I have referred to a Bloomberg article dated Sept 30, 2011 many times as a prelude to what can happen here in the US. Titled "Utilities Giving Away Power as Wind, Solar Floods European Grid", the article points out that in several instances, European electrical utilities have had to pay customers to increase their use of electricity.
The 15 mile-per-hour winds that buffeted northern Germany on July 24 (2011) caused the nation's 21,600 windmills to generate so much power that utilities such as E.ON AG (OTCQX:EONGY) and RWE AG (OTCPK:RWEOY) had to pay consumers to take it off the grid. Rather than an anomaly, the event marked the 31st hour this year (as of Sept 30, 2011) when power companies lost money on their electricity in the intraday market because of a torrent of supply from wind and solar parks. The phenomenon was unheard of five years ago.
You read it correctly. Electrical power companies paying customers to take electricity. How could this happen?
It is pretty simple, really. There are four levels of power generation - base load, intermediate load, intermittent load, and peak load. Base load refers to those power-generating facilities that operate 24 hours a day, 7 day a week, 365 days a year. Base load power generation cannot be easily turned on and off, and power generation is nearly constant. Coal-fueled and nuclear power plants are examples of base load generation. These generate the basic demand levels so that when you turn on your lights at 3:00 am, they actually come on. Peak power generation refers to the line of last resort when demand outstrips other types of generation. These plants have the ability to be turned on and off relatively quickly. Intermediate load plants make up the difference between the two extremes of base load and peak load. Intermittent load refers to capacity or power generation that is not continuously available and whose availability may not be controlled.
Wind and solar are examples of intermittent load generation.
Natural gas has been historically used as the fuel source for intermediate and peak power generation due to the ability to be turned on and off over a relatively short timeframe, for instance 6 hours. Larger coal plants can take between 8 hours and several days to go from non-operational to full power. Nuclear power plants will take about three days or more to move from shutdown to full power.
According to most state regulations, wind and solar power generation have a guaranteed place on the grid, and utilities are required to buy this electricity. In the case where base loads requirements are satisfied by current base load generation and intermittent generation is high, there will be too much electricity on the grid. There is currently insufficient electricity storage so that the excess can be "banked" for when it is needed, for instance when the intermittent generation is offline.
When there is insufficient demand to satisfy both the base load generating capacity and the intermittent generating capacity, utilities have been paying customers to use more electricity.
Bloomberg published another article on the topic Sunday night March 10 outlining this exact situation - not in Germany or Denmark, but in the US Midwest. It is titled, "Nuclear Industry Withers in US as Wind Pummels Prices", This article should be necessary reading for all electric utility investors.
Prices Below Zero
Wind power has two advantages. Green energy laws in many states require utilities to buy wind energy under long-term contracts as part of their clean-energy goals and take that power even when they don't need it. Wind farms also receive a federal tax credit of $22 for every megawatt-hour generated.
Thus, even when there is no demand for the power they produce, operators keep turbines spinning, sending their surplus to the grid because the tax credit assures them a profit.
On gusty days in the five states with the most wind power - - Texas, California, Iowa, Illinois and Oregon -- this can flood power grids, causing prices to drop below zero during times when demand is light. Wholesale electricity during off-peak hours in Illinois has sold for an average price of $23.39 per megawatt hour since Jan. 1, after hitting a record low of -$41.08 on Oct. 11, the least since the Midwest Independent Transmission System Operator Inc. began sharing real-time pricing in 2005.
Meanwhile, nuclear and coal plants must continue running even as this "negative pricing" dynamic forces them to pay grid operators to take the power they produce.
"It is becoming more pronounced as more wind is coming on," Christopher Crane, chief executive officer of Chicago-based Exelon Corp., said in a phone interview.
If the push to "over-develop" subsidized wind continues, "there is a very high probability that existing safe, reliable nuclear plants will no longer be competitive and will have to be retired early," according to Crane. "
It is tough to make a profit or justify additional base load capacity investment when electricity prices are negative. It is interesting to note that according to the most recent investor presentation, the profit margin of Calpine's (NYSE:CPN) natural gas facilities is approximately the same as the federal tax credit.
Dominion Resources (NYSE:D) has announced plans to close a nuclear plant in the Midwest and further closures of their coal-fueled assets. According to their press release, Exelon (NYSE:EXC) saw its 2012 4th quarter merchant power operating profit (non-GAAP) shrink by 21.1% from a year earlier. According to the FERC website, PJM auction power pricing has declined by 38% since 2008 putting the big hurt on the merchant power business in the Northeast and Midwest. PJM operates a competitive independent power market in the Northeast and Midwest. Power is purchased for distribution across the transmission grid using an auction mechanism of rolling 3-year contracts More information on PJM and the auction pricing model can be found at their website here and here.
As the Bloomberg article points out, there has been 60 GW of wind power installed since 2003, a ten-fold increase. While this installed capacity about equals the 53 GW reductions in coal-fired plant generation of the most recent past and over the next few years, the important capacity distinction is coal is a base load fuel source and wind is not.
Other excerpts from the recent Bloomberg article:
Before 2006, when wind power began its latest growth spurt, negative prices were extremely rare. The phenomenon is now prevalent in parts of the Midwest, Texas and the West Coast where turbine installations are growing fastest, data compiled by Bloomberg show.
"We can't find enough demand for the amount of energy created by Mother Nature," said Doug Johnson, spokesman for the Bonneville Power Administration, which manages the grid in the Pacific Northwest. The transmission operator, based in Portland, Oregon, paid wind operators $2.7 million last year to stay off line so it could make room for the power from hydroelectric generators handling the runoff from melting mountain snows.
Negative prices are starting to seep into a Southern California power hub and may become more frequent as state regulations mandate that 20 percent of its power come from renewable sources by 2020, Blaha said. "That extra amount is going to knock out about 15 percent" of energy filled by fossil fuels.
Exelon, the largest U.S. nuclear operator, says a surplus of wind power is making negative pricing a problem in Illinois, where it owns six nuclear plants and a wind project. Prices for markets served by Exelon's Clinton and Quad Cities reactors trade below zero between 8 percent and 14 percent of off-peak hours, said Joseph Dominguez, Exelon's senior vice-president for governmental and regulatory affairs and public policy.
The answer most given by wind supporters is simply to build the storage capacity to utilize the excess when it is available. These include the promising technology of flywheel energy storage, grid battery storage facilities and pumping water into hydropower reservoirs for recirculation later. However, look at the history of Beacon Power, a flywheel storage company. It was the recipient of the Department of Energy loan guarantee program but filed for bankruptcy in Oct 2011 and was purchased by a private equity firm in Feb 2012 for a fraction of the guarantee.
Investors in merchant power producers will probably realize the largest negative impact as negative power prices become more common. However, negative power prices will eventually work their way into local Public Utility Commission discussions concerning regulated rates. When that happens, the end result probably will not be good for electric utility shareholders -nor utility customers.
Be careful what your wish for. The European-ization of the US continues and has the electric utility business in its crosshairs.
Author's Note: Please review important disclaimer in author's profile.
Disclosure: I am long EXC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.