A Special Report by Engineering News-Record and Power Magazines
Since 1998, the U.S. has experienced an unprecedented and largely unexpected boom in new powerplant construction. Between 1999 and 2001, about 83,000 Mw of new capacity has come on line, adding nearly 10% to the generation base. Another 300,000 Mw to 400,000 Mw of new capacity is in the pipeline, virtually all proposed by independent "merchant" developers who have replaced traditional utilities as the industry's driving force.
But almost no one believes that all of the projected capacity will actually be built. Market forces, constraints on available fuel, transmission capacity and financial resources will factor strongly. Several late-2001 analyst reports dismissed "capacity glut" worries, claiming that the boom may have already peaked and wondering how sharply new capacity development will fall off.
For 2002, analysts expect capacity additions to continue around 45,000 Mw, about the same as 2001. But after that, all bets are off and most expect a drop-off. The initial predictions of high-capacity additions for the 2002-2007 period simply cannot be taken at face value, says Neil Stein, an analyst with Credit Suisse First Boston. As few as one in three announced projects may actually get built.
SHAKE-OUT. The underlying 2.5 to 3% annual demand growth in the U.S. market would normally support additions of 25,000 Mw to 30,000 Mw per year. That means a substantial baseline level of new plant construction is still likely, especially in capacity-short regions such as the West and Northeast. Most analysts also expect a shakeout in ownership of new merchant capacity, with a small number of financially strong players consolidating their positions as weaker groups fade.
|PINCH POINT Old attitudes hamper delivery of power to load centers. (Photo courtesy Exelon Infrastructure Services)|
The stunning collapse of Enron in November 2001 and earlier announcements by several other major players of more cautious powerplant development strategies increased the sense that the boom was beginning to fade. Officials of developer AES Corp., Arlington, Va., say that they have recognized the new conditions and have become more conservative. "It now takes a lot more for our people in the field to get a new project approved by headquarters," says a spokesman.
Developer NRG Energy, Minneapolis, also agrees with projections of a plant construction slowdown. Officials believe only about 147,000 Mw of new capacity will be added in the U.S. by 2005. But NRG is sticking to its own plan to develop some 28,000 Mw by then. Officials say they believe they can move ahead with such a large amount of new capacity because they are operating in several separate regions.
COLLISION. A sustained 3% annual growth in U.S. electricity demand through the 1990s collided with a virtual standstill in new powerplant construction through the mid-1990s, squeezing the electricity industry's overall capacity reserve margin from about 20% in 1990 to about 7% in 2000. In response, a small army of project developers descended on practically every location in the U.S. where a gas pipeline came close to a power transmission line. State environmental and regulatory agencies were hit with a barrage of air and water permit applications, causing some states, including Tennessee and Kentucky, to call "time out" and reassess their permitting procedures for powerplants.
But California, desperate for new power sources, began turning around permits in a few months. Officials in many other states, determined to avoid California's mistakes, welcomed new plants. Georgia, for example, put a limit on utility purchases of out-of-state power to force more plant construction at home and Louisiana approved new tax incentives for merchant plants.
According to the Electric Power Supply Association, a Washington, D.C.-based lobbying group for the independent power industry, there were at least 524 merchant projects-322,700 Mw of capacity-either in construction or in development in the U.S. as of late 2001. The Newton data base of RDI, like ENR and Power a unit of the McGraw-Hill Cos., lists 473,000 Mw of new capacity in construction or development, but says that about 60,000 Mw of this has been canceled or put on hold. The rate of cancellations and suspensions is now outpacing new project announcements, RDI reports.
According to Ray Niles, senior market analyst for Salomon Smith Barney, reserve margins had already begun inching up by 2000. By mid-2001, the rapid construction of new capacity coupled with slow growth caused a decline in forward energy prices. He now expects many developers to cut back project plans based on negative commodity drivers, with the new "down cycle" bottoming out in 2003 when a more balanced market will emerge.
FUEL CONSTRAINTS. Christopher Ellinghaus, senior analyst with Williams Capital Group, New York City, argues that it would be virtually impossible to install 400,000 Mw of new merchant capacity in the U.S. anytime soon. He claims that 90% of the proposed plants use gas and there simply isn't enough of a supply to fuel them all. Ellinghaus notes that fueling an extra 300,000 Mw of gas-fired capacity would require an addition of 14 Tcf to gas supplies by 2005, an increase of more than 50%. At best, the gas industry is expected to increase supplies 1 to 3% annually in the coming years. He expects capacity additions of 46,000 Mw in 2001 and between 36,000 Mw and 53,000 Mw in 2002 based on plants now in construction and in advanced development. Thereafter, he expects the gas constraints will limit further additions to about 20,000 Mw annually through 2005.
Coal-fired projects have been proposed in several regions in the last two years precisely as a hedge against over-reliance on gas. The problem with coal is that the permitting and construction process is much longer than for gas. Projects initiated in 2001 are not expected to come on line before 2005 at best. Coal also presents more air-quality and "not-in-my-backyard" objections than gas, and most "clean coal" technologies are still in the demonstration stage.
Nuclear got a boost from the Bush administration's energy plan in 2001. A few large merchant nuclear operators, including Entergy, Dominion Energy and Exelon, are mulling new reactor projects in 2002, the first in over 25 years in the U.S. But the Sept. 11 terrorist attacks created a major new security issue for the nuclear industry. The public may simply refuse to accept building new reactors.
TRANSMISSION. A third major factor likely to restrict new powerplant construction is the nation's patchwork electricity transmission system, which was not built to handle large-scale merchant traffic between regions. Several states have been forced to slow permitting because local grids cannot handle additional load. The North American Electric Reliability Council, an industry group that loosely coordinates grid operations, has specifically warned that excessive new plant construction may overburden transmission systems in the Southeast, Southwest and Midwest. NERC reports that less than 10,000 miles of new transmission capacity will be built in the U.S. in the next 10 years. That 5% addition to current capacity is well below likely generation additions.
The Federal Energy Regulatory Commission has begun to address these problems by mandating creation of a few large Regional Transmission Organizations (RTOs), which would have wide powers to plan new transmission links. The administration also is considering legislation to get eminent-domain power for transmission projects deemed to be of national importance.
A final major constraint to massive new investment in powerplants is money itself. Industry analysts estimate that the power industry since 1999 has borrowed about $50 billion to finance the new wave of plant construction. The less optimistic forward energy price estimates and the recession have created a new climate in which credit ratings for the competitive energy industry are expected to drop, making it harder to refinance existing loans and raise new capital. The chillier financial climate likely will most affect projects financed with short-term loans and selling mainly into volatile peaking markets.
A related problem is Wall Street's valuation of energy company stocks, which tend to closely follow up and down cycles in wholesale electricity prices. After several years of increases through early 2001, stock values began to drift downward around midyear, according to Barry Abramson, an analyst with UBS Warburg. Abramson does not see a stock value drop as the "end of the world" and says that the power generation business as a whole will continue to be profitable and provide decent returns to investors. "It is just that not everyone in the business will be able to do well and a period of declining power prices could help separate the strong players from the weaker ones," he says.
For the merchant generation companies, the clear trend in 2001 has been away from continuing all-out expansion of capacity to gain market share and toward a more market-oriented strategy focused on finding buyers for the new capacity and hedging production as far into the future as practical. This has tended to favor developers with integrated electric generation, gas and energy-marketing strategies such as Duke Energy, Mirant and Dynegy. Groups that may have less of an advantage are large generators such as Calpine Corp., NRG Energy and AES, which have been slower to develop marketing businesses.
During late 2001 some developers, such as PG&E National Energy Group and Constellation Energy Group, announced slowdowns in new plant development, while others, such as Calpine and NRG, held to ambitious pre-2001 capacity development goals. But Calpine also said that it would pay attention to changing market conditions.
The experience of the last few years has also shown that some potential restraints on powerplant construction have not materialized. There was wide concern in 2000 about a looming shortage of turbines. Many new plants were being proposed and energy companies committed for dozens of turbines at a time to assure availability. But it appears the actual turbine demand in 2000 was below expectations because several plants were canceled and the supply is now keeping up with demand. It also appears that the sudden halt in the move toward retail competition, due especially to the failure of deregulation in California, has not noticeably affected merchant generation construction.
While California actually did return its system to retail regulation this fall, generation there remains under control of merchant generators. The real issue for developing new capacity in the state is that the rules for selling wholesale power to the utilities remain unresolved.
Overall, EPSA calculates that 36% of all generation in the U.S. is now operated on a competitive merchant basis, compared to 8.5% in 1997. This includes both newly built merchant plants and utility plants divested to competitive groups.
Even with the fading boom in the U.S. generation market, things are generally considered worse in international markets where economic and politic instability and more recent terrorism threats have forced U.S. developers to pull back. Jean-Louis Poirier of the PA Consulting Group, Washington, D.C., says that about 315,000 Mw of new capacity is likely to be built worldwide in the coming 10 years with a total value of $200 billion. He predicts about 220,000 Mw of this will be in North America with much of the rest in Europe.
That means the U.S. will be the main attraction in the global marketplace for new plant construction for the foreseeable future, replacing overseas markets that had boomed in the 1990s. And despite the downturn in the market, prospects for new construction are still better than they've been in years.