Supply-Demand Balance Key to CA Future

Even with more federal regulatory intervention and a return to closer-to-normal hydroelectric supplies in the future, California is facing at least two more years of electricity supply-demand imbalance and the prospect for higher wholesale power prices as a result, according to Andre Meade, utility analyst at Commerzbank Securities.

Until newer, more efficient generating plants make up a bigger part of the state's power supply mix, the old, inefficient, high heat-rate plants will keep prices high, even with the Federal Energy Regulatory Commission's move Monday to mitigate wholesale prices throughout the western states.

During a 30-minute interview a few hours before FERC took its action, Wall Street-based Meade predicted that most reaction to FERC's latest action would be negative, but said he thought the decision would be mostly good for generators.

"The price caps essentially mimic what would have happened if California had allowed the power plants to be built sooner," said Meade. "So the mix of old, inefficient plants will set prices relatively high and allow most generators to make profits over the marginal costs.

"If the state had had a lot of new plants, you would get the same effect. So I don't think the mitigation measures are terrible, and the bottom line is there'll be some plants with inefficient heat rates setting rates in California. It may provide some stability that would allow the politicians to call off the dogs and allow the market to work itself out of the supply-demand imbalance without some really severe re-regulation or cost-based ratemaking, which would not be in anyone's best interest."

Meade said that absent additional new power plants, the regulatory and political uncertainty and corresponding higher risk in California is offset by the higher profits that should be sustained for another two years. Longer term, many of the same fundamental pricing scenarios applied to other areas and states apply to California, Meade said.

"So most of the merchant operators (Mirant, Duke, Dynegy, et al) are content to stick with the plants they have and wait and see how the regulatory/political decisions come out in the next couple of months," Meade said. "At that time, they will decide again whether they want to re-commit capital to California."

It is unclear at the outset of summer --- one in which Meade is predicting average temperatures to prevail throughout most of the nation --- what the merchant generators will decide to do longer term in California and what role, if any, the newly created state power authority will play. Initially, at least, he doesn't think the new state agency will be a factor, and it is unclear what its role will be --- a means of cutting wholesale prices, providing power to certain customers, selling into the spot market, or what?

"The California Power Authority is not going to be able to do much because in the near term, it has no access to turbines," Meade said. "And the near term is when you really need them. Longer term, there are a lot of plants on the table (for California and surrounding states) that should bring supply-demand back into balance and prices down to reasonable levels."

This summer, Meade agreed with other industry observers that the current price reductions for both natural gas and electricity are only a temporary "blip" because of the current "shoulder" period with mild weather tending to soften prices. But heading into the official summer, which started last week, most areas of the country --- not just California --- have pretty tight supply-demand balances, he said.

"A lot of people see a lot of power plants being built and think the party's over in terms of high power prices," Meade said. "But I think we're a long way away from being in (supply-demand) equilibrium. We'll see what happens when we get some hotter weather."

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