Another Letter to the PSC

In addition to the considering coal, natural gas and wind power via the energy RFP, the Public Service Commission (PSC) has opened another docket on Delmarva’s Integrated Resource Plan (IRP), which includes conservation measures as well as a new power plant. I sent this rather technical letter to the PSC earlier today:

May 2, 2007
Ms. Arnetta McRae
Chair
Delaware Public Service Commission
861 Silver Lake Blvd.
Dover, DE 19904
Re: PSC Docket 07-20, Integrated Resource Plan
Dear Ms. McRae:
Having reviewed the docket and considered the economic risks to Delmarva’s customers, I conclude that the public interest is best served by building a wind power facility to reduce the exposure to price increases borne by ratepayers. My views are informed by my experience in government negotiating environmentally complex, capital-intensive, long term contracts, and by the analytical tools I gained while earning an MBA in finance. More specifically, I conclude (1) that Delmarva’s stated preference for continuing to buy energy via three year auctions would not provide any price protection to its customers, and (2) opting for wind power would contribute to price stability for Delmarva’s customers.
1. Three year auctions would not enhance price stability.
Delmarva’s proposed IRP includes several key elements: demand side management (DSM), upgrades to transmission capacity, adding 125 MWs of generation capacity and continuing to purchase power via three year auctions.
Delmarva's preference for continuing to rely on three year contracts is clearly stated in its Response to Comments on the IRP (March 23, 2007): “To reduce price volatility and obtain competitive energy prices for RSCI SOS customers, the IRP recommends continuation of a procurement strategy that relies on multiple suppliers competing through an auction process for three year full requirements contracts to serve a percentage of RSCI SOS load.”
While I agree with the importance of DSM, and support the creation of a sustainable energy utility (SEU), I do not agree that auction purchases of energy is in the best interests of Delmarva’s customers. Even with DSM, continuing to rely on the auction process would leave ratepayers exposed to price volatility.
In comparing risks of price stability, Delmarva’s consultants assigned a “N/A” rating to the Conectiv Base proposal—the same rating given to Bluewater Wind. I find this methodology flawed; Delmarva’s SOS customers are already exposed to considerable market risk. Instead of demonstrating that the current procurement practice provides the best possible price stability, it appears that Delmarva’s consultants simply assumed that to be the case. This assumption is unwarranted. Unlike gas or coal, we know that the cost of wind is not expected to increase over the next 25 years.
On this point, it is important to distinguish between Delmarva’s risks and those of its customers, who are now exposed to considerable risk of fuel price increases. It is understandable that Delmarva’s management would be concerned about the financial obligations imposed by a long term contract. In rating the financial strength of utilities, Standard & Poor’s has traditionally imputed debt for long term purchased power agreements (PPAs). In other words, S&P calculates a risk factor or percentage of the net present value of PPAs with terms of three years or longer, and treats it as being similar to debt. Last year, S&P announced that it “is abandoning its practice of not imputing debt for purchased power agreements (PPAs) with terms of three years or less.”
S&Ps offers this rationale for its announcement: “Because expiring contracts must be replaced with either debt-financed capacity additions or replacement PPAs for regulated utilities to meet load serving obligations, Standard & Poor’s must look beyond the termination of near-term and intermediate-term contracts to approximate the fixed obligations that will succeed the current contracts in evaluating a utility’s financial
profile."
In other words, utilities cannot escape the reality of long term obligations even if they choose to meet those obligations with short term purchases of power. While a long term supply contract creates a risk for the company, purchasing power every three years is not without risk. Specifically, three year purchases of power leaves Delmarva’s customers more exposed to the risk of future price increases—which is precisely the risk that the RFP is intended to ameliorate.
Delmarva has said that it does not want to engage in a long term process as envisioned in the RFP, citing the risk of lower than projected demand from SOS customers. It is understandable that Delmarva would not want to contract for more electricity than it can sell to its customers. Here we see another advantage to wind power: It is scalable. The unit cost of 200 MWs isn’t much different from the unit cost of 600 MWs. The size of the proposed wind farm is an issue that could easily be addressed in contract negotiations with Bluewater Wind. On this point, the announcement today that the Delaware Municipal Energy Corporation has agreed to buy $200 million to $300 million of electricity from Bluewater Wind over a twenty year period should significantly reduce the risk to Delmarva.
2. Wind power would contribute to price stability.
Including wind power as part of Delaware’s generating capacity would help protect customers from future increases in the costs of fossil fuels. According to the U.S. Energy Information Administration, the price of Brent crude oil climbed from $13.08 per barrel in January, 1978 to $63.93 last month. The wellhead price of natural gas, measured in dollars per thousand cubic feet, increased from $0.54 in 1975 to $6.66 in February. There is no reason to believe that the price of oil and natural gas will not continue to climb in the future, apart from any future changes in required emissions controls.
The costs of these future controls will be considerable. The technology of carbon sequestration is in its infancy. Perhaps the best estimate of the cost of carbon controls can be found in a study from MIT titled “The Future of Coal,” which estimates that carbon sequestration is likely to increase the cost of electricity by 27 percent and reduce effective power generation by 19 percent.
(“The Future of Coal,” p. 30, http://web.mit.edu/coal/)
NRG and Conectiv seek to place the entire economic burden of compliance with future controls on carbon emission squarely on the shoulders of consumers. Conectiv is seeking recovery of possible future carbon taxes. The PSC’s consultants have noted that NRG has proposed an exception from provisions that it “absorb any additional environmental compliance costs caused by a change in law,” and its “proposed pricing for [carbon] sequestration is essentially a cost pass-through proposal that is inconsistent with the RFP requirements.”
In conclusion, I am increasingly convinced that price stability is the crucial consideration, in which we see the public’s environmental and economic aligned. To the extent that Delmarva continues to rely on three year auctions, its customers will remain vulnerable to price volatility. Wind power is the best long term option for protecting ratepayers from future price shocks.
Thank you for the opportunity to offer my views on this important decision.
Sincerely,
Thomas Noyes

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