Energy #17 – Death Spiral

Ontario Power Generation is going to go bankrupt.

No, I am not speaking metaphorically.  Just as its predecessor Ontario Hydro did in 1999, so too OPG will reach the point of insolvency when it is no longer a viable commercial entity – i.e. bankruptcy – and it will have to be saved.

Rivers of Thought Coming Together

I came upon this stunningly obvious revelation through – as is so often the case – a confluence of events.

On Sunday, my colleague and I completed our final argument in OPG’s five year rate case;  fifty thousand words of scintillating, edge-of-the-seat prose that will certainly change the world.

There were lots of interesting tidbits that came up, but two stand out.

First, nuclear power, currently about 6 cents per kilowatt-hour, is forecast to go to more than 16¢/kwh over the next ten years, and that is understated by not including all of the cost components.  If rate riders are included, it will be more than 20¢/kwh.  And that’s without any cost overruns.

Second, the Darlington Refurbishment Project, which was absolutely guaranteed not to cost more than $12.8 billion (at a 90% probability), is already over budget by 14% ($14.55 billion), and that is not even including many cost overruns that are known, but don’t have final numbers yet.

They just started the project.  It takes serious skill to be able to go over budget right out of the starting blocks.

So, then, on Monday, the Mowat Centre, a public policy think tank affiliated with University of Toronto, had an all-day session on how distributed energy resources (DER) will affect wires companies.  To my surprise, the many utilities there seemed, for the most part, to be largely unconcerned that these significant changes in the electricity market will prompt a “death spiral” for wires companies, as some have predicted.

At the Mowat event, I shared a conversation I had with the manager of energy for a medium-sized electricity customer.  He said that, in the next ten years, the delivered price of centrally-generated electricity will be more than 30¢/kwh (about a 65% increase).  With that forecast in mind, his primary job is to reduce his employer’s exposure to grid-supplied electricity, preferably to the point where they can exit the grid.

Finally, on Tuesday I attended a public forum at the Energy Probe-owned Green Beanery in Toronto.  Energy critic and blogger Parker Gallant was speaking on his favourite subjects, increasing electricity prices and the evils of renewable energy projects.  A fun time was had by all.

Amidst all the wailing and gnashing of teeth about wind turbines, and extolling the virtues of burning fossil fuels instead (more on that later), Parker made an interesting side comment.  In part tongue in cheek, but in part serious, he said that one solution to our rocketing electricity prices is to use more electricity.

This is not as crazy as it seems.

How Can a Death Spiral Happen?

Sit back and look at these three events, and think of the concept of the “death spiral”.

Start with accepting the fact that large nuclear projects always go massively over budget, and OPG has proved to be a master at achieving that goal.  It even exported that skill to hydroelectric, going more than 60% over budget on the Niagara Tunnel.

In the case of nuclear, OPG is just following the pack.  Recently, Westinghouse (yes, THAT Westinghouse), the world’s biggest supplier of nuclear generating facilities, went bankrupt from constant problems with cost control.  Its Vogtle project, for the Southern Company, is delayed and over budget, with the U.S. federal government on the hook for the problems that result.  The Westinghouse problems may even undermine the strength of its parent company, Toshiba, although that is still speculative at this point.

So how much will the Darlington Refurbishment Project actually cost?  Assume it is only $25 billion, i.e. better cost control than any previous OPG nuclear project.  If the eventual cost of Darlington is $25 billion, the cost of that power is at least 35¢/kwh, and the delivered cost of that electricity is about 50¢/kwh.  Plus inflation in operating costs.

Add to that the recently announced Fair Hydro plan.  Basically, certain customers will pay less today, but that money will be treated as a debt to be paid in the future.  We will be paying part of our electricity bills on the credit card, effectively.  What will actually happen under the Fair Hydro Act is that OPG will bundle those future customer debts together and sell them as investment instruments to financiers.  In effect, OPG will become a factoring agent for receivables from customers down the line.  (They don’t have enough to do?)

And what happens when those future debts have to be repaid.  Ah.  The price of electricity goes up even more.

Now let’s look at the situation from a customer’s point of view.  For any business customer, there is an ongoing build-or-buy decision for each of its costs.  Call centre?  Is it cheaper to outsource, or to hire, manage and house your own people?  Legal department?  How much does Bay Street have to charge before it is better to have your lawyers in-house, on salary?  Do you build your own factory, or do you lease premises from someone else?  Every aspect of your costs has to be optimized, and in many cases the question is, do I outsource, or do I do this myself?

At the top price today, about 18¢/kwh., it is already cheaper for many of the largest customers to generate and consume their own electricity, and some are doing just that.  While few have gone completely off the grid, their load is declining.  Eventually, as prices rise further, some or all will exit entirely (or leave the province, which is even worse).

If you move the cost up to 30¢/kwh., suddenly there are a whole lot more electricity customers who would save money by moving energy production in-house.  Certainly at that price, fossil fuel production in house will be cheaper than grid delivery.  There is a risk of the impact of carbon pricing, which will limit that, but the savings are substantial enough to at least take a look.

But now move the cost from the grid up to 50¢/kwh.  At that price, even a local homeowner can save money by combining solar and storage, perhaps with a small fossil fuel backup generator.  That is especially true if the homeowner can flatten their load, for example by shifting their space and water heating from gas to geothermal, and by using an electric car.  The more your load is constant, day and night, winter and summer, the cheaper it is to self-generate.

The point here is not the individual prices;  it is the conceptual progression.  As the delivered price of centrally-generated electricity goes up, the number of customers who would save money by reducing their use of that electricity, whether through conservation or through self-generation, increases.

Move back to the utility point of view.  If more and more customers are reducing their electricity consumption from the grid, what does that mean for the utility?  Most utility costs are fixed.  If there are fewer customers to serve, the price each remaining customer pays must increase to cover the fixed costs.

This is not rocket science.

For a wires company, some protection can be achieved by moving to a single monthly charge for each customer.  That doesn’t help you with the customers who just disconnect, but it does help with those who reduce their load, without eliminating it.  Everyone pays $150 a month, whether you use 1 kwh or 1000.   Prices will still have to go up, though, particularly since the big customers, who pay most of your bills, will have the greatest incentive to disconnect.

For OPG, though, the problem is more dire.  What do you do when the cost to produce your product, nuclear energy, is so high that no-one wants to buy it?  What do you do when that high cost creates ripple effects in the industry, driving up the unit costs of transmission and delivery and so making customers even less likely to want to buy your product?  What do you do when, as a result of lack of interest in your product, you have too much of it, but you have already spent the high capital costs to produce it?

Luckily for OPG, they have experience with this.  In the 90s, again because of Darlington cost overruns (you know what they say, “fool me once….”, well, you know the rest), they faced capital costs that were too high to include in the cost of electricity.  Seeing the writing on the wall, they went to their friendly neighbourhood provincial government, who were only too happy to oblige with a bailout.  Don’t you worry your pretty little heads over this $20 billion of debt, they told Ontario Hydro.  Just hand it over to us, and we’ll find a place to hide it.

Now, OPG will go bankrupt again.  Cost overruns at Darlington, even small ones, will be sufficient to make their product too expensive for people to buy.  Customers will vote with their feet, and OPG will be left with debt, and insufficient revenues to cover that debt.

Here’s the kicker.  They could bring the rest of the sector down with them.  Under the current system, customers can’t decide to buy power from someone else.  If you are connected to the grid, you have to buy a certain percentage of your electricity from OPG (via the global adjustment).  As that cost goes up, your need to avoid it also goes up, but your only option to avoid the GA is to exit the grid.

The “death spiral”, indeed.

Are We All Just Screwed?

The answer is, probably not, but let’s be really clear.  We can’t solve this problem ten or twenty years from now.  When the exodus begins, it is already too late.  We have to act now.

Fat chance, of course, but let’s just pretend.  Treat it as a hypothetical.

There are basically four policy steps that could, in theory, reduce the risk of the death spiral:

Conserve, conserve, conserve. The environmental groups have been saying this for years, and they’ve been right for years.  Using energy more efficiently is the cheapest and most immediate way to reduce energy costs.  Not only does it reduce your own bill, as an individual customer (the “I’m all right, Jack” response to the problem), but in the long run it reduces the need to build new, more expensive generation.

The government can make us all more successful at increasing efficiency by reducing the “handouts” approach to conservation planning.  Instead, increase the role of regulations, technical standards, building codes, and the like.  Or, just wait for the price to go up more, forcing people to take action to conserve in self-defence.

Electrification.  As Parker Gallant correctly noted yesterday, using more electricity could help us with electricity costs. We have to be smart about it, though.  Using more electricity doesn’t mean using it less efficiently.  What it means is that some energy needs that are currently served by fossil fuels can be shifted to electric, and the whole electricity system can work better.

Space and water heating, as well as transportation, are the key sectors that rely heavily on fossil fuel burning, but can be served by electricity from a decarbonized grid, or by local generation.  In the case of space heating, this would balance the load between winter and summer.  With geothermal as the delivery mechanism, it would reduce air conditioning load in the summer, and increase load for heating in the winter.  In the case of transportation, electric vehicles can be designed to charge when other loads on the system are lightest, thus balancing loads between times of the day or days of the week.  This allows greater use of the inflexible generation from nuclear, most hydroelectric, wind, and solar.

Betting on the Winners. The cost to generate electricity from nuclear is only going to go up, and at a rapid rate.  The cost to generate electricity from fossil fuels is only going to go up, because of the cost of carbon.  (It doesn’t matter whether you believe in climate change or not.  Carbon is going to be priced, around the world.  That is inevitable.)

On the other side, the cost of wind, and the cost of solar, and even the cost of newer renewable technologies, is going down.  Existing contracts are fixed, and the cost risk has been offloaded to the developers/owners.  Technology improvements are reducing the cost for new projects.  Further, when the contracts expire, the assets are still generally useful, but they are fully paid for.  Once you’ve paid off the mortgage on the house, how much does it cost to live there?  The same is true for solar and wind.

So, what is the best bet for the future:  nuclear and fossil fuels, whose costs are rising; or, wind and solar, whose costs are falling?   Seems like a no-brainer.

Storage.  Many of our cost increases are driven by the inherent inflexibility of most of our current generating technologies.  While electrification will reduce that, the near term solution is to develop greater ability to store the electricity we don’t need right this minute, so that we can use it when we do need it tomorrow morning, or next week.

This is nothing more than a problem of technology.  We know how to push technologies towards commercial viability.  Time to do that.

Problem Solved, Right?

Well, you know better than that.  Just because we know what we should do, doesn’t mean we’ll do it.

We’ll continue throwing good money after bad on nuclear power, if for no other reason than – as everyone in the energy sector knows – the Power Workers’ Union is more powerful than the Ontario Energy Board and the provincial government combined.  We will be tentative about electrification, and about storage.  We will hope that, as time unfolds, more solutions will emerge.

In fact, all that will happen is that it will more and more be too late to do anything about it.

All of which goes to show that I should stop thinking about this, and go play golf.

      –  Jay Shepherd, May 31, 2017

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About Jay Shepherd

Jay Shepherd is a Toronto lawyer and writer. This site includes a series on energy issues, plus some random non-fiction on matters of interest. More important, it includes the Lives series, which bridge the gap between fiction and non-fiction, and now some short stories. Fiction is where I'm going, but not everything you want to say fits one form. I am not spending any time actively marketing what I write, but by all means feel free to share if you think others would enjoy reading this stuff.
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