Aug

29

 I rarely have erudite thoughts. Occasionally I have some pedestrian views.

First, oil has made a fool out of me. Nevertheless, I believe oil prices will revert to $80 and beyond. Unless there's a geopolitical event, oil prices should remain low for the next 24-36 months as the market rebalances and works down excessive inventories. However, I believe one or more geoplotical events will take place. It will likely take place within the 24-36 month timeframe. It could be severe enough to cause crude oil and LNG prices to spike.

Second, Mexico will become an important energy partner for US and Canada. Energy powerlines, pipelines, and unit trains will cross borders to facilitate trading, blending and shipping commodities. By merging Canadian, US, and Mexican resources, North America can become energy independent and energy secure.

Third, here are different views about North American electric and gas.

One trend underway today is for producers to exit from commodity markets and migrate towards regulatory assets. In some cases where the migration isn't possible, producers want to force consumers to pay above-market prices for electricity and natural gas. For example, nuclear power producers have convinced New York State, Georgia, and South Carolina regulators to force consumers to buy their electricity at above market prices. Coal producers argue that consumers should be paying above market prices and, at the same time, regulators should allow their customers to pollute air, land, and waters so the state can save mining companies and jobs. In addition, companies like Dominion, Duke, Exelon, PPL, and NextEra are dumping market assets and buying regulated assets (or hedged assets). It turns out, traditional utilities dislike free markets. These "conservative" companies prefer being regulated.

Industry leaders describe other trends. You may find some of these ideas interesting - or not:

1. America can no longer build large nuclear or coal-fired power plants. Yes, there are five nukes under construction. One is scheduled to reach commercial operations shortly. However, capital costs far exceed any financial benefits, and government subsidies are necessary to finance construction.

2. The only profitable option for those needing large-scale power producing assets is high technology gas turbines (combined cycle gas turbines). While capital costs are low, there are substantial [financial] risks in owning gas turbines. If fuel prices leap, generating assets depending on that fuel could become marginalized and unprofitable. Also, gas turbines need to be built near interstate gas pipelines with surplus capacities. Profitable locations are rare. As such, geographic limitations have become substantial barriers to widespread development.

3. Thermal coal consumption will continue to decline in North America. As more coal-burning power plants' production costs drift towards the markets' margins, owners will throw in the towel and retire uneconomic units. Like renewable energy, coal burners have been granted substantial government supports, which are slowly dissolving. Without government supports, coal burning costs increase and energy production becomes uneconomic.

4. Investors and regulators will continue to favor [new] wind and solar assets. Returns on these assets are substantial and financial risks are comparatively minimal. Compared to other alternatives, wind and solar are winners because they are frequently the markets' cost leaders.

5. The biggest winner is energy efficiency. It is the cost leader. It requires minimal investments in new infrastructure. Companies like Exelon are exploiting energy efficiency with success. Most expect energy efficiency programs will grow. As more technology is introduced and merged with energy infrastructure, investments in energy efficiency could explode.

6. You guys like might like one trend. It's called transactional energy. Instead of buyers and sellers transacting bulk power deals at the wholesale level, transactional energy will allow retail buyers and sellers trade electricity at the local level. Transactional energy is currently limited by policy. Those limits may change as regulators struggle with increasingly difficult choices.

7. A precursor to transactional energy is distributed energy, which is gaining traction. Distributed energy turns the current utility system upside down. Instead of spoke and wheel system centered around a single central power station, small generating assets are moved closer to consumers. High costs associated with spoke-and-wheel systems provides growing economic incentives for locally-owned fuel cells, batteries, solar panels, wind farms, and energy efficiency. It also eliminates the need for more transmission lines and associated costs.

8. Local electric and gas utilities will likely migrate to a different business model. They will keep their monopoly status, but they will likely change their core activities to the simple business of renting wires and pipes. After they change their model, they will likely allow customers to hang approved equipment off their distribution systems for a fee. Presently, California and New York State are heading in this direction; others will follow.

9. Motivation to change the current model will likely come about by consumer frustration. Today, wholesale regulators are piling on costs that reward power producers at the expense of consumers. At the same time, retail regulators are adding costs that must be borne by consumers. Taken together, the cost of electricity is substantially less than the cost of renting wires and related equipment to deliver that electricity. In some areas the ratio is 2-to-1. In other areas, it's 4-to-1. As the ratio grows, consumers will be motivated to self-generate or build distributed energy systems. The first to exit will likely be large business and government [military] consumers, followed by small consumer groups. In fact, the exodus has already begun. It will accelerate should natural gas prices jump above $5.00, because that price will be ripple through the value chain and amplify electricity prices.

Some trends are in progress and may accelerate in the near future. Others could take decades to gain traction. The underlying assumption is that all things will remain equal. Of course, all things will not remain equal. A recession will slow change. A recovery will accelerate change.


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