Last year, American Electric Power Corp. announced that it would build a 1,000 megawatt coal-fired power plant, equipped with state-of-the-art gasification technology to remove pollutants. During a speech before the National Coal Council in Washington, D.C., Morris explains the progress his company has made with the integrated gasification combined cycle (IGCC) facility it wants to build in Ohio. He also talks about the factors driving AEP's decision, including new interest in the utility sector from General Electric Co., plus the belief that the federal government will someday limit carbon dioxide emissions.
Michael Morris: Like everyone else I watched the readings from Montreal this weekend, or this past week, with great interest as people debated whether this is a plus or a minus. But it's clear to us, and I'll talk a bit more about this as I get deeper into this discussion, that there will be a world change in the way that we deal with greenhouse gases sooner or later. And the United States continues very hard and this administration continues very diligently to try to lead that debate to include the most significantly growing carbon adders in the world. And that would be the economies of India and China. I know that for many that's hard to understand, yet nonetheless we think it's critically important that we continue to work on those issues together. And we think that the technology advance that integrated gas combined cycle will bring to the discussion is essential. And so in that sense I really do think that part of what we're working on truly is an assignment that must be successful. In the early '70s, as you know, we as an industry decided to embrace thermonuclear generation because of the cost advantage that we were absolutely convinced that it would give to us. At the time, that was the beginning post 1969 of the environmental movement and oil as fuel for generation was dropping off of the horizon. Gas was out of the political equation. And coal was getting an environmental pressure, so we as an industry embraced thermonuclear and almost all of the major utilities in this country were dedicated to doing that. American Electric Power among them.
And then a funny thing happened in the process, in 1979 as we all know, an incident at the Three Mile Island plant made bringing those plants online almost impossible, bringing them to completion almost impossible. And more importantly, laying in front of the state regulator, an impossible task of what to do with a project that originally was going to be in the hundreds of millions and now was in the multibillions. Because of that we, as an industry, as we tried to wash through those debates together, stopped building generation facilities period. A couple of the federal agencies like TVA and Bonneville and others went forward, but every one of the investor owned utilities simply stopped in place because we didn't know where we were and we didn't know where we were going. And as you know a vacuum loves to be filled with something and it was filled with not well thought through legislation. In 1978 the Congress passed a couple of pieces of legislation that impacted you and me more than we realized at the time. The Fuel Use Act of course took natural gas out of the boilers for generation, but more importantly the Public Utility Regulatory Policy Act allowed for PURPA machines to be built with the cost of the energy from those plants to be determined at the state level to the equivalent of our avoided cost if we were going to go forward and build our own central stations.
And both of those events, particularly on the coasts, became extremely dramatic. As the New England states of New York approved avoided costs of $0.12 a kilowatt hour in then a 3-cent market. And California approved $0.15 a kilowatt hour in then a 3-cent market. And that brought forward a tremendous amount of PURPA capital investment. All of it with the legislative guarantee that the utility that needed capacity and energy was legally bound to take that capacity and energy at that avoided cost, whatever it was. Now we were really frozen out of the generation game because if any of us came forward and said we want to build our own it would seem as though we were trying to frustrate the intent of PURPA. And to frustrate the intent of PURPA in front of a state commission that had determined you had a need and determined the avoided cost would lead not to a very rosy life for any of us in that space. So we bought the PURPA machines and went forward. And of course that put tremendous price pressure on the generation part of the overall delivered kilowatt hour, which led to another ill advised piece of legislation in 1992, the Energy Policy Act. The National Energy Policy Act of 1992, which created the independent power producer with not the PURPA requirement that you buy from it, but an open marketplace. Another event in 1985 that deregulated natural gas, after all of the years of natural gas being frozen out of the generation marketplace, caused for a huge increase of supply compared to demand. Increased supply, depressed demand, the price of natural gas went from $4.94 regulated federal government to $2.00 to $1.80 to $1.50. Canadian gas went to $.94 per 1,000,000 Btus [British thermal units].
So what do you think happened in the independent power producer marketplace? One decade worth of natural gas power plants. Meanwhile we continue at the investor owned utility to be frozen out of the marketplace because we didn't know where to go fuel wise and all these plants were being built and again, somewhat being forced on us through the regulatory model. So a decade of natural gas power plant construction led us to incredible rise in demand with an ever dwindling supply, which led to as you can well imagine an increase in the price of gas. Today, and although today is not typical of every day, but today natural gas is $15 per 1 million Btus. Gas is forecasted in the 2006 strip, you can buy an entire year's worth of gas supply that never goes below $10 per 1 million Btus. So what that has led us to is a fleet of peaking units if they went to demand, base load demand production, we would put a 26 trillion foot demand on the supply equation that is now at 18 trillion feet and shrinking. Today we are a 22 trillion foot consumer of natural gas, about 18 trillion of it from the well heads, about 3 to 4 trillion of it from our friends north of the border in Canada and about a half to a trillion and a half of Mexican and LNG gas that is imported into the country. If we were to go to a 26 trillion cubic foot demand, the price of gas would stay at $15-$20 per 1 million Btus, by American Gas Association's own study.
So that led all of us to a reality check of we need new base load. We don't need new peaking. Oil is out of the equation. Gas, financially, is out of the equation. I am not a subscriber to Alan Greenspan's theory that LNG is going to wash over this country at $3 or $4 a million BTUs. That's wrongheaded thinking and not going to happen. So we have to turn in a decisionmaking process to two fuels that make incredible sense to us, U.S. domestic coal and nuclear. When American Electric Power looked at that decision, we are a coal-based company even though we have 2,000 megawatts at the D.C. Cook Plant that I'd probably tell you is running and running well. All nuclear operators always worry about that statement. And it is, quite honestly, a very good station, but new nuclear isn't our space. New coal is. So when we looked at that decision model we had in front of us the same notion that our leaders back in the '50s had. And that was if we're going to build a station let's build a station that is near the fuel source and use our incredible transmission network to bring that energy to our customers in not only the five state area that we served in a traditional sense, but now in the entire 11 state footprint that we serve through the combination of AP and what was central Southwest.
So when we looked at coal and said what is it that will allow coal to be built going forward? It had to be a project that would address itself to be ever changing, ever increasing in stringent control that is, environmental requirements that are going to face coal going forward. When we look at a plant that's going to have a 40 year physical life we are absolutely convinced that gasification technology is the right way to use coal in a base load model. And rather than go forward with one more, no offense, DOE supported science project, we decided to forward on our own with a traditional utility rate base coal-fired power plant that would use the gasification technology. A couple of very important and interesting things happened along the way, as we got to that decision that helped us make that decision, probably the singularly most important issue was that General Electric Corporation bought the technology from ChevronTexaco that allowed for someone with engineering technique, with construction management and project management and most importantly the corporate ability to stand behind what they built. I think that made the gasification technology available to us as an industry because up until that time the license holders of the technology would sell you the manual and wish you well. And if the gas-fire didn't work they sold to the manual obviously you didn't follow it. That isn't what a rate based state controlled regulated utility ought to bring to its customers or to its regulator. That simply isn't fair.
So the decision with GE in the loop made it considerably easier for us to go forward with we know we have a base load need. We know that coal is the fuel. We believe that gasification technology is the best for reasons that I'll talk to you on in a moment or two. And that led to what is probably a much easier decision than you would think. The uniqueness of what we came to at the end of the decision however, which we'll talk about in a moment or two, is equally interesting. And I want to share some of that with you. But with those facts in front of us we need coal base. We know the environmental rules are going to continue to get more stringent, not less. We know that this plant is going to have a 40 year life. And during that period of time greenhouse gas, carbon capture control, will become a worldwide reality. We're convinced of that. Coal itself, the low sulfur varieties, are going to continue to see price pressure as each of us chase after that unique ton of coal. And if you can't buy that unique ton of coal you're going to have to buy NOX, SOX and/or someday mercury credit. And with all of that in front of us, believing that all of those prices were going to go up, that led to what we think is a very rational decision.
Now the planning of the project itself, for American Electric Power, is inside of what I would call our core competencies. I shared a panel a week or so ago with John Wilder, a name familiar to many of you, from Texas Utilities. And John shared a story of his days at an unnamed utility where he used to work and offered up that utilities aren't very good at building things. In fact, during his tenure at that company someone suggested that they didn't have the skill sets to even build a chicken coop. Well at American Electric Power we're pretty proud of our ability to build things and I couldn't let that go on answered. So I tried to suggest to John that I shared with him the accuracy that utilities typically aren't very good at this, but that some are and they should go forward and do it. So our planning process is deeply involved with our own team. In conjunction with GE as a designer all of the gasification block and a bit of the power block, and Bechtel as the ultimate builder, but that our own engineering team is deeply involved in this analysis. And we break it into three phases. First that site characterization study, where we employed outside experts as well as our own. And we have submitted three sites for characterization by the Pennsylvania, Jersey, Maryland RTO, regional transmission operator. The three sites. One in Ohio, on a greenfield site in Meigs County along the river, near the fuel supply, near the transmission grid. Just so typical of the AEP way of doing things. The second one, in West Virginia, at our existing mountaineer station where the footprint is large enough to accommodate a third generation facility. And thirdly, a site in Kentucky, along the river, greenfield, near the fuel supply source. Again, with a typical AEP view to it. So the planning itself became very realistic, site characterization going on at the same time as early permit evaluation and likelihood. Knowing that cleaning up the environmental responsibility of the fuel before you introduce it to the power block is better than try to clean up the flue gas out of the other end of the power block.
Again led us to some very interesting facts on that planning cycle that tell us that this is a much more cost effective way to do it. It's a much more environmentally effective way to do it. It uses considerably less water. It uses considerably less space. And because it was planned, rather than retrofitted, it is going to be much more cost effective as we go. All of that led us to what I think is a very reasonable planning cycle. We are now in what they call the final engineering design phase of it, at the end of which, which will take most of the calendar year of 2006, we will have a guaranteed price to build that plant by Bechtel and GE. With penalties for failure to achieve and maybe with rewards for above, or under schedule, under budget and ahead of schedule delivery of the plant. All of which we hope will allow our regulator to find the comfort that comes from not repeating our history of bringing in a $400 million nuclear plant and later bringing in a $3.5 million price tag. We think those are very important parts of the planning cycle there we're going through right now.
So lastly, the execution piece of it and this is different and difficult, but it is essential. Because when I talk to all of my colleagues, in the investor owned utility space, there is an absolute prerequisite for any of us going forward with new central station, whether it be coal-fired or nuclear, and that is an upfront analysis and review and approval by our in-state regulator. And what does that really mean? There is a history in our space where we would be like Kevin Costner in that great baseball film, we would build it and hope A, the customers would come and B, that the regulator would allow us to earn a return of it on the capital. The history of the failed nuclear stations led all of us to the reality that that can't be the way to put a billion or so of your shareholders dollars and your bank financing dollars at risk. That the overall more traditional convenience public certificate, public convenience and necessity is needed. And what we're asking the in-state regulator to do is not only approve the need, and you need to approve that need in view of conservation, in view of renewables, but in view of also the growth that we are seeing that's just simply undeniable in our space. And it isn't 7 or 8 or 9 percent growth year over year in gigawatt hour command or demand. It simply is a 2 or 3% growth, but a 2 or 3 percent growth unanswered for two or three years leaves you with a huge shortfall in your base load requirements. So we're asking them to A, approve the need. In this event we're asking them also to join us in improving the technology. Because notwithstanding the 40 year life benefit of integrated gas combined cycle, which is absolutely demonstratable, there is upfront costs that are higher than a pulverized coal, supercritical, not ultra supercritical. And we need to demonstrate and we need the regulator to support us in that endeavor to say that this does make sense even though we know it's more costful today. When we look at that cycle of four years, we know the customers will be better served by this technology.
And of course that means approve the costs upfront. And what that says is let's begin to recover the actual capital invested as we build. Because that has the tendency, for those of you who aren't familiar with the ratemaking process, of taking a billion dollar project and by the time you actually put it in service it may only be 900 million or less. Rather than taking a billion dollar project, an allowance for funds used during construction, and by the time you go to put it in rates it's a billion two or billion three. Because over that construction cycle, which will be about 48 months, the cost of capital, the cost of money being spent on the project, if it's collected in a contemporaneous sense, will save the customers money in the long run. All of those things are very unique. All of those things are different, but all of those things are essential. And for us, because we have asked three sites to be characterized, we have some options at American Electric Power. We very much want to build this plant in Ohio. I know that I have a commissioner here from the Public Utility Commission of Ohio and I don't want to do anything to put her ill at ease in this regard. But the facts are that's a great place for us. It's Ohio coal. It serves Ohio demands. Because of the way we dispatch our fleet it's great for our customers. And we hope that the commission will see to it that all makes sense to them and they will issue an order that allows for us to go forward.
If they don't we have already filed in West Virginia a marker saying that we will file for it, because we do need another facility to be built to come online in the 2012 timeline. And of course we will continue and do continue dialogues with our friends in Kentucky. So not in any way, shape or form to be threatening, simply meant to mean we have to find an answer. And as I said just a few moments ago, we really do embrace renewables. We're huge in the wind space. We believe in conservation. Those two things absolutely will not kill the bill. Gas is ill advised. Oil is clearly off the board. We think we need to go in this direction. We very much want to go in this direction and that's what we're asking them to do.
So we are in the process of decision done, planning well under way, permit activity already begun on all three of the sites. And execution under way in Ohio, case has been filed, hearings have been held, briefs have been filed, awaiting permission decision. West Virginia announced filing has been made, filing for an integrated gas combined cycle will happen in the very near future. We continue to dialogue with our friends in Kentucky. We're very excited about the opportunity to do this. We really do believe that it's essential not only for our customers and the economies that we serve, the environments that are nearby, but if treated the way that we're asking the in-state regulator, it will be a benefit to our shareholders as well. We're not trying to run from that reality. We are an investor owned utility, but at the same time it's a labor of love. It's a dedication to seeing to it that coal is in the mix. That the United States has an energy policy plan that will bring forward, no offense to the previous speaker, even if the Legislature cannot bring it forward and they really can't and they didn't. We're happy with the energy act as it was passed, but it is woefully weak in many, many areas. Only one thing came out of there for the poor folks and that's the investment tax credit. Good idea? We'll take full advantage of it because it lends value to our customers in the process. If I were building new nuclear, the last person that I would want to give me a loan guarantee to build that station is the federal government. No offense to anybody here from the federal government, but you're not much of a partner and you're not much of a banker. And you ought not be in those two spaces. You ought to let us do that and let the people that do banking do banking.
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