For much of the past decade, US power supply increasingly exceeded demand, putting downward pressure on power prices across the country and threatening the economic viability of power plants in deregulated markets. Beginning in 2018 and projecting beyond, the power industry’s supply-and-demand profile is likely to change, especially in places such as Texas—driving better pricing power as old power plants retire and demand continues to grow. This dynamic should generally lead to improved earnings and better-than-expected cash flow for surviving power generation companies.
During the past decade, reserve margins—the additional power capacity available to meet demand during high-demand periods—were amply supplied. Peak power load, the amount of electricity required to prevent a wide-scale power outage, generally exceeded the standard 15% rate. While some coal-powered plants were closed due to stricter federal environmental standards aimed at reducing air pollutants, new gas-fired power plants and an increase in renewable energy sources (e.g., wind power production) largely offset the reduction in coal-fired power capacity. As a result, the US power market remained well oversupplied, and power prices fell into a multiyear decline from 2008 until hitting bottom in 2016.
More recently, there have been signs that supply-and-demand conditions within the US power markets have begun to shift. Lower power prices have driven down the profit margins for coal and nuclear plants to the point where more plants have closed, some new power plants have struggled economically, and the planned production of other new gas-fired plants has come to a halt.
Nowhere is this trend more apparent than in Texas, 1 of the 2 major power pools in the US, where the Electric Reliability Council of Texas (ERCOT) manages the flow of electric power to 24 million customers, representing 90% of the state’s electric load. Texas is one of the few power markets with substantial power-demand growth, due to above-average economic and industrial growth, driven mainly from energy and chemical companies with operations along the Gulf of Mexico. At the same time, due to the economic pressures from the resulting power oversupply, new combined-cycle gas turbine (CCGT) plants—which use a gas and steam turbine—have been put on hold, and coal- and gas-fired plants are being retired.*
In sum, these plant closings are accelerating supply rationalization in Texas, solidifying our conviction that not only will power supply and demand tighten in 2018 and beyond, but this contraction will occur more quickly than the market is anticipating (see chart). Further, if there is severe weather in the summer, combined with outages—such as extended heat waves that stress older plants—that gap could tighten even faster. As Texas regains a more balanced supply-and-demand ratio, we expect other markets will quickly follow, benefiting those surviving power generation companies that exhibit solid business fundamentals.
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