There are over 100 new gas fired power stations under construction in the US. The US Energy Information Administration (EIA) projects that domestic gas demand will rise 6% next year as some of those new plants enter commercial operation. All we can say is this is not likely to be a blip but rather a new, higher, demand baseline. These new gas power plants are designed to last more than thirty years. As we’ve said before, this is the transition in central station power generation that the US utility industry has long hoped for. And it looks as if the industry is going to get it thanks in part to enormous data center demand. The question is whether they get it good and hard as H. L. Mencken used to say.
The US utility industry has probably been planning this transition since the EPA began informing the public about the dangers of coal plant emissions in the 1980s. Unfortunately, by then new nuclear power plants were out of the question due to runaway costs and the bad publicity from the Three Mile Island partial core meltdown. So gas won by default. In addition, new shale gas discoveries coupled with a well developed pipeline system made this a logical next step. Back then US exports of LNG at high volumes weren’t even on the horizon. If you suggested that the US would someday try to replace Russia as a gas supplier to Europe, people would’ve laughed. But here we are, and that’s the problem we face. Just as the US is seriously entering a new build phase for gas-fired power generation, we are also increasing LNG exports. To us, this policy is contradictory with potentially disastrous results. If we export enough, the price of gas will likely do two things: trend higher (which is not great for consumers), but more importantly, it will be much more volatile. Why? Because the world market for any commodity is much bigger than any domestic market. And this means that any major violent conflict or physical upheaval anywhere in the world will then affect local prices, and not in a good way. Today, oil is priced in a global market. Due to ongoing tensions in the Middle East, prices have risen over 50% over the past several months. While our gas is still mostly priced domestically, this is already changing. And it is this prospective increase in gas price volatility that is our focus today and which will render this new generation of power plants problematic.
What’s so surprising about this is how unnecessary it is. From a policy perspective, this is what people in sports refer to as an “own goal”. We are doing this to ourselves. Simple export controls on gas would solve this problem and ensure a relatively low cost energy source for US consumers and industry, CO2 implications notwithstanding. But it seems we will try to burn as much gas domestically as we can, while trying to export as much as we can at the same time—regardless of the potential for local price volatility. And it is the adverse potential of this volatility that we feel is being seriously underpriced in today’s market. If we’re right, the bulk of new gas fired power plants being built will be underutilized or abandoned long before the end of their useful lives. This is where the prospective economic pain will occur for utilities. Power plant builders went to great lengths to construct plants at reasonable costs. They never assumed that gas prices could be super volatile. Our thesis is simply that extreme fuel price volatility in the near future will prove to be a fatal flaw and will likely induce a major competitive response. There are only two main cost inputs into a power plant. Capital and fuel. And we believe volatility in the latter is about to upend a lot of previously held assumptions.
And we have evidence for how this is likely to play out. In California, for example, batteries have significantly displaced high cost gas peaking units, outcompeting the latter on a simple price basis. This process of batteries outcompeting or displacing higher cost (fossil fired) generation seems to be ongoing. The question really is when batteries begin to displace baseload units. But there is a market psychology aspect that also has to be addressed. People hate price volatility. Individuals and families can’t rapidly adjust to a sudden spike in electricity prices and neither can corporate planners. Our thesis here is quite simple. Consumers may accept the first gas induced price shock to electricity prices as whatever. But if there’s a second or third price shock, they will head for the exits. And the renewables industry will be waiting with open arms.
Once these new gas plants are built, there isn’t very much that state regulators can do to protect consumers from higher prices. Typically, an increase in fuel costs is passed directly along to consumers by utility commissioners. The alternative would be severe financial distress for any utility. So there’s no relief or safety valve there.
Maybe this is what technology transitions always look like. Messy. But to us, in a way, renewables have already won the key battle for dominance in electricity markets while their prices continue to decline. They already produce the commodity, electricity, at a lower price than their fossil fired competitors. As gas prices are poised to increase in volatility, this only enhances the economic attractiveness of renewables. We believe that this economic tension causes financial distress for new gas fired power plant owners sooner than people expect.