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

mooimanm@franklinpierce.edu

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(*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)