Iguaçu Falls (Part three) – An exercise in fiction

On September 29, General (4 stars) Oscar Rossi, couldn't shake off a bad headache.  The evening before, he and two dozens general officers had attended the retirement party for General Adriano Galvaõ dos Santos, the Army Chief.  The affair had lasted until the wee hours of the morning, wine and cachaça had flowed with abandon.  By the time Rossi’s plane landed in Porto Alegre, the rain had stopped and it was daylight.

The political and security climate only made his headache worse.  The economy was in recession, wracked by sky high interest rates, an imploding currency, a confidence crisis, general strikes, and a government in total disarray.  Crime and politically inspired violence had multiplied as police forces, which had been widely criticized for excessive violence, were basically holding back.

Sensing its vulnerability, the Rousseff government had clumsily issued a decree to transfer some of the general officers’ powers to the Minister of Defense.  This didn't go down well, and an unease had developed where it had not existed.

With its economy in free fall, the majority coalition in disarray, the opposition not ready for prime time and the public clamoring for order and better wages, the army was the one force not tainted by corruption or incompetence.

General Rossi was the Head of the Southern Military Command (CMS) which covered the states of Parana, Santa Catarina and Rio Grande do Sul.  Before the oil boom, this region had been at the heart of an industrial Brazil.  It also abutted with Argentina, the perennial regional challenger and occasional historical foe.  Heading the CMS was indeed quite a career achievement for an ambitious 47 year old soldier.

The dinner had not been without controversy and had bared some tension.  Oscar Dürenberger, the brash leader of the 12th Infantry Airborne Brigade, having raised his glass to toast Galvaõ, looked at him straight in the eyes, smiled thinly and asked:” Well General, how long before we have to clean up this mess?”

Silence had fallen over the assembly.  Galvaõ had not risen to the top Army job by baiting his minister or displaying excessive ambition.  He also remembered history.  He held Dürenberger’s stare, lowered his glass, crossed his hands on the dining table, and slowly answered his junior commander:
-“Oscar, there is an elected government in place, it is up to them to figure out what to do and take responsibility.  We are neither cowboys nor crazed revolutionaries!...Besides, if you read your recent Latin American history, you will see that the armed forces rarely grabbed power; more often than not they took over when a substantial proportion of the population pushed them to….and I don't see this happening here.”

When General Almeida from the Northeastern Military Command proposed another toast, to a man, everybody stood up and the discussion veered into another direction.  Yet Rossi was still analyzing Galvaõ’s words in his head, and a brief look across the table convinced him that he was not alone in doing so.

Rossi looked at his watch.  It was a quarter past ten in the morning.  He was still worried, and the fact that he want alone feeling depressed was small consolation.  What would this new day bring?  A lot of change as it turned out.

2,000 miles to the North East, over the draught stricken sertaõ, a large cb cloud system had been gathering foe s verbal hours.  At 10.43 am, a huge thunderbolt hit the 500 kv transmission line and the substation at Sobradinho.  The latter burst into flame and a chain reaction ensued, with circuits tripping one after the other.  For whatever reason, the energy management software at Cia de Eletricidade do Estado da Bahia (Coelba) failed to activate.

Brazil depends on hydroelectricity to the tune of 64%.   But persistent draughts, high transmission losses and erratic government energy policies which discouraged new investments had left the system both unbalanced and inefficient.  Over the course of the previous four weeks, the Ministry of a Energy had discussed the possibility of putting some of its thermal power plants back on line.  Unfortunately, no decision had been made.

The national grid was now tremendous stress; mismatches between loads and generation caused the system to break down into uncontrolled islands, collapsing frequency or voltage.  By 10.55 am the Imperatriz node was taken out of service, and with it the critical North-South electric transmission axis.  The 8,400 MW Tucurui hydroelectric plant was now a useless monument of concrete lost in the Amazon.

Resplendent and majestic in the morning sun, the Itaipu dam was still one of the world greatest engineering and construction marvels. Its massive turbines had a combined 14,000 MW electric generation capacity and their energy was transmitted over a triple set of 750 kv power lines.

At 11.20 am, the northern half of Brazil, down to Brasilia, was in the dark.  The states of Acre and Roraima, already self sufficient and not integrated to the national grid, were spared.

The cascading blackouts kept moving south.  By 11.30 am, with the big economies of São Paulo, Rio de Janeiro, Minas Gerais at full demand for electric energy, the southern grid system went out not massive overload.  Not even the mighty Itaipu could make up for the loss of the Northern power system.  Following protocols, the Itaipu system tripped; 98% of the Brazilian population and 90% of the territory were now without power.

Outside, somewhere behind the officers mess, the Cummins standby generators kicked in.  Shortly thereafter, Rossi's phone rang.

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.