US Energy Realities

 
The recent spike in crude oil prices has made it clear, once again, how much the US are dependent on imported energy. The Solyndra fiasco has shown how illusory the promise of readily available, cheap and clean renewable energy really was, at least for now.

One day perhaps, we will be able to generate wind and solar power effectively, cheaply and reliably enough so that it will become a significant component of our national power infrastructure. By“effectively” I mean without having to cover hundreds of square miles of land with solar panels or wind farms; by “cheaply”I mean without having to offer large subsidies or tax breaks; by “reliably” I mean without having to build backup conventional power plants to make up for the very low capacity factor inherent, so far, in these alternative power sources.

This may take two or three decades before becoming a reality, or it may never happen. Right now, it makes little sense to spend considerable sums of money at a time when federal and local government finances are strapped to promote “new” energy sources that are not ready for prime time. Furthermore, we have two much better (meaning cheaper, more scalable, and environmentally friendlier in my view) sources of energy: natural gas and nuclear.

The US has plentiful reserves of conventional, offshore and shale gas; the US also has great expertise in building and operating nuclear power plants, and Canadian uranium deposits are more secure than Middle Eastern oil and very large.

The following table prepared by the Department of Energy compares the all-in cost/levelized[1]of producing one megawatthour from new plants to be built today and starting operations in 2016. In this first table, the DOE doesn’t differentiate between more favorable and less favorable locations but takes a national average. Alternative energy (wind and solar) are showed at real costs, meaning without the benefit of tax breaks or other incentives.

 

Levelized cost of new generation (2009 US$/mwhr)

 

Plant type	Capacity factor	Total system levelized cost
Advanced coal	85	$109.7
Advanced coal w/CCS[2]	85	$136.5
Natural gas –  Advanced CC	87	$62.2
Nat gas – Adv. CC w/CCS	87	$88.4
Advanced nuclear	90	$114
Wind - offshore	34	$243.7
Wind	34	$96.1
Solar photo-voltaic	25	$269.3
Solar thermal	18	$312.2
Geothermal	91	$99.8

We can draw a few preliminary conclusions from this table:

1. Natural gas is the cheapest option, even after adding the cost of carbon capture and sequestration, with geothermal close behind;

2. Solar is much more expensive than any other option;

3. Wind offshore (where there is little NIMBY opposition) is very expensive while onshore (which carries much higher NIMBY opposition) seems a competitive option;

4. Nuclear is cheaper than coal (and doesn’t pollute) and not so far behind the likes of geothermal, nat gas and onshore wind.

However, it is very important to realize that the above costs are those of the energy produced; they do not include the costs of ensuring that the country is reliably supplied with electricity. When wind farms only produce energy 34% of the time, some other power plant must be built to supply energy during the other 66%. The capacity factors show a very wide difference in the ability of various sources of energy to reliably produce energy.

To assess the true costs of each energy source, we must factor the cost of backup power. We will assume that backup energy is produced by combined cycle power plants equipped with CCS (as it typically is). To compare all options, we will adjust the costs of each plant type so as to reach the equivalent of a 91% capacity factor. We do not include the (high) costs of building extra transmission lines to connect the backup power plants. Nevertheless, the results are telling, as the following table shows:

Levelized and equalized cost of new generation (2009 US$/mwhr)

 

Plant type	Adj. capa. factor	Total system levelized cost
Advanced coal w/CCS[3]	91	$114.9
Nat gas – Adv. CC w/CCS	91	$91.3
Advanced nuclear	91	$114.7
Wind - offshore	91	$348
Wind	91	$200.4
Solar photo-voltaic	91	$433.5
Solar thermal	91	$564.5
Geothermal	91	$99.8

 Once these adjustments are made, it becomes very clear that there are only three types of power plants that are relatively clean, almost always on, and cheap: combined cycle gas turbines with CCS, geothermal and nuclear. As I said earlier, the cost of transmission lines is not included in the above figures, understating the comparative advantages of the three leaders.

While geothermal looks very attractive and is being developed in California and elsewhere, its potential is limited by geology.

Some may argue that, cost-wise, onshore wind is “only” twice as expensive as the leaders. The problem is scalability and land usage. Wind farms occupy huge areas of land compared to natural gas and nuclear plants.  They also pose environmental problems, such as noise, and they have an adverse impact on the value of properties in their vicinities.

As for solar plants, while technology is advancing rapidly, they are still very inefficient and consequently anti-economical.  They also occupy too much land.  Their future may lie at the individual habitat level; but even then, the wide fluctuation in their output would necessitate large investments in smart counters and transmission power lines.

The DOE levelized cost numbers are based on national averages; it is worth mentioning that in the case of wind and solar, location has a much bigger impact on costs than for nuclear or gas-fired. In other words, the gap in levelized costs between the most favorable and unfavorable location/region is much broader. This means that scalability is further constrained.

Range in levelized costs (not equalized)

 

Plant type	Minimum	Average	Maximum	(Max-Min)/Av%
Nat gas – Adv. CC w/CCS	$79.8	$88.4	$102.7	25.9%
Advanced nuclear	$109.8	$114	$121.6	10.4%
Wind - offshore	$187.1	$243.7	$350	66.8%
Wind	$82.3	$96.1	$115.5	34.6%
Solar photo-voltaic	$158.9	$211	$324.4	78.4%
Solar thermal	$192	$312.2	$642.5	144.3%
Geothermal	$85.7	$99.8	$115.8	30.2%

Finally, there is the reality of where we are starting from. In 2011, the name plate capacity of our power plants (not including hydro, oil-fired) was as follows:

 

Name plate capacity in gigawatts

 

Plant type	Capacity
Coal	342.3
Natural gas	467.2
Nuclear	106.7
Wind	39.5
Solar	1
Geothermal	2.4

Given the limited scalability and high levelized costs as well as the dire financial condition of the federal and local governments, it doesn’t make sense to push renewable as hard as we currently are. It is my view that nuclear and natural gas will eventually win the day.

At present, rock-bottom US natural gas prices are wrecking havoc on gassy E&P companies, accelerating the switch from coal to gas-fired power plants and generally compressing the profit margins of merchant power producers. Over time, the price of natural gas is bound to rise for three reasons:

1. Supply will be reduced as it is unprofitable for most E&P companies to drill for more gas; witness the cutbacks already announced by the likes of Chesapeake Energy and Southwestern Energy;

2. Domestic use of gas will increase, be it in the power sector, in some areas of transport or in the chemical industry. To that end, very large investments in plant and equipment have already started; witness Dow Chemical for example;

3. Globally, there is a huge arbitrage opportunity to be exploited: LNG sells in Asia at $13 to $16/mbtu; US gas sells for $2.5 at Henry Hub; the cost of liquefying the gas and transporting it to Asia is about $6. From Louisiana to British Columbia, we see a major drive to build gas liquefaction plants and export terminals. We also see some slowdown in new LNG projects in Australia when these were deemed "no-brainers" a decade ago.

Nuclear power suffers from the fallouts of the Fukushima accident and the past laxity of Tokyo Electric Power (TEPCO), the plants’ operator. But the economics are there for all to see. So are the politics. It makes little sense for Europe to trade some of the energy security afforded by nuclear plants for an increase dependence on Russian imports and volatile crude oil prices[4]. For the US, and with the possible exception of some Californian locations, nuclear power is very safe, and indeed the industry has an excellent safety record, Three Mile Island included.

This is a long game; it could take three years or more before the US nat gas market regains its equilibrium and the specter of Fukushima recedes from collective memories. But besides the objective merits of these energy sources, I feel comforted by American psyche and free markets. In this country, arbitrage opportunities tend to be exploited quickly, and there is abundant capital to be put to work. Indeed, the gap may be closed faster than we think as America often "over-does it" and rushes along. Perhaps the best example of this has been shale gas, while the worst has been financial derivatives.

In my view, the stock price of natural gas and uranium producers is too low; the same is true of merchant power producers that operate natural gas or nuclear plants. I am long these stocks.

 

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[1] The DOE first calculates the costs of building, operating, fuel and maintenance a power plant over a 30 year cycle. It then takes their present value and spreads them equally and annually. Inflation is taken out by expressing these values in real US dollars of 2009. Hence the term “levelized”.

[2] CCS: carbon control and sequestration.

[3] CCS: carbon control and sequestration.

[4] Most natural gas imports from Russia are pegged to crude oil, albeit with a 6 to 9 month lag.