Industry uncertainty prompts utilities to build their own generation

Washington, D.C.

The spectacular collapse of Enron, the failure of electricity restructuring in California, and uncertainty about federal energy regulation are prompting many U.S. utilities that need generation or backup power to build it themselves, according to a report prepared for the American Public Power Association.

The report stated: “Restructuring of the industry for retail choice has slowed to a stop in virtually all locations since the California experiment. Credit markets have voiced their negative view of the process. In the midst of this, the Federal Energy Regulatory Commission (FERC) has issued its comprehensive Standard Market Design (SMD) notice of proposed rulemaking, which is being challenged in many areas of the country.”

Additionally, proposals by federal regulators to encourage expansion of the transmission system “are not going to solve the dilemmas facing load-serving entities who need to plan for additional capacity now,” the report said. “The industry is moving back to a world where the traditional utilities are building generation in many locations.”

“The fallout from the failure of the ‘Enron’ approach to the electric power market has been dramatic to watch,” wrote Kiah E. Harris, a power supply planning engineer with Burns & McDonnell who authored the report. “Bankruptcies, massive layoffs, drastic reductions of electricity trading, cancellation of numerous power projects, and many other changes have occurred in a matter of months.”

The upheaval in the U.S. electricity industry is causing utilities, local regulators and customers to worry more about reliability, Harris said in the report, “Effects of Uncertainty on Market Development: Reliability, Planning and Local Generation.”

“Local generation andtransmission additions are less problematic to deal with than when they involve FERC, regional transmission organizations, independent power producers[IPPs] industry boom/bust cycles, and so forth,” Harris stated. “Local generation typically involves dealing with less bureaucracy, fewer stakeholders, and more reasonable construction times.”

Worries about transmission congestion are prompting utilities to build new power plants as close to their load centers as they can, he said.

The credit markets “are forcing the industry back to the pre-Enron business model for an electric utility,” according to the report. Highly leveraged projects and electricity trading are out. Merchant power plants are being canceled.

With few independent producers building generation, who will build it? Harris asked. His answer: In many areas of the country, utilities and their affiliates are moving ahead with these projects.

In the early 1990s, utilities “used the transmission system and adjacent generation capacity to provide backup to local generation,” Harris said. Today, however, “we are concerned about the effect of the loss of transmission capacity on our capability to meet load.” This requires utilities to build local generation to hedge against the multiple risks of the bulk power system.

The uncertainty in the industry “is telling many parties to take the smaller plant size, site it local to the load so minimal transmission is needed, and forego economies of scale,” Harris said.

Additionally, Harris stated in his report that “the notion that locational marginal pricing (LMP) is suddenly a new revelation to the power industry is ludicrous. LMP by any other name is simply doing the homework on siting generation.

“Resource planners have always used LMP in generation siting studies. We just used to be able to have the transmission planners at the table with us instead of in some RTO office working on the queue. The formalization of LMP to be considered in siting generation is an attempt to correct the mistake of separating generation and transmission planning.”

Harris concluded, “The financial community has weighed in heavily with a resounding ‘forget it!’ to the merchant power/electricity trading business. Credit quality is so poor in the industry that it is difficult to find a supplier financially strong enough to survive the screening in requests for proposals for power supply. Regulators are seeing parent companies of regulated utilities dragged down by their nonregulated subsidiaries. The cancellation of generation projects has been dramatic and is now causing concern about post-2005 generation needs.

“Utilities, having been shown the future by the traders and IPPs, are now left to pick up the pieces and plan for themselves. With minimal control over the process, plans are becoming more local with smaller units. Hedging with local capacity to minimize reliance on the transmission system is being performed. Least cost is being replaced with least risk. It is reasonable to ask, is it time to invest in those local utilities and distributed generation companies?”

Harris, P.E., joined Burns & McDonnell in 1980. Harris may be reached by phone at 816-822-3174 or e-mail at kharris@burnsmcd.com. The entire report is available at http://www.appanet. org/newsroom/index.cfm.

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