More power to you

The Joint Finance Committee of the Wisconsin Legislature has approved statutory changes that would allow a compromise plan for $7 billion in new electric generation hammered out by Wisconsin Energy Corp. (WEC) and business and consumer energy users to advance to the Public Service Commission (PSC).
While input from business ratepayers was included through a compromise between WEC and the organization Customers First!, some analysts remain critical of the plan’s provisions to allow WEC to purchase the facilities after a 25-year period. Some also call into question plans to rely on natural gas as a fuel, given likely price fluctuations.
The plan is to build at least five new power plants with a total capacity of 2,800 megawatts, including two 500-megawatt (mW) natural gas-fired power plants. One is planned for the Port Washington Power Plant site. Three 600-mW coal-fired units are planned for the Oak Creek Power Plant facility.
Construction cost of new generation facilities would be $3 billion, and the utility plans to expend an additional $1.3 billion on upgrades to additional generation facilities and $2.7 billion in distribution system improvements. The total cost of the plan is $7 billion.
Given approval by the PSC regulatory and environmental approvals, WEC plans to begin construction of a natural gas-fired combined cycle unit in 2002, with completion in 2005. The first coal-fired unit would break ground in 2003 with a projected in-service date of 2007. The additional units would come on-line between 2009 and 2013, according to materials on the WEC Web site.
WEC is a Milwaukee-based holding company with subsidiaries in utility and non-utility businesses. The company serves more than 1 million electric customers in Wisconsin and Michigan’s Upper Peninsula and 957,000 natural gas customers in Wisconsin through its utility subsidiaries – Wisconsin Electric, Wisconsin Gas and Edison Sault Electric.
Fostering competition
A key element of the plan is the spin-off of a WEC subsidiary that would lease the new power plants back to the utility for 20 to 25 years. At the end of the lease period, WEC would have the right to renegotiate and continue the lease or acquire the plants outright at market value. Existing plants would remain with the utility rather than being transferred to the subsidiary.
Originally, WEC’s proposal would have handed existing plants over to utilities as well. According to Customers First! attorney Lee Cullen, that was a critical point on which the group of business and consumer energy users were able to reach a compromise. Customers First! is a coalition of local governments, small businesses, farmers, environmental groups, labor and consumer groups and other parties seeking input on energy policy in Wisconsin.
“They were going to take all of the existing plants and deregulate them by putting them into a non-regulated, non-utility company which would have a contract back with the utility,” Cullen said. “We had two major concerns with that. First, the existing plants are low-cost. The prices are lower than the price from any new power plant that you could build. From a customer point of view, we were not interested in changing that situation. Under a regulated contract, all retail customers – residential, small business and industry – get power at relatively low prices. It is cost-based. We didn’t want to alter that at all. Second, the transaction between Genco and a public utility would have meant loss of state jurisdiction – sales of power would have been wholesale transactions. Selling at wholesale is regulated under the Federal Energy Regulatory Commission. Control was shifted from Wisconsin to Washington.”
According to Cullen, both deregulation of existing generation and federalization of pricing were involved in the current California energy crisis. The compromise means that the proposal to spin off generation applies to new power plants rather than existing coal and natural gas facilities.
It also means that, while there will still be a non-utility affiliate, it will just be a passive owner. Existing plants are still owned, controlled and dispatched by the utility. Therefore, state jurisdiction is preserved, Cullen emphasized.
The potential for WEC to purchase the additional generation facilities is being criticized by the Wisconsin Initiative Seeking Energy Reform (WIser), which represents large power users in the state.
WIser attorney Art Harrington said his group opposes immediate construction of additional generation facilities in the state because it would serve as a disincentive for independent power producers to enter the market. The disparity between price of construction versus the market value of the facilities in 25 years also creates potential for problems. WEC could administer the project without a concern for cost but with the knowledge that it will have the opportunity to purchase the generation facilities in the future at market cost rather than at a price that would be directly related to construction cost.
“We have filed a statement before PSC about Wisconsin Electric’s proposal,” Harrington said. “We want them to get construction costs pre-approved, and make sure we are able recover costs of building the plants. We need to look at this cautiously to ensure these are going to be built at a reasonable price. We also need to allow opportunities for these plants to be bid by independent power producers. These plants should not be the exclusive domain of an unregulated affiliate. There is no question we would like to see Wisconsin Energy participate in the program. But we are talking about a long-term solution where after 25-30 years, the total value is owned by the affiliate. We want to make sure the price is reasonable. The proposal the utilities are talking about would put 50% to 60% of generation in the hands of an affiliate. Once those approvals occur, you will have less interest from independent power producers (IPPs) because all the generation is tied up through the affiliate. We’d like to see a greater percentage of generation open to merchant IPPs.
In the 1970s, the state had bypassed two proposals to build additional generation on the belief that conservation technology and practices would reduce demand, which turned out to be the case. Meanwhile, adjacent states built excess generation capacity, allowing Wisconsin utilities to purchase power from them at a competitive market rate. Harrington feels that is similar to a situation Wisconsin should pursue with IPPs.
Statement refuted
Cullen takes issue with Harrington’s analysis of the situation.
“Obviously, I think that criticism is inaccurate,” Cullen said. “It is inaccurate just because of load growth, and the assumption that no plants are retired. Right now, we are looking at load growth between 2% to 3% per year. And power plants need to be retired. There is more than enough capacity to be shared under this proposal. The proposal would build slightly more than 2,000 net mW. That is just a part of what the state is going to need. We will still need merchant and IPP plants. Wisconsin is a state that has not deregulated, unlike California and Illinois. Existing Wisconsin-based utilities have a duty to serve customers and build capacity. Until the assurance that we have a completely deregulated industry, it is imprudent to not build.”
Cullen said his organization was interested in identifying the problematic aspects of energy deregulation in California and making sure that those elements were not duplicated in Wisconsin’s restructuring effort. California deregulated its industry by drawing a line between electric generation, which became a competitive market, and electricity distribution, which remained a natural monopoly. One key element absent in California’s deregulation package was the ability of distribution utilities to enter into long-term contracts with generation facilities.
“This is one of the reasons (WEC’s proposal) represents the opposite of what California did,” Cullen said. “The leases we are proposing are long-term with prices based on cost. What California did is let the short-term spot market set the price of electricity. California even prohibited long-term contracts as hedges against price fluctuation. You will know the entire period of the lease that the electricity you receive will be based on cost, versus what the market sets as the price. Utilities are paying short-term wholesale prices for all the energy – which can represent an increase of eight or 10 times. What we want to do is create a fair set of incentives so we can get enough utility and merchant plant capacity, so when we do increase competition, we won’t have scarcity to deal with.”
Another difference between Wisconsin’s restructuring and California’s deregulation, says Harrington, is that California has created a situation with the worst of both market and monopoly.
“People hold out California as an example of deregulation,” Harrington said. “But that’s not deregulation. California’s policy is filled with regulatory solutions like price caps, and there is no ability of a utility to enter into long-term contract. We think the customer should be given options if the market starts changing. They should have the ability and freedom to allow market conditions to induce people to make choices based on options.”
Wisconsin’s situation is also more stable than California’s, according to Cullen, because of the state’s distribution system.
“If you look at Wisconsin – Wisconsin is blessed with a lot of small distribution companies,” Cullen said. There are 83 municipal utilities and 25 electric co-ops. That is a good thing in that the customer has an entity that buys and sells power that is locally based. In California, Los Angeles and Sacramento have been spared the price run-ups because they have municipal utilities. The municipalities and the co-ops are very active members of Customer First!. We like public power and we like co-ops.”
Natural gas an issue
As proposed, the generation to be built in Wisconsin would rely on natural gas for 1,000 mW of capacity, with the remainder of the increase coming from coal.
“Fuel diversity has been a cornerstone of the plan,” WEC manager of generation communication Dave Santel said. “The reason behind it is that diverse fuel sources for power plants bring more long-term price stability. That equates to lower electric prices for consumers.”
While some industry analysts are warning that estimates of natural gas reserves offered by government and industry sources are shaky, WEC proposes actually eliminating some coal generation in favor of natural gas.
“The plan calls for re-powering our Port Washington power plant – which currently is a coal-burning plant,” Santel said. “We would take out the coal-burning generators and re-power the plant with two natural-gas generating units. It would not be a likely scenario to revert it to coal.”
A University of Wisconsin-Milwaukee economics expert agrees with Santel that fluctuations in natural gas are season- and supply-oriented rather than driven by scarcity.
“As an economic fact, drilling for oil has the byproduct of natural gas discovery,” Richard Marcus, associate professor of business administration said. “If we stop drilling for oil, we stop natural gas discovery. So if the environmentalists have their way, we will have less natural gas. But if industry wins, we’ll see more discovery. I think the difficulty the petroleum industry is seeing is due to blocks and restrictions on its activities. If you make it a priority to discover new natural gas deposits, you will see increased availability. This is what the Bush energy policy does.”
But according to geologist and petroleum industry consultant Joseph Riva, while recent fluctuations in natural gas prices have been market-based, there is an underlying issue of scarcity that will become more and more of a factor in the years ahead.
Riva has 40 years of experience as an exploration geologist, energy and water resources research.
“Back in the mid ’70s, there was a natural gas shortage,” Riva said. “People were not allowed to hook their new homes up to natural gas in certain areas. Electric utilities were not allowed to build gas-powered plants – they had to be converted to coal. The price went up during the shortage and demand fell – so there was a gas bubble – with more potential supply than demand.”
Riva stresses that while production capacity was higher than demand, “all that time we used up gas. We were producing less than peak gas.”
As the price fell due to lower demand, the other shoe fell, Riva says.
“Then after looking at this and the price being very low, the conventional wisdom turned, and the conventional wisdom was that there was a tremendous amount of gas,” Riva said. “The Department Of Energy (DOE) and Energy Information Administration (EIA) have been touting this.”
In arriving at his conclusion that conventional wisdom on natural gas supply was inaccurate, Rive used standard methodology.
“I looked at amount of undiscovered gas, the amount of reserves, and fuel growth,” Riva said. “Fuel growth is a factor based on the fact that when you first discover a field, the projected reserves are conservative – and I put in a factor for this. It turned out that if gas would increase to the extent that EIA projected in 1997, there is not enough gas to sustain natural gas production increases.”
Riva said that since its earlier estimates, EIA added gas onto the estimates – mostly in the unconventional areas that consist of coal seams, tight sands and other situations that present very low gas production versus a conventional gas well. The reason for the change in estimates, Riva contends, is that an energy shortfall is evident when looking at the original figures, and in order to prevent an economic downturn based on concern over energy prices, EIA added to the gas projections.
“It is going to be very difficult to produce a little more gas, and it will be impossible to sustain this,” Riva said. “It would require a very large number of wells – and in the meantime the amount of gas per well has been decreasing. When I presented this paper at a DOE meeting – they became a little bit concerned when they could count on their own fingers and see they were running out of gas. That’s why they added the unconventionals.”
What does that mean for WEC’s proposal?
“There is going to be a serious problem based on the number of electrical generation plants now running only on natural gas,” Riva said.
There are, of course, things WEC can do to assure some measure of stability. “First of all, it would depend on their contract situation,” Riva said. “Most of the gas comes from the Gulf Coast. The deposits they are finding are small and deplete very rapidly. If they can get a contract with one of the large fields that were discovered a long time ago, that would help assure stable supply. Otherwise, they may be looking at very high prices and the possibility of not having any access to gas.”
“We have long-term contracts with ANR Pipeline, which is now part of El Paso,” Santel said. “One of our situations is that we have had capacity concerns because of a lack of an interstate pipeline. ANR for many years has had the lion’s share of market in southeastern Wisconsin. That is why, a little over two years ago, there was proposal for a new pipeline, which has received FERC approval. This will bring in a second pipeline from Joliet, Ill., and will create a more competitive market for natural gas customers here.”
Coal remains the “stable option”
Because the local supply issues are separate from the underlying reduction in extraction potential, coal will continue to be a more stable option, according to Riva.
“Coal will be available, but I would not count on natural gas after the next several years with the demand going up around the country,” Riva said. “It will take a while for a pipeline to come down from Alaska. Another possibility is liquid natural gas. This will not solve the problem, but will help.”
WEC director of regulatory analysis Les Dursky implied Riva’s projections may not be off base – but said WEC planned the conversion of the Port Washington plant to natural gas based on sound data.
“It’s like anything else,” Dursky said. “You can see that in the natural gas industry that the gravy has been skimmed off the top. The price has been depressed because there is a supply. The price is up now – and now you see there are more rigs out there supplying the demand.”
When asked if the potential for increasing natural gas prices was factored into the decision to convert the Port Washington generation facility from coal to natural gas, Dursky said that the utility had factored its projections for natural gas prices into the decision. “Every utility has a formula for projecting and deciding these things,” Dursky said. “Those methods are pretty closely held secrets.”
The real impact increased natural gas prices would have is on merchant/IPP plants, according to Dursky, as those operations tend to almost exclusively rely on natural gas. Natural gas plants, he said, are cheaper to construct but more expensive to operate.
July 6, 2001 Small Business Times, Milwaukee