Kathleen Davis, Associate Editor
EL&P spoke with Hector Ponce, executive vice president of operations for Mitsubishi Power Systems, and Tony Satterthwaite, vice president of Cummins’ commercial generator set business, about the state of the equipment market for generation.
EL&P: New merchant and utility generation is declining. Has the bottom dropped out of the generation equipment market?
Ponce: The generation market has been affected by a collection of a perfect storm and number of untimely factors. These include general decline in the U.S. economy, price of fuel vs. generated electricity expectations, the effect of 9-11 on financial instruments and the Enron decline, with its effects on power producers’ credibility and credit ratings. This, of course, has a direct effect on the generation equipment market and the large number of projects which have been delayed or canceled.
The energy boom originally sparked by brownouts—such as the ones in California in the late ’90s—is over, and we do not expect to see anything like it again. The deregulation measures that were in place were key to the boom, generating excitement with the opportunity to invest and make money even in the merchant scheme.
This caused a large number of IPPs [independent power producers] to race for the win, until reality set in and the economics began to change.
The word “overcapacity” is now key in determining whether additions in any region are necessary and are economically feasible. The fear of investment is real for any probable IPP, and their ability to get financing is the biggest factor in whether a new project can be considered or not. The near future is going to require investment in areas that truly require capacity additions and capacity reserves. The investors may likely be the utilities with existing assets and established business models when they want to expand and depend less on purchased power, or municipalities that have an immediate need to power their local regions. Certain IPPs who remain strong will also likely re-establish their generation programs.
Satterthwaite: It dropped out a year and a half ago. The bottom has been out of the new generation equipment market since the end of 2001.
I think the way to fix the merchant generation business is to get the economy growing again and have economic growth soak up the excess generating capacity. Now, you need some excess, right? The industry has to have around a 15 percent capacity margin. If it drops below that, supplies get tight. I think, though, if you looked at the overall system, there’s more benefit in reducing the bottlenecks, which means investment in transmission and distribution more than investment in generation.
So, how do we fix the generation equipment market? The best thing I could say is to get the overall economy and electricity demand growing more quickly.
EL&P: Looking at the overall generation equipment market, what’s the outlook for the next five years?
Ponce: Based on the factors I’ve mentioned, certain regions or pockets will inevitably need to add capacity. We think that utilities are looking for ways to do this, and their strategy will likely include new additions to supplement modernization programs to keep the existing and older fleets running and increase their capacity, efficiency and reliability. The municipality and IPP strategies will almost certainly involve new equipment, but it would be more localized additions. Also, as one considers the fuel mix of the nation, dependency on any one fuel will give way to diversification now that the utilities become more active. With their experience, they will be looking for balanced programs whereby their fuel mix will be more manageable. We will probably see more activity for coal-fired generation to supplement the gas powered plants that are coming on-line as well as some of the renewable additions, such as wind-powered farms.
Satterthwaite: On the one hand, if we take 2002 and 2003 as the baseline, it’s got to get better. The worry is, of course, that it will get worse. But, we are way down from 2000 and 2001—25, 30, maybe more percent.
When you look at non-residential capital spending, that number is way off from its peaks in ’01, and that number is what has to come back for us to see the generating equipment market go up. We need an increase in capital spending.
We’re very much tied to the economy, and, of course, the big question mark is what happened a month ago [with the blackout]. Personally, I think that can have nothing but a positive effect for this market. I think the whole concept of stand-by generation and what you can use it for was expanded enormously just in that one instance, from life safety reasons to business opportunities. In a macro sense, people’s concept of stand-by generation has been greatly expanded. The hotel whose electric door locks didn’t work when the lights went out suddenly realized that those circuits need to be hooked into the stand-by generator, for example. So, all of a sudden, that company realizes that they need a bigger stand-by generator, and that’s going to drive some business—if not on the large market scale of power generation, at least on the stand-by and DG [distributed generation] level of power generation.
EL&P: How will the blackout and its aftermath impact the generation equipment market?
Ponce: The blackout in the Northeast was, as the President called it, “a wake-up call.” We expect that renewed attention will be given to our energy needs and the stability of our supply. The renewed attention should lead to proper studies, which will inevitably show a need to modernize the grid and to ensure reserve capacity is in place.
With respect to reserve capacity, each region will be cautious of depending on “far away power”; so, there will be a need to ensure each utility or region has local reserves. This should make evident a need for peaking fast start capacity as well as “close to the load center” and distributed generation.
Satterthwaite: I think the blackout will certainly be beneficial to stand-by generation—with a big “if.”
Right after the crisis, we here at Cummins received a number of requests. Many people started to plan. The problem is, if the economy doesn’t pick up, the guy writing the check for that stand-by generator thinks, “Now, wait a minute. The economy isn’t getting any better. Stand-by generation doesn’t bring me any revenue. It doesn’t reduce my costs. Why am I going to do this?”
So, unless the economy gets a little bit better, I don’t expect the blackout by itself to cause investment in stand-by generation to boom if the rest of the economy just sort of stays where it is. But, if the economy gets a bit better, we could get a multiplier effect. As people are investing and business is getting better, then they might think, “You’re right. We need to do something about that stand-by generator.”
But, I don’t think the blackout will have much of an impact in merchant and utility markets—unless it’s on the side of transmission and distribution investment.
EL&P: What big research and development (R&D) areas should generation equipment manufacturers be looking into and/or funding?
Ponce: We believe that we must continue to focus on environmentally-friendly technologies. The need to curtail emissions is a continuing mission. Wise use of our resources forces a need for continued improvement in equipment and plant efficiencies. Reliability is a must to prevent plant outages like the ones that played a role in the Northeast blackout. The leaders in R&D for these areas will undoubtedly be successful in being the supplier of preference. In addition, OEMs [original equipment manufacturers] like Mitsubishi, who have complete capability in scope (up to total turnkey supply) and technologies (gas turbines, steam turbines, boilers, SCRs, wind, diesel and more within one company) and who continue to develop advancements in all these areas, will be the key partners for our customers’ success as they develop their growth strategies and chose the options available to them.
Satterthwaite: There’s one thing that we look into and fund every year, and that’s emissions. Emissions is still a key issue and will remain a key issue.
Secondly, I think one of the big investments needs to be in a process that interconnects and manages over a network critical transmission, distribution, and distributed generation facilities—even to the level of the stand-by facility. To me, running the grid as a network, with more interconnection and more intelligence in the network than we have today is a huge potential area for R&D. How do we get generators online and offline quicker and easier—whether those are small generators or large? Smarter, quicker switches.
To me, the way we’re going to solve the big problem in our industry right now—the T&D problem—is through a combination of transmission and distribution investment and distributed generation. I think the smarter utilities are the ones figuring out how to make DG work for them and not viewing DG as “the enemy.” Instead, they are saying, “How do I put DG in place to help my distribution network, to help my transmission network, to help my customers?” And not just view it as the competition who is “stealing my customers,” which we have seen in some utilities.