Merchant Fever Rising

Issue 8 and Volume 103.

Merchant Fever Has Been Shaking the Electric Utility Industry for More Than a Couple of Years now, but the temperature, and stakes, continue to rise. Not surprisingly, the merchant power trend began in the East. The Eastern United States has the highest electric prices. According to Resource Data International Inc. (RDI), the average 1998 market price in the Eastern region was $27.77/MWh, compared to $22.37/MWh in the Central region and $22.18 in the Western region. The New England Power Pool (NEPOOL) has the highest rates, at $33.00/MWh. A race is on in New England to see which companies can get their merchant plants running the fastest. Those toward the tail of the pack will likely never be built. They will miss the window of opportunity. RDI sees five regions as promising for merchant development in the next few years:

  1. MAIN: The Mid-America Interconnected Network, centered in Illinois, has a large and immediate need for new capacity. Also, fuel prices are low and markets are opening fairly rapidly in Wisconsin and Illinois.
  2. FRCC: The Florida Regional Coordinating Council area needs new capacity immediately, but fuel prices are high and local utilities dominate the market.
  3. SERC: The Southeast Electric Reliability Council region, from Arkansas to North Carolina, faces a similar situation. The area has immediate capacity needs and a large demand looming on the horizon. The market, however, is not yet open in most parts of SERC.
  4. SPP: The Southwest Power Pool, including Kansas, Oklahoma, and parts of adjoining states, has imminent new capacity needs. Also, the markets are opening in this area.
  5. NWPA: The Pacific Northwest and Alberta, Canada, have immediate new capacity needs. Alberta’s market is open, but prospects for merchant plants are dampened by the dominance of the Bonneville Power Association.

Deregulation Jitters
As deregulation fully takes hold across the country and merchant project development accelerates, project sponsors may face a boom-bust cycle. A combination of new plants and expanded older plants might trigger price declines of as much as 20 percent.

Many of the plants now under development and construction are counting on the retirement of aging utility plants to create demand for new units. RDI predicts that 4,675 MW of existing non-nuclear capacity and 13,244 MW of nuclear plants will be retired by 2010. If these retirements are delayed, a power glut could easily ensue. Excess power will favor the larger players, which will be better equipped to withstand fluctuations in market prices. This could cause more consolidation.

Gas Domination
Going hand-in-hand with consolidation is the ongoing trend toward convergence between the fuel and electric sectors in the United States. To be in the best position to play the markets, an energy supplier needs to control a variety of fuels and generating resources. This favors fuel companies, which might gain greater control of the U.S. merchant power business over the next few years. For these fuel companies, electricity generation represents a way of monetizing fuel resources sitting in the ground, pipeline, or railcar. Generating plants provide an attractive market outlet. Merchant plant operators without a broad portfolio of assets to play into the market will be at a distinct disadvantage. This, again, could spur consolidation.

Merchant announcements continue at a steady pace, but the profile of a typical plant remains steady. The capacity of these projects ranges from a low of around 40 MW to a high exceeding 1,000 MW, but the average plant is still a 500 MW, combined-cycle configuration.

Natural gas facilities are the most popular by far, thanks to lower installed costs, shorter construction times, and higher efficiency than many other types of facilities.

Market Penetration
By the end of 1998, merchant plant announcements exceeded 47,000 MW. Announcements continue and by mid-1999, the total had surpassed 75,000 MW and it continues to climb.

The merchant phenomenon has spread throughout the continental United States, with 37 states boasting planned merchant facilities. From Alabama to Wyoming, projects are springing up. Many states have only one or two projects, and some may be very small – offering only a handful of megawatts in excess capacity, or fewer than 100 MW in a cogeneration setting. California, Texas, Maine and Massachusetts have broken into double digits, with more than 10 plants announced within their borders.

The more recent announcements, which show merchant power filling the nation, follow the same lines as the earlier ones. Most of these facilities are natural gas-fired, and most are either combined-cycle or cogeneration plants. The cogeneration facilities generally have an industrial neighbor contracted to take part of the plant’s electricity and/or steam for a guaranteed source of income.

Wyoming is a standout with three merchant announcements – all coal-fired. These plants are to be built at or near coal mines. All are in the planning stages and they run a bit smaller than the natural gas plant average, with all three plants combined expected to yield 520 to 570 MW of generating capacity.

Financing has been, and will continue to be, a top concern and priority for these expensive projects. Other important issues include regulatory changes, environmental issues and regulations and siting issues. The firms attempting to get permits and approvals for these plants face another tough hurdle: the public. In some areas and communities, extensive education is needed to help stop the NIMBY (Not In My Back Yard!) problem. These super-clean and efficient natural gas-fired designs seem to be winning friends for their proponents and helping to move the merchants through the permitting and siting processes.

The Future
We will have to wait a few more years find out which of the many companies competing for the merchant market, and for the deregulating electricity market in general, have what it takes to survive and thrive in a competitive environment. Many of today’s exciting merchant announcements will quietly be cancelled due to lack of financing, inability to site and permit the project, or lack of competitive edge.

Domestic electricity demand grows annually at a slow but steady pace and the nation’s reserve margins are quite low by historical standards, so it is inevitable that some of the 75,000 MW of announced projects will indeed be built and run. But, it will take either a crystal ball or a good amount of waiting, to discover which ones.