Mergers and Market Competition Separate Energy Princes from Regulatory Frogs

EIA US Nuclear Fleet Construction History

If you wonder why there are not more mergers of utility companies in the United States, the lessons from the experience of Exelon and Constellation will open your eyes. It appears that these two companies will finally get regulatory permission to get married, but both have had to kiss a lot of frogs before they found the prince or princess emerging from this deal.

We need more mergers of good performing utilities like these two if we are to live into the potential of smart grid and a clean energy future.  The technology, investment and scale required for success simply is not possible in the fragmented utility markets we have today.  We kid ourselves if we think we will see the customer benefits from all the spending on smart grid if each combination of utility pairs must go through the same tortured courtship these two have endured.

See the graphic above showing the construction history of the US nuclear power generation fleet.  Do you notice that there is not a lot of potential shown on this graphic for new nuclear plant construction in the US through 2035?  That is why Exelon needs this merger with Constellation and why Duke and Progress Energy feel the urge to merge to focus on new market growth.   Running a high quality nuclear fleet may be a steady income business but it does not attract investors looking for growth.

But state regulators considering this deal are treating it as if they have just found the Golden Goose and can force it to squat and lay golden eggs to fund their pet projects.  Read the press release yourself and look at the larded up regulatory extortion (earmarks!)  in spending on projects these two have been forced to do to get the State of Maryland to go along with the deal.

Duke and Progress Energy are facing similar demands in their own regulatory approval process.  Mostly they hold their nose and agree to the regulatory extortion in order to move forward, but both the public and investors are smart enough to realize that some of these regulatory demands have little to do with protecting the public interest and everything to do with politics.

Why Put Up with This?

Utility Fragmentation versus Monopoly. The utility business is fragmented because it was formed largely from the late 19th century growth of small companies.  In those early days of the electric power business there often were many small light companies serving the same city.  Soon the barons of the power business realized the inefficiency in this and Sam Insull began the process of bringing the companies together in the early 20th century.  The result of those efforts was too much of a good thing with the formation of monopolies and all their consequences.  The public policy response to monopoly power was utility regulation and until the 1960’s the rationalization process that emerged worked well.  The ‘regulatory compact’ of reasonable expansion of power generation in order to meet the post-World War II need for power to fuel our growing economy saw the economies of scale work to our advantage with each new power plant typically lowering the average cost of service.  Life was good in those ‘Leave it to Beaver’ days.

The Nuclear Power Roller Coaster. Things changed forever in the 1970’s with the ugly combination of oil price spikes, conflicts in the Middle East, inflation, worries that the US would run out of natural gas, and plans to build a fleet of nuclear power plants.  We know this ugly history—‘too cheap to meter’ turned into ‘OMG how much is this going to cost’!  Then came the Three Mile Island incident and the great hopes of the nuclear energy sector were dashed on the rocks.  Later the Chernobyl catastrophe sealed the fate of the nuclear power industry in America.  But through all that chaos more than 100 nuclear power plants were built and put into service and they have performed spectacularly as the plants were spun off to wholesale power-producer owners who operated them with the care and precision of a fine Swiss watch.  Today that first generation of nuclear power plants still provides about 20% of our electric energy with no carbon emissions.  But more than 50 years later politicians are still arguing over where to put the spent nuclear fuel waste even though a facility was built to house it more than 20 years ago.  But unfortunately it was built in Nevada in the home state of an opponent who happens to be the Senate Majority Leader.

Competition, Smart Grid and the Clean Energy Future Fast forward to the first decade of the 21st century and we have seen tremendous change for both good and ill.  The boom at the beginning of the new century turned into a bust as housing, politics, regulation and finance combined to crater the economy.  In those boom years concerns over greenhouse gas emissions and the desire for renewable energy leading to politically correct policies built on the zero-sum game of trashing low cost coal fired generation.   Higher energy prices, renewable portfolio standards and government subsidies were part of an industrial policy to convert the low cost energy economy into a clean energy economy driven by renewable energy and smart grid to reduce emissions while using the regulatory hammer on coal and fossil fuels and ignoring nuclear.

EIA Electric Power Generation by Fuel to 2035

Unconventional Oil & Gas is Renewing America’s Competitive Future. But the inconvenient truth turned out to be the quiet but ruthlessly effective market response to the regulatory constraints.  Unconventional oil and natural gas exploration and production boomed in unimaginable places like North Dakota, Alberta, Saskatchewan, Nebraska, Kansas, West Virginia, Pennsylvania, and Ohio as well as in familiar places like Texas and Oklahoma.  Instead of worry about running out of natural gas as we did in the 1970’s the US is now an exporter of natural gas.  Competition from unconventional oil and gas enabled by horizontal drilling and hydraulic fracturing has turned America’s worry into America’s clean energy future.

The price of natural gas has been decoupled from oil prices and that now is roiling global markets.  Low natural gas prices hurt coal fired generation (unable to compete with lower gas prices) as well as renewable energy from wind and solar (unable to compete with lower natural gas prices even with subsidies).  The growth of unconventional oil and gas E&P is revving America’s growth engine again and will lead the way out of the current economic ditch.

Get Thee to Grid Parity—Fast!  Competition is also helping to quickly rationalize our clean energy policies and the market potential for wind, solar and other renewable energy sources.  This is not happening because of our government policies at the Federal or State level.  Those policies have only driven up costs of energy and hurt America’s global competitive economic position.  But global competition is driving down the prices for wind turbines and solar photovoltaic panels because of the ruthless competition from China and its desire to build global market share for its exports.  Who would have thunk it!  The communists are out-competing the industrialized free world.  Our own government policy of subsidies as well as those of the EU countries were so generous that China suctioned them up by dumping PV panels at prices below domestic manufacturers worldwide.  That is what caused the solar market crash in Spain and Germany and the bankruptcy of Solyndra and Evergreen Solar here in the US and it is driving every solar firm to grid parity prices as a fierce pace.

The same thing is happening to carbon markets around the world as the political correctness of buying carbon offsets (indulgences) is trumped by the economic and political reality of the lack of a global agreement on reducing greenhouse gas emissions.  Durban COP17 conference that recently ended in South Africa was an excuse for thousands of people claiming concern about the environment to fly thousands of miles to achieve nothing.  The markets have spoken and the politicians are no longer able to spend other people’s money for this or other pet causes.

The good news is for once we should enjoy this ride because the combination of competition from China driving down PV and wind turbine prices and competition at home from unconventional oil and gas production growth driving down natural gas prices is the corollary to the perfect storm transforming our domestic energy market into a lean, mean, competitively priced machine.  Yes it is hurting coal our traditional low cost energy supplier.  In fact, competition is hurting coal a lot more than EPA regulations by stopping most new coal fired generation power plant construction.  The logical replacement for that coal will be natural gas combined cycle generation that is cleaner than coal and load-following to back up renewable energy.

The bad news is EPA is still a terrible drag on the energy market creating uncertainty across the overall economy and still needs to be reined in before it kills off coal before we can build the cleaner natural gas and renewable replacement for the existing units.  We need for the existing coal units to keep running through 2035 according the the US EIA to assure grid reliability and a smooth transition to the clean energy future.

Our government policies are not helping the transition t0 the clean energy future.   They are hurting it by interfering with the constructive natural market forces of competition and rationalization sweeping out the weak players and dirty units and replacing them with better, cleaner, smarter technologies and the consolidated, scalable growth players needed to make it work.

The government must get out of the way!

By delaying the Keystone XL pipeline project the Obama Administration hopes to avoid alienating its environmental base by enraging its labor base.  That labor base will side with Republicans in supporting the pipeline project over the President’s objections. That is the preferred ‘political fix’—Labor and Republicans combine efforts (compromise!) so the pipeline will go forward and the president will be able to tell his environmental constituents those darn Republicans made me do it!  Politics!

That gets me back to the Exelon-Constellation merger.  This is a good combination of good companies and the public interest in served by scaling the ability of high quality utilities to help shape the clean energy future.  Regulatory extortion still means throwing millions of dollars of ratepayer money for politically correct projects (regulatory earmarks)  in the deals but the end justifies the means—-if you hold your nose and believe that a strong, competitive, scalable growth position is better than the alternative for customers, for investors, for American competitiveness and economic growth—and thus the public interest.

Exelon brings the solid income of a diversified utility business and a good performing nuclear fleet.  Constellation brings a strong retail, wholesale competition portfolio.  Together these two businesses operate in as many as 38 states.  They can provide high quality stable rates to their regulated utility customers while positioning the rest of the business for growth with a diversified portfolio of renewable energy, natural gas and retail energy marketing designed to leverage smart grid technology, a diversified market footprint and a clean, efficient, competitively priced portfolio of energy resources.

The faster the government gets out of the way the faster we can get to the clean energy future that is affordable, efficient and sustainable without subsidies as a result of the ruthlessly efficient competitive market rationalization process that separates the princes from the frogs.