Essential to economies, electric power is in the spotlight worldwide

In the US, the overriding issue in the electric power industry is the reliability of electricity delivery. While assuring the public that another blackout as widespread as the one of August 2003 is unlikely, federal and state regulators also say that American transmission grids operate under vague and voluntary reliability standards and that attempts to audit utilities' compliance with those standards are marred by inconsistency and subjectivity.

Though politics continue to prevent passage of comprehensive national energy legislation, US electricity demand for 2005 is expected to increase 2.1%, according to the DOE's Energy Information Administration. The EIA based the demand forecast on anticipated economic growth. It also predicted that next year US generators will put out 4,019 bil kWh, up from an expected 3,939 bil kWh this year. The gap between domestic supply and demand is widening slightly because electricity imports from Canada and Mexico are expected to grow to 4.2 bil kWh next year, nearly twice the anticipated 2004 level of 2.4 bil kWh, the EIA said.

US merchant power blues

Entering 2005, the US merchant power industry faces a variety of obstacles. For example: deregulation of state retail markets is stalled, re-regulation is emerging, prices of all three major fossil fuels used for generation -- coal, oil, and natural gas -- are soaring, and electricity demand is dampened by a national economy that remains, at best, lukewarm. Overcapacity is another problem. Excess US generating capacity in 2005 will hover between 75,000 and 90,000 MW, and it is not expected to be fully absorbed until 2010. Prospects for the merchant sector's recovery differ widely across America's five key regional control areas and 50 sub-regional markets. The Northern California, Arizona, Entergy, South Carolina, and PJM West regions -- and many parts of WECC, ERCOT, and SPP -- have capacity margins in excess of 30%. Only four regions -- New York, FRCC (Grid Florida), PJM East, and MAAP -- are more or less in balance. In Southern California, as much as 3,500 MW of new capacity could be needed by 2006.

US electricity imports

- 2004, estimated: 2.4 bil kWh

- 2005, projected: 4.2 bil kWh

On average, spark spreads for new combined-cycle plants are likely to decrease by another 10% by 2006, and about 55% of the market could see spark spread decreases of 15% or more. Consequently, until 2010, spark spreads for new combined-cycle plants are likely to be too low in many regions -- Entergy, the Carolinas, the Northern California border, Southern California Edison, and even PJM East. But most of the market should recover by 2008 as spark spreads climb to 2003 levels. Meanwhile, look for some 45,000 MW to 57,000 MW (worth between $13 bil and $17 bil) to change hands between now and 2010. In many cases, financial institutions will become big arbitragers because they will own about 45% of the transacted capacity and because they can offer enabling or "bridge" structured financing for periods of two to four years.

Project-specific "fire sales" of 11,000 MW to 15,000 MW are likely from merchants facing difficult refinancing conditions. Also look for 7,000 MW to 12,000 MW of unregulated assets to be converted to rate base status, and for the resale of plant equity interest by banks and investment funds eager to cash in on their investments. Resales alone could total as much as 18,000 MW, said GF Energy Senior Strategist Jean-Luise Poirer.

It is estimated that 33,000 MW in additional capacity will be developed between 2005 and 2010. Some 40% of it will be in the Midwest, with 28% in the Southeast and 25% across three power pools in the Northeast. About 33% of the total new capacity will likely come from now-suspended projects that are restarted, a process that is both faster and less costly than greenfield development. Another one-third will come from utilities eager to build again, leaving only the final third for brand-new projects.

Transmission constraints -- especially in New York, California, and the MAIN and MAPP control areas -- require "support capacity" and thus could necessitate as much as 7,000 MW. And, should the economy strengthen, another 12,000 MW could be needed, but the total could be decreased by demandside management techniques.

Estimated additional US capacity

- 2005-2010: 33,000 MW

- Midwest: 40%

- Southeast: 28%

- Northeast: 25%

Utilities feeling credit pressure

According to Moody's Investor Service analyst Dan Aschenbach, excess capacity and the absence of long-term transmission rights and price-certainty contracts could pressure the credit strength of publicly traded electric utilities entering a new building cycle. "Many of the credit issues that affected public power projects in the 1970s and 1980s have come to the forefront again," he said. "About 9% of all new generation in the US between 2003 and 2006 will be built by public power utilities and thus will be prone to these reemerging credit risks." Power project construction stalled in the last half of the 1990s, when deregulation loomed, because utilities were concerned that the fixed costs of running new facilities might not be recoverable, Aschenbach explained. Now that deregulation has stalled, some public power utilities are proceeding with construction of new generators, peaking plants, and major coal-fired generation facilities, he said.

Will China have enough power?

Elsewhere -- particularly in the developing world -- prospects for electricity sectors are clouded by worries that demand will outstrip supply and by insufficient investment. China and Latin America are two cases in point. According to Zhao Xizheng, president of the State Grid Corp. of China -- the largest of the country's two state-owned transmission and distribution firms -- China's power supply is improving and should be able to match demand by 2006. Zhao was quoted by the statecontrolled China Daily newspaper as saying, "The implementation of macrocontrol measures . . . by the Chinese government and the further increasing of power supply capacity [means that] power shortages will probably be alleviated next year." According to State Grid estimates, 42,800 MW of new capacity will have come on-line by the end of this year and another 60,000 MW will be commissioned in 2005.

Estimated Chinese power consumption

- 2010: 3,090 TWh

- 2020: 4,600 TWh

However, another State Grid official cautioned that the threat of blackouts in China has not ended. Ma Zhizhong warned that the supply/demand situation will remain tense until at least next spring due to continuing economic growth and other environmental factors. Ma also indicated that the power shortfall during peak demand periods has been worse than some government officials have suggested. For example, the head of the Electricity Department of the State Development & Reform Commission's Energy Bureau has suggested the shortfall at peak was around 20,000 MW. However, Ma said that the shortfall at peak in State Grid's service area alone was 29,830 MW. Worst affected, Ma explained, was the East China grid, where the shortage reached 20,780 MW, while the north and central China grids experienced shortages of 7,470 MW and 1,580 MW, respectively.

State Grid Corp. projects that Chinese power consumption will rise an average 6% annually in the near term and reach 3,090 TWh by 2010. By then, China's installed capacity is expected to total 680,000 MW. By 2020, power consumption and generation capacity could be as much as 4,600 terawatt-hours and 1,000,000 MW, respectively.

Latin America needs reform, investment

Many followers of the industry say they are no more than cautiously optimistic about prospects for Latin American power sector reform because the region is emerging from economic malaise. Energy investors are looking at the region in the same way.

Brazil’s estimated capacity needs

2004 (currently provided): 59,300 MW

- 2012 (Platts estimate): 77,300

- 2012 (Brazilian estimate): 95,700

Without question, Latin America will require plenty of investment in its energy sectors if it is to recover from a two-year economic slump and return to a healthy growth rate. While anticipating this recovery, many investors are waiting to see whether governments can convince their citizens that electricity reform -- which often raises electricity prices by ending subsidies -- is necessary to attract needed investment in the sector. Some fear that reforms in places like Mexico and Brazil will not move quickly enough to prevent blackouts.

Jeffrey Davidow, president of the Institute of the Americas and a former US ambassador to Mexico and Venezuela, believes that Latin American governments must begin formulating their energy strategies with private investors now, before energy supplies reach dangerously low levels. Mexico is among the most important Latin American countries attempting to balance the need for investment in their energy sectors with political opposition to opening energy markets to foreign participation. "While the factors in Mexico are bad, they are not yet dire [enough to spur opening the electricity market]," Davidow explained. "In 10 years, Mexico must be able to generate twice the electricity that it does now, and the vast majority of [the new generation] will have to be fueled by natural gas. However," he cautioned, "supplies of gas in North America are expected to tighten going forward. So Mexico must look to both produce more domestic natural gas and build more LNG and alternative energy projects, but I don't see either happening [soon]."

The biggest reason for the lack of reform is Mexico's political paralysis. Because President Vicente Fox's PAN party lacks a majority in the legislature, PAN will have to form alliances with either the PRI or PRD parties to enact reform. But both opposition parties, true to form, oppose opening Mexico's energy sector to private investment because a successful outcome would give Fox a political victory he and his party could leverage in the next presidential election, in 2006.

Nevertheless, while attempts to increase investment in new generation in Mexico have raised more questions than answers, there is a general feeling of optimism about prospects for Latin American energy as a whole. "Last year and this year, it was pretty dour in the region," said Jeremy Martin, director of the energy program at the Institute of the Americas. "But lately, the outlook has become much more positive. For example, despite some people's objections to the new [energy sector] model in Brazil, Lula has done a good job with the economy. Likewise, Gutierrez in Ecuador and Toledo in Peru both have been successful from a macroeconomic perspective."

Areas of significant future growth

A recent Platts analysis estimates that Latin America will require 90,000 MW of new generating capacity by 2012 and predicts that annual demand will grow, on average, by 2.13% through 2007. Of that total, the region's largest economy -- Brazil -- will require 18,000 MW by 2012 because peak demand is predicted to grow by 2% annually, from an estimated 55,000 MW today to over 65,000 MW by 2012. The Platts capacity estimate is conservative compared with one made by the Brazilian government, which says installed capacity needs to go from todayıs 59,300 MW to 95,700 MW in eight years.

In Mexico, it is estimated that electricity consumption will grow by 2.12% through 2012, which would create a shortfall by 2006. However, if the rate of demand growth increases to historical levels of 6% to 7%, demand would increase to 57,583 MW by 2012, creating a supply shortfall of 26,000 MW and requiring 40,000 MW in new plants just to keep pace with peak demand and to maintain reserve levels.

In Argentina, which has a fairly balanced mix of capacity types, significant additions will be required: 21,350 MW by 2012, or about 3,000 MW in each intervening year. Other Latin American countries requiring big investments in their energy supply include Venezuela, Colombia, and Chile.

Although investment decisions in Latin America remain clouded by a number of factors, some contend the region is unfairly characterized as a poor place to invest in energy. Among the nonbelievers are private energy companies that are beginning to look at Latin America as a place where good deals can be had. Joe Lessard, VP for South America at CDC Globeleq, said his company -- which earlier this year acquired Bolivia's 204-MW generator COBEE from NRG Energy -- remains bullish on the region. There's a disconnect between the value that current holders of Latin American assets assign to them and what we think theyıre actually worth, said Lessard. Weıre looking for attractive assets in markets that we think have strategic value, and perusing those as the basis for future inherent growth.

Created: Mar 16, 2005

This article originally appeared in Platts Insight magazine, a companion publication to Platts Global Energy Awards. To view the entire issue or to learn about advertising opportunities, click here.