Massive Hike In Natural Gas Prices To Dramatically Accelerate The Pace Of Change In Utility Industry

The economics of providing electricity to consumers using wind & solar has changed in the last year with soaring natural gas prices. This piece was inspired by a Facebook post by the Sierra Club that pointed me the the NextEra Investor Conference a couple of weeks ago. There has been a lot written about the need to accelerate the conversion of the electrical generation grid from fossil fuels to renewable energy. There has been a lot written about the various subsidies given to both renewable energy and fossil fuels. The regulations, the mandates, the laws, and the lawsuits. All that discussion is important. But that isn’t what this article is about. This article is about how market prices change the economics of producing electricity. I’ll cover a short high-level history of solar and wind generation in America. When wind and solar came onto the scene some 20 years ago, they were used as experimental power generation for only three reasons.

  1. Some were heavily subsidized.
  2. Some were because the entity just wanted to do it for environmental benefit or the off-grid advantages, knowing the cost would be higher.
  3. Some, like Germany, knew it didn’t make economic sense, but they wanted to drive down the cost for future customers and they were unselfishly willing to pay that increased cost for the small present environmental benefits in hopes of substantial future environment and economic benefits. It looks like that investment is paying off now.
<img aria-describedby="caption-attachment-270199" data-attachment-id="270199" data-permalink="" data-orig-file="" data-orig-size="1178,795" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="Lazard Prices over time" data-image-description="

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Chart courtesy Lazard

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Chart courtesy of Lazard.

Then a few years ago, the dramatic decreases in both wind and solar cost of electricity generation led to renewable sources being as cheap as or cheaper than fossil generation in many places. This worked fine to encourage some limited renewable projects. But utilities still had to deal with the substantial disadvantage that solar only worked in the day and wind power could be intermittent in places where the wind resources vary from day to day. These intermittent issues do not have a large effect when the renewable power is a small percentage of the grid, but as the percentage gets higher, that causes more issues. Now, onto the current news — the price of natural gas, which has been very popular source of energy to replace coal for electrical generation, has approximately tripled.

<img aria-describedby="caption-attachment-270200" data-attachment-id="270200" data-permalink="" data-orig-file="" data-orig-size="951,713" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="NextEra Inflation" data-image-description="

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Chart courtesy NextEra

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Chart courtesy of NextEra.

As a result of looking at current and future costs, NextEra agreed to go net zero for scope one and two emissions by 2045. Why are they making this commitment? Certainly, one reason is because they want to help the environment, want good publicity, and want to react to the pressure to produce electricity cleaner. But as they explain in the chart shown above, a major reason is that the economics have changed dramatically in the last year.

In Florida, inflation has unfortunately increased the price of producing electricity in all the alternatives. But it has not affected all forms of electricity generation equally. Natural gas generation has been affected by inflation to a much greater degree than solar and wind. What does this mean? To an economist or an MBA or a decision maker at a utility trying to find the most economical way to produce electricity in an environment of growing demand, that means funding more growth in wind, solar, and batteries.

Until recently, it was not logical to decommission good working power plants with usable life (not for economic reasons, maybe for environmental reasons), even though it did mean investing more in new-build renewable power plants. Since many plants are designed to last 30 years, that means you’re only replacing about 3% of your power plants per year. Add to that the fact that you have another 2% population grown and 2% of additional demand from electric vehicles and the electrification of homes. That is only about 7% a year, even at 100% renewable energy for new capacity.

Now It’s Cheaper To Build Wind & Solar Than Run Existing Legacy Power Plants

But what has changed in the last year, looking at the prices they have analyzed above and assuming those figures are reasonable prices in the future (which may or may not be a valid assumption), is that it now may make sense to replace perfectly good natural gas plants that you just built a year ago with renewable energy ones. Now, I wouldn’t tear them down — you can just mothball them and leave them to run 10 days a year if needed.

There is also a great deal of research being done by NextEra and others on converting these plants to use hydrogen instead of natural gas. Initially, as a blend, but then eventually 100% green hydrogen made from solar power and water. I spent years in microeconomics class learning it is all about marginal costs. If the costs of people and fuel for that natural gas plant are more than the cost for wind and solar with battery backup, it makes sense to shut down the natural gas plant and ignore your sunk costs.

I think we all know that wind, solar, and battery backup have very low operational costs. Why? Because they have no fuel costs. And the people costs are relatively low, since there isn’t much to do with solar other than wash off the panels occasionally. What costs a lot for wind, solar, and batteries is the cost to buy and install them. Once they’re installed, they are very cheap to run. One possible fly in this ointment is that when you have assets like wind, solar, and batteries that have high initial capital costs but low operational and maintenance costs, those assets are more attractive in a low-interest rate environment. Obviously, interest rates are going up this year, and are expected to go up substantially more. If you increase interest rates a couple of points, that adds about 10% to the cost of wind and solar, but with wind and solar costs being 53% and 48% lower, respectively, they still come out way ahead.

<img aria-describedby="caption-attachment-270864" data-attachment-id="270864" data-permalink="" data-orig-file="" data-orig-size="1276,962" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="Lazard Cost of Capital" data-image-description="

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Chart Courtesy Lazard

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Chart courtesy of Lazard.

Lazard did a similar analysis 9 months ago and found that while costs vary widely based on many factors, it was getting economical in many cases to shut down coal and nuclear plants, and in some cases it even made sense to close down combined cycle gas power plants. Not much has changed for coal and nuclear in 9 months, but natural gas prices are up about 80%, making faster shifts from gas power plants to solar power generation economically viable.

<img aria-describedby="caption-attachment-270868" data-attachment-id="270868" data-permalink="" data-orig-file="" data-orig-size="1165,746" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="Marginal Costs of Gas vs new wind solar" data-image-description="

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Chart Courtesy Lazard

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Chart courtesy of Lazard.


There were still some new gas generation facilities being built before this price change happened, but if utility companies act rationally and notice how profitable NextEra has been while leading the conversion to renewable energy, higher natural gas prices should not only stop all new natural gas electrical plant construction — it should greatly accelerate replacing existing coal, natural gas, and nuclear plants just based on price.

It depends if people are convinced that these natural gas prices will stay elevated or if the high prices are transitory. My view is the drilling activity is still quite low, so prices are likely to stay quite high for a considerable period of time. Of course, even if you want to replace all those legacy plants with wind and solar, it will take many years to do it. Regardless, today marks a significant milestone in the renewable energy transition. This is one of the first industry acknowledgements that wind and solar aren’t just cheap enough to outcompete new power plants; they can start to disrupt recently constructed modern plants in good repair!



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