Thursday, November 13, 2014

The Heart of the Matter* – PSNH and Electricity Price Increases in New Hampshire

In my last post, I presented the table below and made a big deal about the large winter price increases that have been put forward by NH Electrical Co-op, Liberty and Unitil, but did not discuss the surprisingly small increase put forward by PSNH (highlighted in yellow). However, in an earlier post, River’s Gonna Rise, I made the statement that, “…with electricity prices shooting up this winter and with PSNH customers, for the time being at least, somewhat shielded from these increases, this does give one pause for thought and to consider that ownership of generating operations may perhaps have some benefits.” Well, I have been thinking long and hard about this and about PSNH’s relatively low winter rates and, after some research, analysis, charts, and graphs, I have now come to a rather different conclusion. Read on.

For the three-winter period shown in the table above, I have plotted the default electricity rates for the different utilities in the graph below.  Bear in mind that these data are not exactly comparable because they involves slightly different time periods (e.g., the NH Electric Coop (NHEC) winter rate runs from October to March, whereas that for PSNH runs from January to June), but it is a convenient way to view the data. Over this three-year period, PSNH rates were generally higher than those of the other utilities except for this upcoming winter, however the other utilities tend to show larger fluctuations from season to season, which PSNH  does not.

Because the other utilities no longer have generating operations, they purchase electricity from the wholesale markets or (in the case of NHEC) directly from generators, as shown in the figure below (excerpted from my last post). As a result, the other utilities are more subject to the ups and downs of the wholesale electricity markets.

However, PSNH is still an integrated utility – it owns its own generating assets – and, as a result, generates a lot of its own electricity. The electricity supply picture for PSNH is therefore somewhat different, as shown in the following figure, where PSNH has a large supply of electricity generated from its own operations (shown in grey).

I have written about PSNH’s generating operation in several posts, including a recent overview of their hydro assets in River’s Gonna Rise and the possible sale of their generating assets in Options. PSNH has approximately 1200 MW of generating assets, as shown below.

The problem for PSNH is that their main assets are the old coal-fired Merrimack and Schiller plants and the relatively inefficient dual-fuel plant in Newington. In a market with low natural gas prices and very efficient dual-cycle natural gas plants, these older PSNH plants are generally non-competitive and there is often little call for the expensive power they generate.

To understand just how much electricity PSNH produces from its own operations, I took a close look at the data presented in PSNH’s latest filing for winter electricity rates. The filing included electricity supply numbers for the whole of 2014, which were a combination of actual year-to-date and forecast numbers.  I used this data to prepare the Sankey diagram below. (For more on Sankey diagrams, see Another View of Statewide Energy Flows in New Hampshire.)

The origin of PSNH’s 2014 electricity supply is shown on the left in gigawatt hours (GWh). The total amount supplied is 4901 GWh. The flows in grey originate from PSNH’s own generation operations, whereas green flows are from contracted suppliers or wholesale market purchases. The right side shows what happens to the electricity generated and sourced by PSNH: the bulk of it, 79%, is sold directly to PSNH customers; transmission and distribution losses are about 6%; and the remaining 15% is sold into the wholesale markets - mainly during the cold winter months.

The chart below shows the same data on a month-by- month basis, calculated as the percentage of PSNH’s total output generated by its own operations. These 2014 numbers are a combination of actual (blue) and forecast data (orange). The chart clearly shows that the PSNH operations – largely the coal-fired Merrimack plant – really ramp up in the cold winter months and are responsible for the majority of PSNH output during these times.  In the warm summer months, when natural gas is cheap and readily available, it is not financially prudent to run the coal-fired operations. Instead, it is cheaper for PSNH to buy natural gas-generated electricity from the wholesale markets. At these times, the bulk of PSNH supply comes from contracted or wholesale market purchases. (That little blip in July comes from supplying electricity for our summer air-conditioning needs.)  The final column, in red, shows that the amount of electricity that PSNH will generate from its own operations this year is projected to be right around 50%.

In the Sankey diagram above, I have included the costs of the electricity purchased by PSNH. Aggregating these costs and calculating a weighted average, I determine that that average cost of purchased energy is 5.4 c/kWh. If this purchased energy is 50% of PSNH output and PSNH is selling electricity at 9.5 c/kWh to its customers, it takes only simple algebra to determine that the all-in cost associated with PSNH-generated electricity is 13.6 c/kWh (0.5 x 5.4 + 0.5 x 13.6 = 9.5). And therein lies the rub: At present utilization rates and with low electricity prices in the summer, the PSNH generation facilities are very expensive to run. The high costs associated with its coal-fired operations weigh heavily on the rates paid by PSNH customers and explains why, more often than not, PSNH rates are higher those of the other NH utilities.

I realize that this calculation represents a gross simplification of a complex matter and it allocates the burden of all government-mandated electricity programs, like RPS and RGGI, to the generating assets only. Even so, the bulk of the costs originate from the assets themselves so I am comfortable with the simplification. This straightforward calculation, when applied to 2015 projections, clearly demonstrates that PSNH low winter rates for 2015 are not as a consequence of its own generating assets. Instead, they are a direct result of its portfolio of supply arrangements from wholesale market purchases and power-purchase agreements from wood-burning plants, including the new Burgess plant in Berlin, the wind farm in Lempster, and other generators.  So my earlier statement that, “…with electricity prices shooting up this winter and with PSNH customers, for the time being at least, somewhat shielded from these increases, this does give one pause for thought and to consider that ownership of generating operations may perhaps have some benefits,” does, in retrospect, not appear to have been well founded, at least from a electricity rate point of view.

This calculation also underscores the decision that lawmakers and regulators in NH are wrestling with at this time: Is it in the best interest of PSNH customers to complete the process of deregulation and compel PSNH to sell its generating assets?  If this happens, PSNH will be like the other utilities in NH and will need to source 100% of its electricity from the wholesale markets in New England or directly from generators through long- and short-term contracts. The next (and, I think, the most important) question is: Can this be done for less than 13.6 c/kWh once those generating assets are sold?

If PSNH has to source all its electricity from the wholesale market, they could run into a problem similar to that discussed in my last post, where, like Liberty and Unitil, PSNH could end up buying right into those winter peaks created by natural gas shortages. In my  last post I was somewhat critical of the short-term “next six month” approach that regulations compel Liberty and Unitil to use to source electricity for their customers. I suggested that a portfolio of different sources, as well as long- and short-term supply, be used. As it turns out, the regulators are ahead of me on this one:  the NH Public Utilities Commission (NH PUC) recently issued Order 25,732 to review the sourcing of electricity by Unitil and Liberty. It is very likely that any changes in sourcing approaches would apply to PSNH after the sale of its assets, so it will be interesting to follow developments in this area. 

It is important to note that this is not the whole story. If PSNH is mandated to sell their generating assets, they will − and correctly, I might add − expect to be compensated for the difference between the book value of those assets and what they will raise from their sale. All indications are that this difference, known as stranded costs and discussed in Options, will be substantial.  These stranded costs will come out of the pockets of PSNH customers. The NH regulators at the NH PUC are presently trying to determine how large this amount will be.

In the equation

Stranded costs = Book value – Sale value,

there are obviously two components, both of which are being scrutinized and debated at this time.

As I noted previously, the generating assets are listed on the PSNH financial statements at $ 1.1 billion but with a net depreciated value, or book value, of $ 660 million. This $660 million value includes the $ 422 million recently spent on the scrubber that was installed at the Merrimack plant to reduce mercury emissions from the burning of coal. The original budget for the scrubber was "not to exceed" $ 250 million, but, by the time it was completed, the price had skyrocketed to $ 422 million. A series of hearings was recently held to determine whether it was prudent for PSNH to have spent $ 422 million for a scrubber on an aging coal plant, and we are currently waiting for the NH PUC to make a determination on the prudency of this investment. I anticipate that PSNH will file an objection to the determination and we can then expect the battle to play out in the NH courts.

The second component of the stranded cost equation, the sale value of PSNH generating assets, is also being analyzed. Consultant reports have been commissioned, blogs have been written, and one thing is clear: in this low-cost natural gas market, the coal-fired assets of PSNH have relatively little value. Interestingly, the crown jewels in the PSNH generating portfolio are their hydro assets, about which I have recently written.

In the end − after all the consultant reports, hearings, determinations, and court battles − I believe the book value will be decreased and the sale value will erode, which is still going to leave PSNH ratepayers on the hook for those stranded costs. In Walking on the Wild Side, I indicate these stranded costs may be of the order of 0.5 c/kWh. This has been borne out in a recent status report issued by the NH PUC. This is an important number, but of far less importance than the numbers that will come from answering this one very important question:  Once the PSNH assets are sold, can PSNH reliably, consistently, and over the long term, source electricity at a lower cost than that incurred by their generating assets? This is the heart of the matter* and one that PSNH, ratepayers, legislators, regulators, and courts in NH will be struggling with over the next few years.

This post has covered a lot of ground, so, to wrap it up, let me leave you with the following takeaways:

  • PSNH rates are low this winter but this is not a consequence of owning their generating assets. Instead, it is a result of their low cost purchases through a portfolio of long-term power purchase agreements and wholesale market purchases.
  • The PSNH generating assets have value in cold winter months when natural gas is expensive. As natural gas supply to the region improves over the next few year, this will become less of an issue and the value of coal-fired operations will diminish even further.
  • Scrubber prudency reviews are an important step in moving PSNH to divest its generating assets but, in the big picture, I do not anticipate that this will have a significant effect on the electricity rates that PSNH rate payers will end up paying.
  • More important will be the rates at which PSNH can procure all its electricity from the wholesale markets and whether they will be able to adopt a portfolio approach to sourcing this electricity.
Until next time, remember to turn off the lights when you leave the room.

Mike Mooiman
Franklin Pierce University

(*The Heart of the Matter – The very moving song from Don Henley’s album The End of Innocence. I really like Henley’s version but it has been very well covered by India Arie. Here are both - you decide which you like best.  Don Henley or India Arie)

Saturday, November 1, 2014

Gonna Take You Higher* – Electricity Price Increases in New Hampshire

If you are a NH resident buying your electricity from Unitil, NH Electric Cooperative, or Liberty Utilities, you are most likely reeling from the recent increases in winter electricity rates. This post begins a series that takes a look at what makes up NH retail electricity prices and the reasons behind the large increases that we are seeing for certain utilities.

Historically, electricity prices have been on the rise. The chart below shows the 24-year historical average NH residential electricity prices.  In 1990, prices were about 10 cents per kilowatt hour (c/kWh) and then climbed to about 14 c/KWh in 1998. Prices then experienced a slow decrease until about 2002, after which they continued their increase to this past winter when we saw average prices of ~17 c/kWh. The trend from 1990 to 2103 represents a compounded average increase of 2.5% per year, which is the same as US inflation over the same period.

Source: EIA

The next chart looks at residential electricity prices for a shorter time period, and compares the NH prices (in green) to those of the NE states (brown) and to the average US monthly figure (blue) since 2000.

Source: EIA

NH has generally followed the NE average, but from 2006 to 2010 was quite a bit lower. However, over this period, our electricity rates have been about 40% higher than the national average.

State-by-state comparison is always useful and interesting. The figure below shows recent state rankings based on July 2014 retail electricity prices. The NE states are all in the top 11, with Vermont and Connecticut higher having higher prices than NH. Our electricity prices are the 7th highest in the US at 17.23 c/KWh − we can take some solace that the price in Hawaii is more than double the NH average. On the other hand, Washington state, which benefits from cheap hydroelectricity, has the lowest prices – almost half of NH’s at 8.96 c/KWh.

Source: EIA

All of the electricity prices I have presented so far are average prices and include all the charges you see on your electrical utility bill. Looking at an electricity bill is not unlike deciphering your cell bill. There are a lot of bits and pieces and it takes effort to understand them. There are three basic components. The first is the cost of power, which is usually a single line item for the cost of electricity per KWh. The second is the cost of getting the electricity to your home, i.e., the cost of distribution and servicing your account, which usually involves several line items, such a fixed account charge, a distribution charge, and perhaps even a transmission fee. Finally, there are all the odds and ends, such as taxes, charges for government-mandated programs, etc.

The reason for all these separate charges is, as I have noted previously in What’s It All About, Alfie?, is that there are three key parts to the electricity business: the generation of electricity, typically at a large power plant located in a central location; the transmission of electricity over long distances from the generation point to towns and cities; and the distribution of electricity through the community via the sub-stations, wires, and transformers to individual homes and businesses. Not all electrical utilities focus on all aspects of the business. Some, for example, such as my local electrical company, just distribute electricity. Others, such as the merchant wood-fired power plants or wind farms, just focus on generation, whereas utilities like PSNH are fully integrated organizations involved in all three aspects of the business. 

The biggest line item in your electrical utility bill is the cost of electricity. This is the focus for the rest of this post.

The electricity industry has been partially deregulated in NH and retail customers can purchase their electricity from different competitive suppliers. However, this electricity still has to run through the transmission lines and electrical wires of their local electrical utility and so customers are charged for the use of that distribution infrastructure.  Should a NH resident decide not to purchase electricity from a competitive supplier, the local electrical utility has the responsibility to source and supply the electricity to the customer. The utilities do so and apply their default electrical service rate. Although there has been competition on the residential supply side of electricity for a few years now, the majority of NH residential customers still rely on their local electrical utility company to source and supply their electricity. This is the reason that increases in default electrical service rates are so important.

There has been a good amount of reporting lately about the big increases in electrical service rates proposed by the utility companies and approved by the NH PUC.  The table below summarizes the present default electrical service rates as well as some information for previous years.  

It is important to remember that these increases all relate to electricity supply (and not to transmission or distribution charges) so let’s take a closer look at the supply side of the NH utilities. The rest of this post focuses on the three utilities, NH Electric Co-op, Unitil, and Liberty Utilities, with approved increases. PSNH's default rates - which are not yet approved by the Public Utilities Commission - will be the topic for my next post. 

Expanding the supply aspect of the simple generation-transmission-distribution diagram presented above, the picture quickly becomes complicated because, as part of deregulation and the drive for competitive supply, we have introduced various intermediaries and market participants.

The electricity supply to residences by three of the four NH utilities (NH Electric Co-op, Unitil, and Liberty Utilities) is shown in the figure below. Competitive suppliers, shown in yellow, purchase electricity directly from generators (red) or through wholesale electrical markets (green). The second source of supply is from the utility itself, shown in blue, which needs to procure electricity for its default electrical service customers. The utility can purchase this electricity directly from generators but the bulk of the purchases are through wholesale electrical markets. There are two types of wholesale electrical markets – the forward sales and the spot markets. Generators sell electricity into both of these markets.  

In order to supply electricity to their default customers, the utilities have to forecast how much electricity will be required for a six-month period and then lock in the price of the forecasted amount of electricity in advance. This is carried out in the forward sales segment of the wholesale electrical markets. Although there is a cost associated with forward purchase commitments, they offer the advantage of locking in the rate of electricity purchases for the period. Should more electricity than forecasted be required, the utility has to purchase this extra electricity on the spot market.

Three NH utilities (NH Electric Co-op, Unitil, and Liberty Utilities) have just gone through the round of forecasting for this winter electricity supply. The utilities have estimated the number of default service customers and their total electricity consumption, and have gone out to markets and solicited bids for supplying this forecasted electricity through the winter months. The bids for Unitil and Liberty were reviewed, documented, and submitted as part of their default electrical service rate application to the NH Public Utilities Commission (PUC). The costs associated with these forward purchases of electricity are then included, without any mark-up by the utility, in the calculation of a single rate for winter months. The NHEC Co-op (NHEC) is unregulated and is not required to submit its rate adjustment calculation to the PUC.

The problem for default electricity customers is that the future prices for electricity for the next six months are high, as shown in the chart below. As the utilities lock in their supply and prices for the winter months, they are buying right into the winter price spikes.

The difficulty with this approach is that the utilities are trying to forecast in September what their electricity sales in the winter will be. This is an enormous challenge because they have to forecast how cold the winter will be, how many customers they might have and their consumptions. They must then commit to purchasing that electricity in advance. However, if the winter is mild, the spot price could be lower. Of course, the opposite could happen: it could be a brutal winter, natural gas consumption could be sky high, and electricity prices could skyrocket like last winter.  This is the challenge that the utilities and their regulators face. Is it better to lock in the price now – called “hedging” – or subject your customers to the gyrations of the spot markets where prices could be higher or lower than the forward market, or should some balance be struck between committing to a 100% hedge or a partial hedge? This is exactly the same decision we face at home. Do we commit to a fixed price for oil or natural gas over the winter months, or do we take our chances and hope it will be a warm winter and that oil and natural gas will be cheaper than that fixed-price contract. What would you do?

The regulators currently require Unitil and Liberty to hedge 100% of their six-month forecasted amounts and commit to the high winter prices. This has lead to the higher winter default service rates posted by these utilities.

This brings us to the question of why future prices for electricity are so high in winter.  In two words: natural gas. As we have closed down nuclear and coal-fired power plants in NE, we are now generating 46% of our electricity using natural gas. Depending on your viewpoint, that could be a good thing: it is a domestic fuel, cheap, and less polluting than coal. It does, however, make us very dependent on the natural gas market and fluctuations in natural gas prices. Natural gas is also used for heating and cooking and, in winter, we do not have the pipeline infrastructure to bring in enough natural gas for heating and electricity generation. During winter, the natural gas utilities and  electricity generators suck very hard on the end of the natural gas straw and when demand increases, markets do what they are wont to do and prices increase accordingly. When natural gas prices increase, so do the prices of electricity. NE has experienced price spikes for both natural gas and electricity during the past two winters, as shown in the chart below.

Source: ISO-NE

Sam Evans-Brown, in a recent NHPR report, does a great job of summarizing the natural gas situation in New England. The political cartoon by Bob Englehart of the Hartford Courant points to the irony of situation: there is an enormous amount of natural gas available in the US, but NE is at the end of the pipeline and that causes problems for us in the high-use winter months.

Bob Englehart

Hartford Courant

Dec 19, 2013

The future electricity prices are joined at the hip to the future natural gas prices. In the figure below, the leftmost chart shows the future prices of electricity and natural gas for the next three years, as provided by the forward markets. (The forward price of natural gas is calculated for the Boston Algonquin Citygate, which is a good proxy for NE natural gas pricing. See The Price for a discussion of natural gas citygate prices.) The winter spikes in forward electricity prices match the winter spikes in forward natural gas prices. Should you need convincing, the right-hand figure shows a direct and very strong correlation between future electricity  future natural gas prices. In fact, the correlation coefficient is 0.966, which indicates a super-strong correlation. (Correlation coefficients vary between 0 and 1. A coefficient of 1 indicates a perfect correlation, whereas a value of zero indicates no correlation.) Although correlation does not necessarily mean causation, in this case we can indeed be comfortable in concluding  that high future natural gas prices lead to high future prices for electricity.

Returning now to the table that shows the default service rates for the four utilities, we note that Unitil, Liberty, and NHEC reflect increases of 59%, 76%, and 71%, respectively, over last winter’s rates. Although NHEC also shows a large increase, their winter rates are substantially lower. Based on what I have been able to learn, these lower rates are due to diversification in the way NHEC purchases its electricity. NHEC does not hedge 100% of its forecasted needs just six months ahead. Instead, it commits to forward purchases many years out and to some just a few months out. It also purchases electricity directly from generators through long-term (20-year) power purchase agreements and will also purchase some of its power on the spot market where it is able to take advantage of lower spot prices at times. As an unregulated utility, NHEC clearly has more discretion than the regulated organizations and some might suggest that these direct comparisons are unfair. I disagree, because comparisons of these different approaches are important in trying to figure out what works best for NH ratepayers.

The Co-op model has a lot of attractive features. The customers are the shareholders and they are not incentivized by returns on capital or dividends. They want reliable supply and the lowest possible prices for electricity and the whole organization is focused to deliver this. With the other utilities, I don’t see the same incentives to keep down electricity prices. The regulated utilities, Unitil, Liberty, and PSNH, are required to pass on the costs of electricity to their customers without any mark-up so there is little motivation for them to search out alternatives to minimize energy prices.

NHEC has a long-term view of electricity prices and, to my mind, the “next six months” approach at Unitil, Liberty and PSNH, as required by regulation, is far too short-term. Wholesale reliance on short-term forward markets does not seem to be the best approach. There is certainly merit to the diversification and flexibility of supply model used by NHEC and I wonder whether consideration should not be given to incentivizing the regulated utilities to develop a longer-term view of electricity supply. One way to do this may be to allow the utilities the flexibility to diversify their electricity supply and reduce the price of electricity below that of the short-term forward markets and to share significantly in any resultant savings.

While researching this post, it struck me that there is considerable variety in the types of electrical utility and a great deal of experimentation occurring in NH. NH arrived early to the deregulation ball and then pulled back when things went awry in California (see Should l I Stay or Should I Go?). As a result we have an integrated utility, PSNH, still in the generation, transmission, and distribution business; we have two deregulated utilities, Unitil and Liberty, that are out of the generation business and who buy all their electricity on the wholesale markets; we have a cooperative in NHEC which is not regulated by the NH PUC; and we have a few municipal electric companies. With all of these options in NH, we have a unique opportunity to figure out which model is the best, and which consistently and reliably delivers low cost electricity to NH ratepayers.

The past two winters have seen a refrain of “Gonna Take You Higher”* and I anticipate that the NH annual average electricity price will rise again this year. When deregulation was introduced, we expected the markets to automatically deliver lower electricity costs. This has not always happened. Sure, we have run into cold winters, natural gas pipeline capacity issues, and the shutdown of nuclear and coal plants, but deregulation appears to have fallen short on some of its promises. This requires some reflection and is certainly worthy of a future blog post.

Electricity markets are different from other energy markets, many of which have an inventory buffers in the form of storage or stockpiles to overcome temporary interruptions and market dislocations. Electricity, on the other hand, needs to be simultaneously generated and consumed: it cannot be stored, and the underlying market components and structures are hellishly complicated. There are a limited number of market players, liquidity can be problematic at times, and − regardless of the cost − it needs to be “on” all of time. Moreover, in NE, the market for electricity now rests on top of the local market for natural gas – another commodity for which local storage is very limited and where delivery constraints come into play. With so much of our electricity dependent on natural gas, we could even reach situations where there is insufficient natural gas to generate the electricity we need. From this viewpoint, it appears that heavy dependence on natural gas has compromised the reliability of our electricity supply. This is all frightfully messy.   

I am a proponent of the letting the invisible hand of the market do its work, but it does need to do so under the very visible and intelligent hand of regulation. My 1/8 of a KWh worth is that progress has been made but there is still work to do to get things right for NH electricity rate payers.

Until next time, remember to turn off the lights when you leave the room.

Mike Mooiman
Franklin Pierce University

(*Gonna Take You Higher – A line from the chorus of Sly and the Family Stone’s tune,  Want to Take You Higher, and a great example of the funky soul music from the 1960s. This was one of the tunes in the Family Stone’s set at Woodstock when they played it at 3 am and had the crowd chanting “Higher”. Here is a video of a 1969 show that gives you a sense of the power and drive of Sly and the Family Stone. Enjoy I Want to Take You Higher.)