Falling commodity prices unlikely to reduce power costs
I find this E&E story on the costs of building power plants troubling ($ub. req’d). The lead is accurate, but dangerously and deeply misleading:
The cost of building power plants and transmission lines have begun falling after years of steep increases, promising to temper electricity rate spikes for consumers, according to a new report.
Are power plant prices falling thanks to a fall off in steel, copper, and other commodity prices? Yes. Are utility rates a function of capital recovery, such that lower capex = lower prices, on an all-else-equal basis? Yes. Did a report say that lower power prices = lower rates? I don’t doubt it. But will lower commodity prices lead to lower power prices? Almost certainly not. They might, however, create the kind of dangerously false sense of security that forestalls economically and environmentally critical (but politically hard) reform.
To be sure, cheaper power plants + fixed equity returns = cheaper power. But if one takes that to mean that the economic problems associated with dirty power are over, the results could be disastrous. Coal still isn’t cheap, and new-build nuke is still an economic boondoggle. But headlines like this might convince us otherwise.
In short, because all else isn’t equal. Commodity inflation was only one of many factors leading to an increase in the cost of power. The lack of new construction over the last two decades played a critical role, as we have suddenly have to start paying for capital recovery in addition to the variable cost of power. Environmental regulations effectively double the cost of a new coal plant relative to the pre-Clean Air Act dinosaurs that still make up much of our baseload generation (and depress their energy efficiency). Those fundamentals don’t suddenly change because copper is 25 cents cheaper per pound, so we still have heavy upward pressure on power price.
But aren’t we at least a little better off if capital costs are lower?
It is tempting, but lazy, to say yes. On an all-else-equal basis (there’s the phrase again!) one could argue that if we were looking at 40 percent rate increases in last year’s commodity price markets, then maybe we’re only looking at 20 percent rate increases as construction costs fall. But all else ain’t equal.
Most notably, if you haven’t noticed, the financial markets have totally seized up. (Indeed, that’s a good part of the reason commodity prices have fallen so far, and so fast). Which means that power plant investors can’t get the capital they need to build the plant, regardless of the cost. Maybe they’ll be able to get rate-payer guaranteed capital on the equity side, but they still have to raise debt.
Consider: In “normal” financial markets, utilities could borrow 65-80 percent of the total capital cost of the project. In the current environment, they’d be lucky to get 50 percent. So that $1 billion plant that used to require ratepayers to cough up $200-350 million in guaranteed rate recovery now requires those same ratepayers to cough up $150-200 million more … all-else-equal. Maybe the billion bucks is down 10 percent, but that project still has a higher price tag for the rate payer.
Worse, the capital market seize up is causing everyone to stall their capital projects. In which case it doesn’t matter that the billion dollar investment now “only” takes $900 million, because no matter what it costs, investors are going to keep their money in their pockets until financial markets settle down. Meaning we get no new generation, supply tightens further, and prices rise. This means at some point we turn into South Africa [PDF] where the supply constraints forced rolling blackouts and ultimately compelled the government to impose massive financial penalties on anyone who didn’t curtail their electric demand.
Which brings us to the final (dangerous) temptation: If fossil-fired generation is shut down and users are mandated to conserve, the environment wins, right? In the short-term, yes (although the environmentalist in the hospital wondering why the machine that goes “bing” isn’t going “bing” anymore may disagree). But let’s not lose sight of the fundamental problem: A world in which regulated utilities get guaranteed returns on economically stupid, environmentally irresponsible plants while the private sector must attract at-risk capital if they want to build economically beneficial, environmentally responsible plants is a world that will, eventually, get what it deserves: dirty, expensive, unreliable power. All the commodity price reductions in the world can’t fix that fundamental failure of electric market regulation … but if we’re not careful, it might just convince us that the economic pain of environmentally irresponsible power is acceptable, which would be disastrous on every level.
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