While not wavering in their long-term support for more alternative energy, major California utilities including Southern California Edison Co. (SCE) envision plenty of real-world challenges to the state's increased renewable energy goal of 33%. Reaching that goal by 2020 holds major implications for the state's transmission grid and existing fleet of natural gas-fired generation plants, according to Edison International CEO Ted Craver, who spoke earlier in November on a third quarter earnings conference call (Nov. 6).

Craver agreed with California Gov. Arnold Schwarzenegger's conclusion that bills passed late last summer by the state legislature would have been counterproductive, establishing provisions for hitting the renewable target that would be what the utility holding company considered "overly restrictive and too costly." In addition, the measures that were vetoed by Schwarzenegger in favor of a second executive order were considered too risky to grid reliability longer term.

Analysts with Standard & Poor's Ratings Services (S&P) separately wrote earlier this month that the North American natural gas markets and sagging national economy are in combination fouling the immediate futures of many independent electric generators, and the credit ratings of some of the merchant power firms are suffering as a result. Their analysis was published in "U.S. Power Merchants Continue to Suffer from Low Natural Gas Prices."

Recent third quarter results from Edison and Sempra Energy's respective independent generators confirmed this as Edison Mission Group (EMG) reported a loss for the third quarter and Sempra Generation reported profits that were nearly half of what they had been in the same quarter a year earlier ($43 million versus $94 million for the same quarter a year ago).

"Achieving a 33% portfolio standard by 2020 is highly ambitious, given the magnitude of the infrastructure build out required and slow pace of the transmission permitting and approval," said Craver, who quoted a transmission study recently completed by the California Public Utilities Commission which said the 33% goal will require $115 billion statewide, including about $12 billion in new transmission lines.

"We will strongly urge the state to study the renewable provisions in the [federal] Waxman-Markey bill and U.S. Senate energy proposals as they craft renewable energy provisions. We can get to 33%, but we need to do it in a thoughtful way that balances the need to transition to more renewables with the cost and reliability concerns of electric customers."

In response to questions about how much back-up generation will be needed to support a 33% RPS goal, the California Independent System Operator has indicated that to support 20% renewables, all existing gas-fired generation in the state needs to stay online, and to get to 33% the state will need even more gas-fired generation, in addition to all its existing resources, according to SCE CEO Alan Fohrer.

"Exactly how much more [gas-fired generation] depends on where the renewable energy resources are ultimately located," said Fohrer, adding that was why at one time policymakers and utilities were counting on relying on a lot of out-of-state generated renewable energy credits (REC). The RECs would make a huge difference, compared to talked-about requirements to have all the renewable generation come from inside the state, he said.

"Those issues still need to be resolved to determine exactly how much more gas-fired generation will be required," Fohrer said. "There will have to be substantial additional gas-fired generation, primarily peakers, available in the state to integrate the amount of additional renewables, but it depends on ultimately how much out-of-state resources are allowed and where the facilities are located in the relative mix..."

Fohrer said SCE primarily looks to the independent power market to provide the added resources, although it wants the utilities to have the flexibility to provide generation when it is in the best interest of their retail utility customers.

In the past six months, S&P said it has downgraded three companies, upgraded one, and revised an outlook on another company to negative. S&P said its "most significant" ratings change was the two-notch downgrade of EMG's Edison Mission Energy to '"B" from "BB-". The outlook remained negative.

That downgrade was based on declining spark spreads in a portfolio that was largely unhedged and facing what the rating agency called "significant upcoming environmental spending requirements and other committed capital on the company's wind generation investments."

Conversely, S&P upgraded NRG to "BB-" from "B+" and revised its business risk profile to "fair" from "weak" due to the company's highly hedged book through 2012 and an improved financial profile. Finally, the rating firm removed Constellation's corporate credit rating from "CreditWatch negative" and lowered it to "BBB-" from "BBB" on the Maryland regulators' approval of the company's proposed nuclear joint venture with Electricite de France International. S&P said the downgrade was accompanied by a change in the company's business profile to "satisfactory" from "strong."

"The past year has underscored the exposure of U.S. unregulated merchant power generators to commodity price risks," the report said. "The recession has not only decimated natural gas prices, but also increased the possibility that reserve margins tightening, which power merchants desire, will be pushed further out, changing market fundamentals. Meanwhile, additional gas supply has come in at exactly the time when demand was falling."

Realization of strong cash flows and an improvement in financial profiles could occur much later than many power merchants hoped for.

"A lot has been said, as should be, about a plunge in demand," S&P analysts wrote. "However, the supply side is also emerging as a major contributor to the bearish merchant sentiment in the near to medium term." S&P cited the Oct. 27 preliminary report by Congressional Research Service (CRS), Congress's public policy research arm, which estimated a 25% increase in three years in the nation's recoverable gas reserves.

CRS said the increase represents almost 90 years of economically recoverable reserves. "While it is unclear how economical this production could be, new horizontal drilling and hydraulic multi-stage fracturing can result in lower-than-expected natural gas prices, even in the long term," the S&P report said.

Nevertheless, the report concluded that natural gas prices will likely remain susceptible to volatility due to supply shocks.

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