The Real Meaning of Kewaunee’s Demise

A commentary by Michael Vickerman, Director, Policy and Programs at RENEW Wisconsin: 

 Shock waves reverberated across the Upper Midwest when Dominion Resources announced in late October that it would permanently shut down its Kewaunee nuclear generating station in early 2013. Operational since 1974, the Kewaunee station, located along Lake Michigan 30 miles east of Green Bay, currently generates about 5% of the electricity that originates in Wisconsin.

Virginia-based Dominion, which bought the 560-megawatt Kewaunee plant in 2005 from two Wisconsin utilities, attributed its decision to its inability to secure long-term power purchase agreements to keep the plant going. Without securing purchasing commitments from utilities, Dominion would have to sell Kewaunee’s output into the regional wholesale market at prices well below the plant’s cost of production.

While the pricing environment for all bulk power generators is nothing short of brutal these days, Kewaunee carries the additional burden of being an independently owned power plant, since the entities most likely to buy electricity from that generator—utilities--have power plants of their own that compete for the same set of customers. And a growing number of these utility-owned generators burn natural gas, which is currently the least expensive generation source in most areas of the country.

Dominion’s decision comes down to simple economics. Wisconsin utilities believe that over the foreseeable future natural gas will remain cheap and supplies will remain abundant. That would explain their unwillingness to enter into long-term commitments with Dominion, even though Kewaunee recently acquired a 20-year extension to its operating license and does not need expansive retrofits to comply with environmental standards, unlike a host of utility-owned coal plants in Wisconsin.

But even if Dominion’s managers were convinced that natural gas prices have nowhere to go but up in 2013 and beyond, the company, lacking a retail customer base in the Midwest, could not risk producing power below cost while waiting for the turnaround.

Wisconsin utilities have placed heavy bets on natural gas in the expectation that it will remain the price-setting fuel for years to come. Over the last 12 months, they have bought several combined-cycle generators from independent power producers. Buying power plants enables them to pass through their acquisition and operating costs directly to their customers while generating returns to their shareholders. I suspect these utilities are anything but broken up over the impending demise of a nonutility competitor that could have supplied electricity to Wisconsin customers for 20 more years.

But there is another side to this story; the low-price energy future that Wisconsin utilities are embracing can only materialize if natural gas extraction companies continue to sell their output below production costs. This expectation is unrealistic, given the massive pain being inflicted on these companies in the form of operating losses, write-downs, and credit rating downgrades.

Don’t just take my word for it, ask Exxon Mobil ceo Rex Tillerson, whose company spent $41 billion during the shale gas boom to acquire XTO, a large gas producer that is now yielding more red ink than methane. As reported in a recent New York Times article, Tillerson minced no words in assessing the impact of its recent misadventures on the company’s bottom line. “We’re all losing our shirts today,” Tillerson said. “We’re making no money. It’s all in the red.”

Much of the industry’s woes are self-inflicted. The lease agreements that drillers eagerly signed during the height of the shale gas boom obligate them to extract the resource by a certain deadline, regardless of whether such activity is profitable. That these companies cannot disengage quickly from existing leases is greatly diminishing their appetite for exploring new natural gas prospects. Until a pricing turnaround occurs, they will refrain from spending money on exploring new resource provinces like Ohio and Michigan.

Sooner or later, this slowdown in exploration activity will tip the supply-demand equation in the opposite direction, resulting in lower-than-average gas storage volumes. Barring a repeat of last winter’s unusually mild weather, the crossover point should occur around January 1st . But with so many balance sheets in tatters from this highly unprofitable market environment, nothing short of a strong and sustained price increase will be required to persuade drillers to start taking risks again.

When this corrective price increase begins rippling through the electricity markets, it will be interesting to observe how the customers will respond. Right now Wisconsin utility managers are convinced that they are making the right call on natural gas. So completely have they swallowed the shale gas “game-changing” mystique that they were willing to let a 560 MW nuclear plant fall out of the supply picture for good. In this brave new world of theirs, gas is the new coal, and resource diversity is passé.

In the aftermath of Dominion’s announcement, a few commentators have defended the impending closure as a textbook example of how markets work. But this view ignores the delusional thinking that sent shale gas extraction into overdrive, causing prices to plunge below the cost of production. The real game-changer, as it turns out, here was not the emergence of “fracking” technology but the industry-generated public relations campaign that implanted the narrative of a nation awash in cheap natural gas into virtually every American cranium. But as we now see, this narrative has boomeranged on the natural gas industry, and they are paying for their current woes in ways that guarantee a pronounced pendulum swing in the direction of higher prices.

The question going forward is: will this narrative also boomerang on Wisconsin electricity users, after the last employee leaving Kewaunee turns out the lights?

 Michael Vickerman is program and policy director of RENEW Wisconsin, a sustainable energy advocacy organization. For more information on the global and national petroleum and natural gas supply picture, visit previous posts Madison Peak Oil Group’s blog: http://www.madisonpeakoil-blog.blogspot.com. This commentary is also listed on RENEW Wisconsin's blog: http://www.renewwisconsin-blog.org/

Natural Gas: Wrestling With Reality

August 10, 2012
A commentary by Michael Vickerman, RENEW Wisconsin, Director, Policy and Programs:

After skidding below $2.00/MMBtu this winter, wholesale natural gas prices are now creeping toward the $3.00 mark. This upward movement is the result of below-normal volumes of natural gas going into storage for the winter heating season. The latest report, released August 16th, marks the 16th straight week where injection volumes lagged significantly behind the five-year average.

Notwithstanding this mild rebound, everyone in the energy industry, including the traders themselves, knows that $3.00/MMBtu is well below the cost of producing natural gas, and cannot deliver a return that can support future drilling efforts. This is particularly true with shale gas, the so-called “game-changer” that industry flacks contended would topple King Coal’s reign over the electricity sector.

High-profile shale gas producers like Chesapeake Energy are now running out of ways of concealing their financial distress. Consider the following developments that occurred over the last fortnight.

• Chesapeake Energy announced plans to reduce domestic gas production in 2013 by 8%; 
• BHP Billiton wrote down $2.84 billion on the value of Fayetteville shale gas assets it had acquired in 2011; and 
• The most recent count of rigs drilling for natural gas in the United States is 495, down 70% from the record-setting levels seen in September 2008.

“Write down” is a fairly bloodless way to describe the loss of $3 billion; “carnage” is better at conveying the pain that now grips the natural gas sector. This begs the question: why are wholesale natural gas prices still under the $3.00/MMBtu level?

I believe that there are two reasons for this phenomenon. The first is that energy traders, like virtually everyone else in this country, are truly convinced that the United States is awash in shale gas, thanks to a brilliant industry-led public relations campaign. Lower prices help reinforce the popular belief that cheap gas will be with us for another century. Unfortunately, federal energy agencies and universities have also bought into this view of the supply picture big-time, leaving little room for skeptics and agnostics to influence public perceptions.

This overarching belief has been unintentionally reinforced by local and regional controversies over the practice of hydraulic fracturing solid rock to obtain the shale gas trapped inside. Virtually unheard of four years ago, “fracking” has vaulted into the public consciousness, and in doing so, sustains the society-wide belief that natural gas can be accessed almost anywhere in the United States.

Ironically, the myth of abundance that E&P companies so carefully cultivated--and bankrolled--is now clearly working against their short-term interests.

The other factor that keeps prices so low is the traders’ fear of large demand swings. For example, the phantom winter of 2011-2012, which cut demand for heating fuel by more than 25%, creating a colossal oversupply that sent wholesale prices crashing. The supply pendulum is now swinging the other way, and more than half of the bulge has melted away. Assuming a continuation of smaller-than normal injections, natural gas inventories should be in line with the five-year average by mid-December.

Traders attribute the ongoing reduction in inventories to a hotter than normal summer, prompting utilities to switch on more gas generators to meet system peaks. But weather isn’t the only thing that influences the storage picture; output does as well. But as long as traders and speculators subscribe to the myth of nearly limitless supply, they will discount the possibility that declining output is also responsible for lagging storage volumes.

The paradigm shift ushered in by the fracking phenomenon won’t go away easily. But in the not-very-distant future, the reality of reduced drilling activity and capital spending, along with rapid decline rates in shale gas plays, will bite deeply into natural gas supplies and cause yet another overturning of expectations in this sector. For electric utilities as well as end-users, the results will not be pretty.

Michael Vickerman is program and policy director of RENEW Wisconsin, a sustainable energy advocacy organization. For more information on the global and national petroleum and natural gas supply picture, visit "The End of Cheap Oil" section in RENEW Wisconsin's web site: www.renewwisconsin.org. These commentaries also posted on RENEW’s blog: http://renewwisconsinblog.org and Madison Peak Oil Group’s blog: http://www.madisonpeakoil-blog.blogspot.com

Problems with natural gas "fracing"

In response to the post below about living near a wind turbine, someone posted a comment about comparing wind generation to hydraulic fracutring (fracing) for natural gas. The movie Gasland expseses the problems with fracing.