A commentary by Michael Vickerman, Director, Policy and Programs at RENEW Wisconsin:
Shock waves reverberated across the Upper Midwest when Dominion Resources announced in late October that it would permanently shut down its Kewaunee nuclear generating station in early 2013. Operational since 1974, the Kewaunee station, located along Lake Michigan 30 miles east of Green Bay, currently generates about 5% of the electricity that originates in Wisconsin.
Virginia-based Dominion, which bought the 560-megawatt Kewaunee plant in 2005 from two Wisconsin utilities, attributed its decision to its inability to secure long-term power purchase agreements to keep the plant going. Without securing purchasing commitments from utilities, Dominion would have to sell Kewaunee’s output into the regional wholesale market at prices well below the plant’s cost of production.
While the pricing environment for all bulk power generators is nothing short of brutal these days, Kewaunee carries the additional burden of being an independently owned power plant, since the entities most likely to buy electricity from that generator—utilities--have power plants of their own that compete for the same set of customers. And a growing number of these utility-owned generators burn natural gas, which is currently the least expensive generation source in most areas of the country.
Dominion’s decision comes down to simple economics. Wisconsin utilities believe that over the foreseeable future natural gas will remain cheap and supplies will remain abundant. That would explain their unwillingness to enter into long-term commitments with Dominion, even though Kewaunee recently acquired a 20-year extension to its operating license and does not need expansive retrofits to comply with environmental standards, unlike a host of utility-owned coal plants in Wisconsin.
But even if Dominion’s managers were convinced that natural gas prices have nowhere to go but up in 2013 and beyond, the company, lacking a retail customer base in the Midwest, could not risk producing power below cost while waiting for the turnaround.
Wisconsin utilities have placed heavy bets on natural gas in the expectation that it will remain the price-setting fuel for years to come. Over the last 12 months, they have bought several combined-cycle generators from independent power producers. Buying power plants enables them to pass through their acquisition and operating costs directly to their customers while generating returns to their shareholders. I suspect these utilities are anything but broken up over the impending demise of a nonutility competitor that could have supplied electricity to Wisconsin customers for 20 more years.
But there is another side to this story; the low-price energy future that Wisconsin utilities are embracing can only materialize if natural gas extraction companies continue to sell their output below production costs. This expectation is unrealistic, given the massive pain being inflicted on these companies in the form of operating losses, write-downs, and credit rating downgrades.
Don’t just take my word for it, ask Exxon Mobil ceo Rex Tillerson, whose company spent $41 billion during the shale gas boom to acquire XTO, a large gas producer that is now yielding more red ink than methane. As reported in a recent New York Times article, Tillerson minced no words in assessing the impact of its recent misadventures on the company’s bottom line. “We’re all losing our shirts today,” Tillerson said. “We’re making no money. It’s all in the red.”
Much of the industry’s woes are self-inflicted. The lease agreements that drillers eagerly signed during the height of the shale gas boom obligate them to extract the resource by a certain deadline, regardless of whether such activity is profitable. That these companies cannot disengage quickly from existing leases is greatly diminishing their appetite for exploring new natural gas prospects. Until a pricing turnaround occurs, they will refrain from spending money on exploring new resource provinces like Ohio and Michigan.
Sooner or later, this slowdown in exploration activity will tip the supply-demand equation in the opposite direction, resulting in lower-than-average gas storage volumes. Barring a repeat of last winter’s unusually mild weather, the crossover point should occur around January 1st . But with so many balance sheets in tatters from this highly unprofitable market environment, nothing short of a strong and sustained price increase will be required to persuade drillers to start taking risks again.
When this corrective price increase begins rippling through the electricity markets, it will be interesting to observe how the customers will respond. Right now Wisconsin utility managers are convinced that they are making the right call on natural gas. So completely have they swallowed the shale gas “game-changing” mystique that they were willing to let a 560 MW nuclear plant fall out of the supply picture for good. In this brave new world of theirs, gas is the new coal, and resource diversity is passé.
In the aftermath of Dominion’s announcement, a few commentators have defended the impending closure as a textbook example of how markets work. But this view ignores the delusional thinking that sent shale gas extraction into overdrive, causing prices to plunge below the cost of production. The real game-changer, as it turns out, here was not the emergence of “fracking” technology but the industry-generated public relations campaign that implanted the narrative of a nation awash in cheap natural gas into virtually every American cranium. But as we now see, this narrative has boomeranged on the natural gas industry, and they are paying for their current woes in ways that guarantee a pronounced pendulum swing in the direction of higher prices.
The question going forward is: will this narrative also boomerang on Wisconsin electricity users, after the last employee leaving Kewaunee turns out the lights?
