Cathy Kunkel, Energy Analyst, Institute for Energy Economics and Financial Analysis
Last year was a tough one for independent power producers—companies that own power plants operating in deregulated markets. They include AES, Calpine, Dynegy, NRG, and Talen, companies whose stock prices dropped in 2015 by 30% to 66%.
Independent power producers became increasingly prominent after deregulation of the electric power industry drove regulated utilities to divest their power plants into separate companies. Power markets were set up to allow power plants to bid into the market with their operating costs; plants whose output is needed to meet demand receive the market clearing price.
Deregulation is a gamble—power plant owners are betting that the revenues they receive from selling power at market prices will be enough to recover their operating costs, as well as their fixed costs and profit. It’s a gamble that has had a rocky history: most major independent power producers have gone through bankruptcy at least once in the last 15 years (NRG, 2003; Mirant, 2003; Calpine, 2005; Dynegy, 2011; AES Eastern, 2011; Edison Mission Energy, 2014; Energy Futures Holdings, 2014).
Today, independent power producers, once again, are facing financial problems. So are utility holding companies that own both independent power producers and regulated utilities (companies such as Exelon, FirstEnergy and NextEra).
The root of the problem, of course, is low wholesale electricity market prices. Gas prices continue to be low, and likely will remain so throughout this initially warm winter, pushing wholesale power market prices down. And electric demand continues to grow very slowly, or not at all in some regions of the country, which helps keep power prices low. Nationally, electricity demand grew only 1% from 2013 to 2014. By comparison, from 1980 to 2000, electricity demand grew by about 2.5% per year.
It has taken the electric utility industry a long time to adjust to the reality of slowing growth in demand. Every year from 2010 through 2014, PJM issued a load forecast that was revised downward the next year. Only in 2015 did PJM finally revise its load-forecasting methodology; its most recent load forecast shows a decline of 3.6% by 2019. This is a structural new reality, not simply a result of the recession, as PJM’s most recent load forecast belatedly acknowledges.
What does this mean for independent power producers in the near future? All indications are that low power prices and relatively flat electricity demand will continue for the next couple of years at least, meaning continued financial difficulties for the owners of merchant power plants.
Such an environment—in which growth is difficult—is ripe for future mergers and acquisitions. And companies that own a lot of merchant generation are desperately trying to add additional regulated operations, which have more stable earnings. (In a memorable email leaked last month, Hawaiian Electric Company’s CEO described her company as a “snack” for NextEra, the energy conglomerate on its way to a “buffet luncheon to acquire other regulated utilities.”)
The only other strategy that such companies have for turning their financial performance around is to find creative new ways to stick ratepayers with the costs of obsolete generating technologies, as FirstEnergy and AEP are currently seeking to do with their proposed ratepayer-funded bailouts in Ohio.
As the 2016 Federal administration prepares to announce new policies that cut back on subsidies for companies that mine coal from federal lands, the reforms are “Welcome, long overdue and in the best interest of taxpayers,” said Tom Sanzillo, director of finance for the Institute for Energy Economics and Financial Analysis (IEEFA).
“This, at bottom, is also a step toward better U.S. energy security,” Sanzillo said.
“Current policy subsidizes the development of economies that compete with the United States and that allow coal producers in the Powder River Basin of Montana and Wyoming to continue their campaigns to accelerate sales to China, Taiwan, Japan, South Korea, Vietnam, Thailand and India,” Sanzillo said. “With the depletion of Central Appalachian coal, the Powder River Basin becomes the nation’s largest and last coal reserve. It is a national resource of strategic importance, and should be treated as such rather than as a source of subsidized profit for coal companies and foreign development.”
Sanzillo said the reforms “could reestablish a fundamental risk-and-reward relationship between coal producers and U.S. taxpayers.”
“Coal exports will still be mined from the Powder River Basin even with the market difficulties the coal industry faces. As long as that’s the case, federal taxpayers and host states are due their share of compensation on what they own.”
“The coal industry is failing spectacularly,” Sanzillo said. “Current policy only props up a business model that cannot compete with low natural gas prices, rising market penetration of renewables and increased public support for alternatives to coal. It is plain that the country is moving away from coal usage, a policy trend that is inconsistent with providing public subsidies to coal exporters.”
In August, IEEFA submitted public testimony in favor of reforms (see ￼￼￼￼￼￼￼￼”The Federal Government Owns the Nation’s Largest Coal Deposits—and Must Act Accordingly”). IEEFA in August also wrote a formal letter to Interior Secretary Sally Jewel in favor of reform.
In 2012, IEEFA published “The Great Giveaway,” a study that concluded 30-year-old federal coal-lease policy was outdated.
Director of Finance Tom Sanzillo has 30 years of experience in public and private finance, including as a first deputy comptroller of New York State, where he held oversight over a $156 billion pension fund and $200 billion in municipal bond programs.
Filed Under: Financing, News, Policy