The nation will be flooded with excess gas-fired electric generation for at least another five years, according to a new survey of 57 generators by Merrill Lynch. The analysts predicted comfortable reserve margins on average nationwide, with a few tight spots (New York, Long Island, possibly California again), through 2008-2009.

Gas-fired power generation capacity additions are likely to peak this year and begin a sharp decline thereafter, according to the survey. In 2001 and 2002, generation capacity increased a total of 94,900 MW, and in 2003, generation is projected to grow another 57,800 MW (7%) Capacity additions in 2003 and 2005, however, shouldn’t exceed 25,000 MW, Merrill Lynch said.

With only 2-2.5% annual increases in demand (14,000-18,000 MW), nationwide average reserve margins are expected to peak at 28-29% in 2003-2004 and then begin a slow decline. The market equilibrium reserve margin is about 15%, and it’s unlikely that the industry will see something less than 15% until very late in the decade, the survey said.

“That said, 2004 appears to be the inflection point. We could see initial signs of tightening in the 2005-2006 period, although clearly not to the new-entrant levels.”

While spark spreads (the key unit of margin for gas-fired generators) may have bottomed recently, Merrill Lynch does not expect meaningful improvement in the near term because the excess supply situation is likely to continue over the next five years. “The current level of forwards now equals or exceeds the median over the past 12-14 months in most regions. In markets where gas is on the margin 24/7 (such as Texas and California) spark spreads for new combined cycle plants actually have increased modestly.

“The West, Southwest and Texas have been helped by hot weather fairly early in the season. The East is not off to a good start, with a cool and rainy spring that has continued into June,” the analysts noted. “The Southeast and Midwest remain the most difficult markets from a spark-spread standpoint, although coal and nuclear generators here should do reasonably well if gas prices stay high and the summer is at least normal.”

According to the survey, the generation oversupply is greatest in Texas and the Southeast. In Texas, plants already are being mothballed (7,300 MW or about 1% of the installed capacity base).

“We could see stranded merchant generation in the Southeast as a result of transmission issues and the absence of a level playing field,” Merrill Lynch said. “This is a challenging region for merchant plants and companies with exposure bear close watching.” The survey found that the amount of generation added in the Southeastern Electric Reliability Council in each of 2002 and 2003 would have been adequate to cover demand growth for the entire country in each of those years.

New York and Long Island, meanwhile, are short power. California also could become short again in 2004 or 2005, Merrill Lynch predicted.

The factors that could change the oversupply picture, include unexpected demand increases (although demand has grown at a rate of about 2.5% per year for the last 12 years), tougher environmental restrictions (unlikely under the Bush administration), or sustained high gas prices which would stimulate the cancellation or shutdown of inefficient power plants.

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