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October
09
2021

The Electricity Crisis Was Not Caused By A ‘Perfect Storm’
Leonard Hyman & William Tilles

• From hydropower failures in South America to natural gas shortages in Europe, and coal prices soaring in Asia, the global electricity crisis has clearly gone global
  
  
• While plenty of observers are willing to blame this on a ‘perfect storm’ of events, the truth is electricity providers were simply not prepared when they should have been
  
  
• As a result of this crisis, consumers are likely to disassociate themselves from unreliable and profit-chasing producers as they search for resilience 

Recent news from the global electricity sector looks grim. South Americans, heavily dependent on hydroelectricity,  face drought-induced scarcity. Hard to believe in a continent laced by three enormous river systems. The alternatives for South American electricity users are an increased reliance on fossil fuels or turning off the lights (conservation). And unlike relatively inexpensive hydroelectricity, generating electricity with fossil fuels (apart from the ecological consequences) incurs fuel expense, which raises prices.

The news emphasizes growing inflationary pressures. And this certainly feeds into that narrative. But there is a more worrisome problem for energy planners here. More droughts mean that hydro can no longer be considered a “firm” long-term resource for the electrical grid. Subtracting a major low-cost resource like hydro from a region’s energy mix and replacing it in any other fashion is an enormous financial undertaking. Just as countries are moving to reduce reliance on fossil fuels, one of the cleanest energy sources becomes scarcer.

But there is a distinctly global flavor now to stories of electric utility infrastructure under duress not simply due to extreme weather. Failure of human ingenuity plays a part here. In Puerto Rico, the reorganized and semi-privatized electricity system, PREPA, experiences frequent blackouts. Yet customers seeking to install their own generation (and potentially resell power to the utility at critical times) can’t get the power company to hook them up. India faces an electricity shortage because power companies failed to restock coal inventories. Their executives expected a meaningful decline in coal prices which never materialized so they’re stuck. In the UK the windpower yield was below expectations and that dramatically pushed up power prices. 

But winter is coming—when the existing natural gas shortage pushes prices even higher. And then there is China. Electricity demand rose, coal usage increased, and coal prices went way up. But the government puts a ceiling on the price of electricity which causes generators to lose money on power sales in periods of rapidly escalating fuel prices like the present. So who wants to lose money on every KWH sold in the hope of making it up in volume? After experiencing blackouts and other usage reduction measures, the electric companies went to purchase more coal. However, world coal markets are now tight. One obvious short-term solution is a rapprochement with regional neighbor Australia despite a recent chilling in relations between the two governments. 

In many places, the price of natural gas determines the price of electricity. If global warming were not a pressing concern, natural gas would be the boiler fuel of choice. In its absence, they would burn coal or oil. Natural gas prices have more than doubled this year in the US and quadrupled in European markets. No doubt a combination of higher demand and more cautious development by petroleum companies has tightened the market. But Europe depends to a great extent on Russian supplied gas and there are indications that the Russians did not fill European storage facilities in order to manipulate scarcity to their advantage. The Europeans do have alternatives to Russian gas, such as pipelines from Algeria (which is not the most stable supplier). Morocco wants to sign a deal but it has a problem caused by the sometimes rebellious Polisario Front which claims to represent the western Sahara region. European countries could sign big gas deals with Israel and Cyprus but would face Turkish objections. As they say, it’s complicated. 

These and similar problems are not accidents and do not result from one-off difficulties or calamities. Forget about the perfect storm excuse. The problems arose because electric companies chose to defer capital and maintenance expenses, skimped on adequate fuel reserves, and focused on cost efficiencies. Customers would have been better served had they focused on hardening grid infrastructure and preserving continuous service against an increasingly hostile climate. Excessive focus on creating shareholder value can mean cutting corners to achieve savings. But the implied hope (and whether hope is an adequate basis for corporate strategy is another question) is that nothing untoward happens as a result. It’s like building a house of cards outside assuming the wind will never blow. It was in this vein that electric utilities adopted what amounts to a just-in-time supply system mentality with respect to electricity. 

And there is another point to be emphasized. A well-functioning just-in-time inventory management system is a thing of beauty, efficiency, and cost minimization. But because of the extreme interdependency, one factory relies on the output of another, often thousands of miles away, any break in this carefully choreographed manufacturing process results in chaos and dysfunction. This corporate mentality has resulted in electricity systems that are now relatively low-cost but increasingly fragile.

Puerto Rico, for example, is a simple case of underinvestment. The electric company, PREPA,  would have had to raise prices substantially to improve the network. If the UK had sufficient gas reserves in storage low wind conditions would not have been a big problem for power generation. But new construction and adequate gas reserves cost money. And UK regulators have worked heroically to keep down capital spending.

The Europeans signed up voluntarily for Russian gas and nixed other projects. More pipelines serving their market meant paying the overhead on several competing gas transport lines which were not deemed economically efficient. As for Chinese and Indian utilities, having at least a 90-120 day coal inventory may become part of normal operations if one burns coal. But again all that adds substantially to costs.  

Roughly four decades ago, neo-liberal economic principles were introduced to the electricity sector. The industry gradually changed from one dedicated to serving the public and encouraging economic development to one focusing instead on maximizing profits. Along the way, the political and regulatory systems seem to have become unusually obliging with respect to corporate interests as big money in US politics exerts its corrupting influence. Where will this lead? Well, sadly we don’t think it will lead to any serious evaluation of the structure of the electricity markets, or natural gas networks, or government policies that control them. Introspection or reflection about better utility arrangements takes time possibly even for trial and error. But our present system lurches from crisis to crisis.

So where does that leave us, the electricity consumers? First, power users will try to disassociate themselves from increasingly expensive and unreliable networks. There are two reasons for this, reliability and price. As we wrote recently in reference to Entergy’s four- to six-week power outages following hurricane Ida, repeated outages of this duration are unacceptable in that it makes those regions both commercially disabled or even uninhabitable for protracted periods. We believe for this reason alone those who have the means will increasingly look for alternatives to the local power company.

In addition, we’re also now witnessing rapid fuel price increases which are driving escalating electricity prices. Installing individual, non-fuel power generation and storage systems provide the energy user with long-term price stability. Once installed, a solar and battery storage system provides long-term price stability for the life of the system, possibly 20 or 30 years! This is a gigantic inflation hedge— although not looked at that way at present. In inflationary times self-generation permits power users to cap their (self-generated) rates for an extended period—a considerable benefit against a backdrop of volatile energy prices. 

Lastly, we should mention the resurrection of nuclear power generation technologies both small-modular and gigawatt-scale. New and existing nuclear is heralded as the perfect low emissions, base load complement to intermittent wind or solar. It is relatively unaffected by the variabilities of nature and does not rely on fossil fuels with volatile prices. Nor need its fuel be imported from unfriendly nations which may suddenly turn off the “spigot” so to speak. As the notion of energy independence once again gains currency, widespread nuclear new-build may actually resume. But there is always something. The resumption of interest in new nukes is occurring against a backdrop of rampant price inflation. We will conclude by saying that the last time those two teamed up in the 1980s it wasn’t pretty. 

By Leonard Hyman and William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and has provided advice on industry organization, regulation, privatization, risk management  and finance to  investment bankers,  governments and private firms, including one effort to place nuclear fusion reactors on the moon. He is a Chartered Financial Analyst and author, co-author or editor of six books including  America’s Electric Utilities: Past, Present and Future and  Energy Risk Management: A Primer for the Utility Industry. 

You can find Leonard Hyman's lastest book Electricity Acts on Amazon 

 

 

William I. Tilles is a senior industry advisor and speaker on energy and finance. After starting his career at a bond rating agency, he turned to equities and headed utility equity research at two major brokerage houses and then became a portfolio manager investing in long/short global utility equities. For a time he ran the largest long/short utilities equity book in the world. Before going into finance, Mr. Tilles taught political science .

 

 

 

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