Saturday, July 13, 2013

Hatfield’s Ferry Closure: The Real Reason

Earlier this week FirstEnergy, the eighth largest U.S. power producer, announced that it will shut down two coal-fired power plants in Pennsylvania by October of this year.  According to the company, new environmental regulations, particularly MATS, were a major reason behind the decision.  But Hatfield’s Ferry (HF), the plant which made up over 85 percent of capacity being shuttered, is efficient, can reap economies of scale (at 1.7 GW it is a relatively large plant) and has the most expensive bit of the environmental kit (scrubbers) already installed.  In other words, HF is precisely the sort of plant that would have little trouble complying with MATS. So why might FirstEnergy be retiring this plant?

Dismal economics.  HF’s production costs likely exceed revenues that current wholesale electricity markets offer and what FirstEnergy can expect to earn at the plant in the future, given prevailing market outlook.

Average spot electricity prices in the PJM West region (where HF is located) ranged between $26 and $36 per MWh in 2012.  My estimates suggest that after factoring in coal transportation charges, HF pays about $34 per MWh for fuel alone.  That leaves no margin to pay for fixed and other variable costs.  HF's margins are squeezed from both ends by factors beyond its control.  The plant is a price-taker of both electricity, which it sells, and coal, the main raw material that accounts for most of its production cost.  Even as low natural gas prices depress spot electricity prices by reducing the marginal cost of supply, Asian demand for coal, particularly for the type that HF burns to produce electricity–Appalachian, keeps the plant’s input costs high.  All this is exacerbated by a flat or declining outlook for electricity consumption as growing penetration of demand side resources and renewables diminishes demand for the plant’s output.

HF’s other source of revenue–the PJM capacity market–offer little succor.  Abundant capacity and a relative lack of transmission constraint have driven down resource prices significantly in the PJM region where HF is located: the clearing price declined by more than 56 percent year-on-year in 2013.  The issue, however, may be moot.  Nearly 10 GW of coal-fired capacity that was offered in the same PJM auction was deemed unnecessary to satisfy market needs and failed to clear.  If HF was among them (the auction administrator does not disclose a list of failed resources), capacity market revenues would be unavailable to the plant.

That FirstEnergy chose to pull the plug on HF now instead of in 2015–the date by which it must comply with MATS–provides further evidence that the plant is already losing money.  If the opposite were true, the most rational decision would be to run the plant till 2015 and then shut it down to maximize profits.

In short, everything points in one direction: FirstEnergy’s decision to close HF was driven primarily by prevailing electricity market dynamics. 

More broadly, the HF story illustrates just how difficult life has become for coal plants, even for the larger and more efficient ones, in the face of low natural gas prices, relatively high coal prices, meager consumption growth rates and a flat electricity demand outlook.  If current electricity market conditions continue, expect many more like HF to come out of the shadows and throw in the towel.

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