Clean Power Plan

S&P's Ferguson discusses rule's impact on energy markets, credit

As state governments, industry and regulators dig in to potential Clean Power Plan compliance pathways, which industries could sustain the most significant credit impacts resulting from the rule's implementation? During today's OnPoint, Michael Ferguson, associate director of Standard & Poor's Ratings Services, discusses a new series of analyses on the impact the plan could have on energy markets, credit and the viability of power generators.


Monica Trauzzi: Hello, and welcome to OnPoint. I'm Monica Trauzzi, and with me today is Michael Ferguson, associate director of Standard & Poor's Ratings Services. Michael, thank you for joining me.

Michael Ferguson: Thank you for having me.

Monica Trauzzi: Michael, as states, industry and regulators dig into potential Clean Power Plan compliance pathways, S&P has compiled a series of analyses on the impact of the plan on the various stakeholders and on credit. Which industries could sustain the most significant impacts resulting from the rules implementation?

Michael Ferguson: Certainly. I think you can look at a lot of industries and say that, by and large, there are going to be positive outcomes from this. If you look at natural gas infrastructure in the midstream energy space, if you look at renewables, these are largely positive developments for them, and of course, they're continuations of trends that have been underway anyway.

Where the impacts are a little bit more mixed, I think, is within the IPP space, within the merchant power generation space, and I -- the reason I say that is there are a couple of factors at work there that are complicating analysis to this. We look at IPPs -- and there are very different types of IPPs out there. There are some that are more weighted towards nuclear assets and gas-fired assets; there are some that are still more focused on coal-fired generation. So if you look at that and you look at this as a rule that effectively penalizes coal-fired generation to the benefit of, again, of natural-gas-fired generation or potentially nuclear units, think some of the coal-heavy IPPs could suffer as a result of this over time.

The real variable here is whether or not the EPA and the states that are formulating their own SIPs underneath the federal guidance, whether or not they're going to choose to use demand reduction as a means for reducing carbon emissions, and that's certainly a viable strategy, and I think that that's been endorsed by the EPA. So that happens. Not only is the dispatch curved in a shift in favor of gas-fired generators, but the actual power price may not go up as much as some folks think that it's going to as a consequence of the rule.

So I think that there's still a lot of moving parts there, and we'll see how that comes together as the SIPs are put in place and as we see how much the states plan to rely on demand-side management to comply with the rule.

Monica Trauzzi: How do natural gas price trends impact potential compliance pathways for stakeholders, and also, sort of the overall impact that the plan has on industry?

Michael Ferguson: Sure. Natural gas prices are obviously very crucial for something like this. Part of the reason why a plan like this has been seen, by some participants, as not being overly onerous and expensive is that gas prices, in our estimation, and I think in the estimation of the EPA, are slated to remain low for a long period of time. Now, there's no certainty in that, of course. There are other trends that could upset the apple cart there, but it's one of those -- it's one of these things where it -- natural-gas-fired generation has become more appealing even independent of coal-fired -- independent of carbon regulation because it's become more economical than coal-fired generation, and this should continue going forward. So any incremental price increases are going to have to be weighed against the fact that natural gas plants are just inherently going to be better in this -- in a Clean Power Plan environment because they're not going to carry the same carbon costs. There's just another component to energy margins you earn to energy economy here that has to be considered going forward.

And as far as how industry is going to be affected by this, I think, certainly, you're going to see a lot of industries that are energy-intensive; they're going to look to ways to be resourceful, and it's not necessarily a bad thing. I think you've seen, in some of the parts of the country, where demand reduction is already being priced into capacity markets. It hasn't been as much in recent auctions, but to the extent that it is, you're going to see that continue because it's going to be a way to curb price increases for certain industries that are very sensitive to it.

Monica Trauzzi: How, then, does the heavier emphasis on renewables in the final plan impact gas-fired generation?

Michael Ferguson: Certainly. So one of the things you're already seeing in -- and again, this is independent of the Clean Power Plan. One of the things you're already seeing in states like Texas, for instance, a heavy influx of renewables is actually depressing power pricing, and it's depressing power pricing for natural-gas-fired generators. Effectively, what you see is that excess renewables -- greater supplies of renewables -- are depressing power prices; they're creating lower demand for gas-fired generation. I think that that has a weakening effect on power prices, and to the extent that that continues going forward, that renewables penetrate to a greater degree, I think you'd see energy margins continue to weaken somewhat for gas-fired generators. Now, the other side of the coin, there is that as you introduce more and more renewables onto the grid, the grid becomes inherently less reliable, inherently more intermittent, and I could say the same thing about introducing more demand reduction strategies.

So what does that say? Well, we've seen that in certain grids such as ISO New England and the PJM, in the past, there have been challenges with reliability, not through the Clean Power Plan, due to just gas transmission issues, and the way that this -- that's been addressed in the past is by a more significant focus on a stronger capacity market construct. So I think that if you see the grid becoming less reliable -- and certainly, that was one of the chief criticisms of the Clean Power Plan -- I think you would see stronger capacity markets in certain unregulated markets in the country. And even in markets where there are very weak capacity constructs right now or no capacity constructs, that may be an idea, as a compliance strategy, to ensure reliability amid a very changing grid.

Monica Trauzzi: Trading mechanisms are being considered by most --

Michael Ferguson: They are.

Monica Trauzzi: -- if not all of the states. How wide of a reach are you expecting carbon trading to have on Clean Power Plan compliance?

Michael Ferguson: It'll be significant, we think. Certainly, we expect a lot of states are going to want to use a market-based mechanism in order to reduce carbon emissions. Why? Because it creates incentive -- as it has done in California, as it has done in the RGGI states -- to reduce carbon emissions, and this causes generators to be more resourceful, not just to switch from coal to gas, but how to make coal plants that are still going to be there more efficient.

How to use renewables more efficiently -- it creates a more efficient grid in some ways, and I think the most efficient way to manage carbon trading, to manage allowance trading, is by having wider regional alliances. If you look at what's going on in RGGI right now, the RGGI carbon prices -- the allowance prices -- have come way down in recent years. Part of the reason that they have is that they've been very successful in remediating carbon. But it wouldn't have been quite as successful had we been looking at individual state exchanges. Now, that works in California because it's such a large state with such a large reduction goal in the past, but if you had looked at Connecticut or Rhode Island doing their own carbon exchanges, you wouldn't have had the level of transparency, liquidity and fundability required in order to successfully remediate carbon emissions or provide incentives for that.

So I suspect that you could see some like-minded states bonding together in order to create regional carbon alliances in order to create, again, more transparent markets.

Monica Trauzzi: And on the question of mass-based versus rate-based, you're predicting that most states will go the mass-based route. Who would benefit, though, from going the rate-based route?

Michael Ferguson: Yeah, I suspect that there -- most states would probably benefit from a mass-based approach because it is a little bit more flexible and permits more avenues. However, if you look at states like South Carolina, which are going to lean pretty heavily on nuclear generation, that speaks to using more of a rate-based goal, and there could be other states that fall into that bucket.

Monica Trauzzi: And your sense is that existing nuclear facilities were -- we'll see their lives extended so that nuclear generation can play a role in compliance. Is that consistent, though, with what we've seen lately with many nuclear facilities retiring?

Michael Ferguson: Sure. Well, the nuclear facilities that have retired have not retired because they've gotten to the end of their useful lives, necessarily. I mean, that may be the actual reason, but in reality, some of these have retired because they're not economical anymore. Because in a low-gas-price environment, a nuclear asset with this massive fixed costs and variable cost structure that isn't that flexible, they don't tend to do well. So I think you've seen a lot of the merchant nuclear units closing for that reason.

However, in an area where we're pricing carbon, nuclear assets tend to benefit from something like that. Certainly, they don't emit any carbon, and if you see any uplift in power prices, it's going to benefit nuclear units, which are going to continue to run at baseload levels, but they need higher margins to continue to exist, and that's going to be an interesting dynamic over the next couple years. Certainly, a lot of nuclear units are not doing well right now, but you have to wonder if it makes sense to tide these over because they are so important for liability purposes, if there's going to be incentives given by states and by utilities to keep them open between now and 2022, when, presumably, they would start to collect some kind of a carbon fee.

Monica Trauzzi: So in 2030, what are your predictions for what the power grid will look like?

Michael Ferguson: Well, very different. We expect that there's going to be about 80 gigawatts of coal closures between now and then. We expect a lot of these nuclear units, as you say, are still going to remain open except for the ones where we have seen scheduled closures. We also expect that the capacity of the grid is going to exceed about 30 percent of renewables. Certainly, installed renewable capacity has increased recently.

There's one big variable here that's starting to be talked about a little bit more. Battery storage could change all of this. The extent that battery storage becomes more economical -- and we're not necessarily anticipating that it will, but if it does, you're going to see us relying much more heavily on renewable, and you're effectively going to have baseload renewables if that's the case. Of course, doing that would require more and more transmission installations, and that could be a significant component of the grid, but certainly, the grid of the future's going to look a lot less centralized than today's grid. We're going to move from something that is effectively regional to something that is done both at the local level, but also connecting regions together over time.

Monica Trauzzi: Lots of moving parts. Thank you for coming on the show.

Michael Ferguson: There certainly are.

Monica Trauzzi: Thanks for your insights.

Michael Ferguson: Thank you.

Monica Trauzzi: And thanks for watching. We'll see you back here tomorrow.

[End of Audio]



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