FirstEnergy could see big boost from doubled electricity prices due to smaller fleet of plants available to meet power needs in parts of Ohio; analyst prediction comes week after utility blamed closing six plants due to U.S. EPA regulations
February 3, 2012
– Instead of complaining about clean air rules, maybe utilities should cheer them.
Sometimes, the rules lead to big gains.
First Energy, a utility based in Ohio, got such a boost Thursday, a week after the company announced it would close six coal-fired plants, blaming new federal rules aimed at slowing emissions of mercury and other toxins.
Without these plants, electricity prices in parts of Ohio dominated by First Energy are expected to nearly double at a power auction scheduled for May.
The reason: There will now be a smaller fleet of power plants available to meet potential power needs. This smaller supply means the price to coax companies like First Energy to make their plants available will rise.
Julien Dumoulin-Smith, an analyst at UBS, predicted rates would rise from $126 for every megawatt available per day to $200. For the 8,000 megawatts of power plant capacity owned by First Energy in the region, that would be an extra $216 million for the year covered by the auction.
Jonathan Arnold, an analyst at Deutsche Bank, said there's a chance prices could approach $500, which would be an enormous windfall for First Energy.
First Energy shares rose 3.3 percent Thursday on a day in which the Dow Jones Industrial Average fell slightly.
Electric utilities have complained about a raft of new and tightening environmental standards. They argue that the rules are too stringent and that utilities are not being allowed enough time to prepare for them
The rules address several environmental issues: Emissions of toxins harmful to human health, pollutants that lead to smog and acid rain, the amount of water used to cool plants and disposal of power plant waste products.
Utilities argue that the cost of complying with the rules is too high, that electric power supplies could be constrained in certain regions and that electricity bills will rise.
What they don't generally say, however, is that the rules can lead to higher earnings in some cases.
Electric utilities are regulated differently in every state, so the way utilities can benefit differs too. Here's how:
— In states where power prices are set by market forces, fewer plants means lower electricity supply, and higher prices. Companies that have plants that comply with the new rules stand to benefit from higher prices. First Energy has nuclear and modernized coal plants that meet the new standards.
— In states that are regulated, utilities have to ask public utilities commissions for permission to install new equipment or build new plants. But the utilities are allowed to earn a higher return on these big-ticket investments than they are for selling power to customers. To the extent that the new environmental regulations allow regulated utilities to build new equipment, they will likely lead to higher earnings.
But some companies will suffer. For example, utilities in unregulated states that have to pay for upgrades themselves and cannot benefit from higher prices won't be able to offset the cost of the equipment. Similarly, if state regulators refuse to allow utilities in their state to pass the cost of the upgrades or new plants to customers, those companies could suffer too.
The industry also argues that higher prices could also lead to lower power demand and profit.
First Energy chose to close plants that likely would have been unable to operate under the new rules on toxins. These plants are generally older and inefficient, so installing emissions control equipment would have cost the company too much money. These plants were already seldom used, so by closing them the company does not stand to lose much revenue from the small amount of power they generated.
But in the markets First Energy operates, plants earn money two ways: by selling power, and by making power plants available for use during peak periods, even if they are never actually needed.
With the closure of four plants in Ohio, there will be less power available to meet demand. That is expected to drive prices for capacity higher.
"First Energy's nuclear plants and baseload coal plants with environmental controls are the primary beneficiaries of the EPA rules," says Hugh Wynne, an analyst at Sanford Bernstein.
Power prices have been driven lower in recent years by low natural gas prices, which in many markets set the price of electricity. Because of this, prices for capacity have become more important to company earnings.
Customers in northern Ohio will pay higher prices than they otherwise would have in the coming years. The final prices they pay, however, will depend on several other factors, including the price of coal, the price of natural gas, and power demand.
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