recent Annual Energy Outlook 2011 with Projections to 2035 is a good example. Unfortunately, many have received this report as if it were important. It is not.
EIA warns that its outlook does not represent where the country is headed. It discloses that projections are "based generally on Federal, State, and local laws and regulations in effect as of the end of January 2011. The potential impacts of pending or proposed legislation, regulations, and standards are not reflected in the projections."
If that were the only deficit, EIA's projections might be worth reading. But EIA's outlook has far more serious problems that render the entire report useless.
A good example is EIA's projected costs for new power plants. The agency estimates the total cost of electricity produced from advanced nuclear power plants will average $113.90 per megawatt-hour in 2016. It also estimates every other form of power generation for the same year, including gas turbines at $124.50 per megawatt-hour, photovoltaic solar cells at $210.70, offshore wind at $243.20 and solar thermal at $311.80. According to EIA, onshore wind will beat nuclear. The winners will be combined cycle at $66.10 and advanced combined cycle at $63.10. Before anyone relies on these numbers, know that EIA estimates ignore future federal, state and local subsidies, which is appropriate for this type of analysis.
With these numbers in the public, it's a no brainer for utilities to decide where to make their next investment. EIA's report is a clear signal EIA believes that everyone concerned about costs should invest in power plants that use natural gas. More importantly, anyone not investing in natural gas is making a financial mistake.
The problem is regulators, bankers and investors rely on EIA and its vast reservoir of data. EIA's outlook could introduce confusion for power plant owners and developers such as AES Corp. (AES), Atlantic Power (AT), Calpine (CPN), Dynegy (DYN), GenOn Energy (GEN), and NRG Energy (NRG). Utilities may find their attempts to finance new power projects depend on how their particular project aligns to EIA's reports and views. It appears if utilities propose anything other than a combined cycle gas turbine, regulators, bankers and investors might argue that their proposed project is not prudent. Furthermore, savvy shareholders could argue that the proposed project would be noncompetitive, could expect lower gross margins and earn less.
But they would be wrong. The probability that EIA's estimates are correct is somewhere near zero. If fact, if the entire report is read carefully, EIA warns that there could be a large gap between reality and EIA's estimates.
There are a couple of reasons. First, buried in EIA's estimates is a list of important assumptions. They include EIA's estimates of the average cost of capital (interest rates) and average cost of delivered natural gas for each year over the next five years. EIA assumes these costs will remain low for the foreseeable future. But any sensitivity analyses on these assumptions will produce wild variations in the levelized cost of power generation. They will also change the relative value of cost of generation.
It would be a mistake for anyone to assume natural gas prices and interest rates will remain flat for the next five years. More important, regulators, bankers and investors cannot assume that the levelized cost of power will remain static from all sources over the next decade and beyond.
Second, EIA is only providing an estimate for a point in time. Therein lies the danger. When it comes to capital costs, power plant investors are locked in for 40 to 50 years. The same investors assume enormous risks when it comes to fuel costs, as natural gas prices change daily.
So when EIA provides a single point estimate for levelized costs at a particular year, it is not claiming those power plants will always be profitable; EIA is only estimating that they might only be profitable on the first day of operations.
EIA's outlook does not consider risk and it should not be relied upon to make investment decisions. The outlook is an attempt to model the impossible. It is about process, not outcomes.