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Here’s How Oil Could Skyrocket By 138%

Here’s How Oil Could Skyrocket By 138%

Oil prices have struggled to…

Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Why Power Companies Can’t Ditch Coal Just Yet

We’ve always had difficulty understanding why US electric companies have not simply closed down old, smaller and least efficient coal-fired power plants quickly. From a simple bargaining perspective we thought the US utility industry would have jumped at the chance. In return we would’ve asked for full recovery of the now “stranded” coal assets and at least ten years of regulatory status quo. Upgrading a power generation fleet in this manner is akin to a corporation flush with cash upgrading its vehicle fleet to EVs ahead of schedule to lower fuel expense. This would have left the US electric industry with a more modern generating fleet and lower O&M expenses. What’s worse is industry leaders may have also squandered an opportunity to lower fuel expenses by swapping coal for natural gas. If this were a competitive industry this sort of managerial misstep would be a fatal mistake.

But there is another problem now. All of our readers know that both coal and natural gas fired power plants emit CO2 along with other emissions. And we’re not looking for a fight here about which is a cleaner boiler fuel on an “all in” basis. Our point here is that there was a period when industry executives could have conceptually segregated their CO2 emitting assets in the public mind. This would’ve meant sacrificing and replacing coal up front. Then? Get regulatory buy- in for gas as the transitional boiler fuel. Not ideal perhaps but this could have been seen as a compromise towards a cleaner energy future.

But instead US utility executives have chosen a different path. We don’t know what the opposite of Stockholm syndrome is, but we think we’re looking at it. It’s no secret that the US regulatory regime is a pale imitation of its former more robust self in the early twentieth century. The academic literature often refers to this as regulatory capture, that is, regulators are “captured”, either financially or cognitively, by the industry they are supposed to regulate. (Although a crude example, this is akin to a judge on the mob’s payroll dispensing lenient sentences for cash.) But what happens to the industry leaders after they “capture” their regulators? In the US we have seen the utilities partner with the energy industry and flirt with the political advocates of climate change denialism. Related: Oil Rallies On Bullish EIA Inventory Data

And here’s the problem. Ultimately regulation is a political process. And if polluting, climate change denying utilities are increasingly seen as part of the problem, then enterprising politicians will soon appear promising to appoint “honest” regulators. As a practical matter this means increasing scrutiny for all CO2 emitting power plants, both coal and gas assets alike. The opportunity for some sort of grand bargain about the composition of the US power generation mix has passed because industry leaders over played their hand.

We certainly didn’t expect profiles in courage, but at least something beyond their half hearted, slow motion drift to carbon reduction. A recent study from the energy equity analysts at Bank of America provided the answer although not in so many words.

The brokerage’s report showed US investor-owned utilities still had $55 billion of coal related assets still in their rate base (half for power generation/ half for undepreciated “scrubbing” equipment). That amount totals 10% of their rate base. (Author’s note: rate base represents the utility’s assets that its regulators, mostly at the state level, permit them to earn a return on their investment on and recover all costs of.)

Public power utilities may have another $15 billion of investment remaining in coal plants. Those utilities would never consider shuttering a coal-fired plant unless it was either fully depreciated or prices had moved substantially against them and co-op members were in revolt— which is beginning to happen.

They will argue that they made a deal with regulators to accept a low return on investment in return for safety of principal and income. They did not earn extra for contingencies. (Non-utility generators also have investments but have elected to wager they could earn out sized profits from the dirtiest fossil fuel power stations before the public became alarmed about climate change. It would appear they have lost this wager.)

But it is this undepreciated balance of coal fired generating asset base, and the regulators that continue to allow it, that is one key impediment to permanently closing coal-fired generating stations in the US. These assets are responsible for 15% of U.S. greenhouse gas emission.

There is another impediment to rapid industry environmental remediation. Electricity generated from relatively ancient coal fired power stations is still cheaper. The coal has become more expensive than comparable amounts of natural gas. But the capital costs of old assets are so much lower due to power plant cost inflation over the last thirty or forty years. Furthermore, if energy storage is required for renewables, then the cost comparison of new vs old power generation becomes even more unattractive.

We did a quick calculation for electricity prices in the coal burning states and concluded that replacing coal with renewables over five years plus paying for the stranded costs would raise prices 7-9% per year over that time period. This is about two to three times the expected annual level of price increases for utility service. Not good. But power generators, if they want to stay in business, have to replace aging equipment eventually. Related: Saudi Arabia Eyes Total Dominance In Oil And Gas

And even fossil fired, conventional power generating plant cost far more than similar equipment did 40 years ago. Prices would have to rise, we calculate, maybe 4-6% per year just to modernize the existing fleet at its current emissions profile. As a result, the incremental cost to US consumers of power plant decarbonization comes to about 3% per year. (See our articles of March 14, April 13 and April 23, 2020 for further details).

From a governmental or public policy perspective addressing coal-fired power generation has an advantage over other means to reduce emissions. There are only a few hundred of these power plants in the entire country. Much easier to regulate. And they are all owned by a relatively small number of utilities fully capable of environmental compliance. By contrast there are tens of millions of automobiles and buildings. Not to mention factories and farms.

The principal obstacles to meaningful change are as follows. Southern and western states currently enjoy low electricity prices because their utilities burn coal. Their regulators will remain reluctant to impose environmentally related changes that would raise prices. Second, utilities remain oppose to fleet decarbonization unless they can fully recover stranded costs. Third, decarbonization is claimed to have detrimental impacts on local economies (higher electricity bills, unemployed coal miners). Nevertheless, eliminating coal burning is the easiest and possibly most cost effective ways to decarbonize US electricity production.

There is also a role here for the federal government. A carbon tax makes coal-fired generation less competitive. The Feds could also purchase old power stations at book or market value from cooperating firms (leaving the others to take the risk of future losses) with the proviso that the money received must go into non-fossil generation or other means to reduce carbon emissions. The Treasury has the ability presently to borrow for public purposes like this at very low cost. Why? Because a 15% reduction in US greenhouse gas emissions produces tangible benefits for the entire country.

Overall we see overcoming the stranded cost roadblock as the paramount difficulty in accelerating the electric industry’s decarbonization program. The industry itself, by taking sides in the politics of CO2 emissions, has made an easy resolution of this increasingly difficult given our highly polarized political climate. They have in effect added fuel to a fire and are now surprised by the heat.

By Leonard Hyman and William Tilles for Oilprice.com

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  • Mark Potochnik on July 01 2020 said:
    Its days are numbered. $2/watt new solar systems are the death of fossil fools. Falling prices won't stop.
    Just make you plans now.

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