The Philadelphia Inquirer recently ran a story titled Exelon’s Rowe an unlikely booster for shale gas. The headline writer was wrong; John Rowe is one of the most motivated natural gas salesmen in the United States right now. Though he will not receive any commission checks for his efforts, he stands to profit immensely if other people take his advice to buy and burn more natural gas.
The profits will continue for a long time if his words help encourage other electrical power industry decision makers to invest in combustion gas turbine based electrical generating equipment that can ONLY be put to use by burning natural gas. As most salesmen know, there are enormous benefits in obtaining a customer “lock in” that forces them to continue making additional purchases. (Cellular telephone and cable television salesmen are notorious for pushing contracts with high cancellation fees in order to obtain the continuing monthly income for as long as possible.)
I suspect that the headline writer who thought that Rowe was an “unlikely booster for shale gas” is not alone in his misunderstanding of market dynamics and corporate profit motives. I will attempt to use as few words as possible to explain the basis for my assertion that John Rowe is currently one of the most likely gas boosters in the United States.
John Rowe is the exiting CEO of Exelon, a company that owns 17 reliable nuclear power units that sell their electrical power output into a “deregulated” electricity market. Though he is retiring, I am sure that he owns a large number of shares in Exelon and probably has a substantial number of options to buy more.
The price at which Exelon’s power plants sell their power is determined by what is known as a reverse auction. The grid operators determine the amount of electrical power that they will need for given times of day. They accept bids from supplying companies for the amount of power they are willing and able to sell and the price at which those companies are willing to sell that power at the time requested.
The grid operator then makes a list of the amount of power and the price of all bids and sorts the list in order of price. They run a cumulative sum of the power from the bids and draw a line when the total reaches the expected demand. All bids below the line are accepted. The market price for that segment of time is the price of the highest bid required, no matter what the individual supplier bid.
The bids will vary depending on a number of factors, but for plants that burn fossil fuels, the biggest driver is the marginal cost of the fuel that the plants must burn in order to produce the amount of electricity they agree to sell.
When fuel costs are low, electricity suppliers that burn those fuels can afford to submit lower bids to the grid operator without fear of selling the output of their plant for less than the cost of the fuel that they would have to burn to generate that power. As fuel costs increase, it drives the bid prices up at almost exactly the same rate.
Though no business likes to have expensive capital equipment just sitting idle, even people without any business training at all can recognize that it would be better to keep a facility idle than to pay more to run it than you can earn by selling the product that the facility produces.
That means that market bidders who burn natural gas will ensure that they submit high enough bids to the grid operator to ensure that they cover their fuel costs. Low marginal cost suppliers, like Rowe’s nuclear fleet, ensure that they submit low enough bids to remain below the cutoff line and can sell all of the power that they make.
There are certain costs associated with stopping and starting a facility, so there might be some bidders – mostly those who operate the coal plants that Rowe has been lobbying to hamstring with additional emissions regulations – who are willing to operate for short periods of time when the market price is lower than their fuel costs – a situation known as having a negative “spark spread.”
One of the reasons that many electricity suppliers buy combustion gas turbines, however, is that they can be readily shut down or restarted. The equipment is relatively responsive, requires little warmup and can often be operated from a remote control station without any local operators needed for the startup or shutdown processes.
In contrast to electricity suppliers burning fossil fuel, the cost of operating a nuclear plant all the way up to its full design capacity is essentially the same as the cost of owning the plant in the first place. The marginal cost of electricity from those plants is virtually zero.
What this means is that the profit available from running a nuclear plant, once the operators and maintainers have done their job correctly and ensure that the plant can reliably operate at full capacity for as many of the 13,000 or so hours between each scheduled refueling outage, is almost completely driven by the market price for the electricity that they sell.
When the market prices are high, nuclear power plants are referred to as cash cows. Even when they are low, the plants can still afford to operate because operating them costs no additional money compared to just owning and maintaining them in the first place. When market prices are high, Exelon’s profits increase, the company looks more attractive to stock investors, and executives like Rowe get rewarded with larger bonuses and paychecks. That happens even if its executive have not done a thing to change their daily output.
The market price of fossil fuel is determined mainly by the balance between the supply available for sale at the time that the customer needs it and the number of customers that need the fuel. The bigger the imbalance, the higher the market price will have to be in order to destroy some of the demand to bring the market back into balance.
Inventories can buffer market volatility. Fossil fuel is much easier to store than electricity, but there are differences between fossil fuels in terms of the ease and capacity for storage.
It is relatively cheap and simple to pile up coal. Coal inventory systems simply require enough available land and systems that can move the coal from the pile into the plant. However, even on large sites with plenty of land, there are practical limits to the amount of coal that generators are willing to purchase in advance of their needs. The money spent to purchase coal sitting in inventory is not available for any other purposes. Oil requires more investment in the storage infrastructure and the inventory carrying costs will be about 5-10 times as much as coal for the same amount of stored heat.
Natural gas is the most difficult fossil fuel to store because it is a low density, explosive vapor. It requires large volumes, expensive capital equipment (compressors, refrigeration, etc.) and substantial safety precautions. Most competitive electricity suppliers that burn gas maintain a zero inventory. Depending on the type of supplier, they may make some contract based provisions with someone else for storage services, but they often simply buy whatever is available and plan to stop operating if the price is too high.
Bottom line – Rowe would love for the market to return to what he has referred to as the “boom years for nuclear” – that glorious period (please hear the intended irony when you read that) in “the middle of the last decade when gas prices were high.” (2004-2008)
Rowe is not passively waiting for the market to change; he is on a nationwide sales trip working hard to do whatever he can to increase gas demand, change the long term supply-demand balance, drive up the price, and increase the value of his stock holdings.
His friends in the 1% will benefit, but all other natural gas customers will see higher total energy expenses as the price of natural gas used for home heating and cooking increasing as electricity prices also rise.