© National Journal Group Inc.
Monday, March 3, 2008

“There is no state or country on earth that's been able to use conservation and efficiency to stop growth in electricity.” — Lawrence Makovich

National Journal reporter Margaret Kriz interviewed Lawrence Makovich, vice president and senior adviser for Cambridge Energy Research Associates, about the important policy issues facing the electricity utility industry. Following is an edited transcript of the Feb. 11 interview.

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Q: American utility companies are facing conflicting demands -- they need to produce more electricity at the same time Congress is about to require them to curb their greenhouse gas emissions. What impact is that having?

Makovich: In the past year, there's been a very remarkable shift within the power business. A year ago, we saw the development of as much coal as we've seen in a couple of decades. We had about 13,000 megawatts of coal-fired power plants under development in 2007. That came from recognition that there is [a] growing need for power supply. And we've been through a period of time where natural gas prices went up very dramatically. And in fact they're still relatively high today.

Now, what we've seen over the past year is a very dramatic reversal in thinking -- away from the idea that diversification of fuel is a good thing, given how unpredictable and volatile [natural gas] fuel prices can be. And climate change has really trumped most any other concern, including the one for fuel diversity.

So last year, in 2007, we saw as many coal plants canceled as we have under construction. About 13,000 megawatts that were under development -- some of them where money had actually been spent on construction -- cancelled. So you've got very clear evidence here that the thinking changed very dramatically within a very short period of time.

This carbon dioxide issue is really front and center right now. I think that the general consensus is that the U.S. is going to implement some kind of a national CO2 policy after the next election. So that would mean there would be a binding, probably market-based allowance-trading scheme out in the 2012 or 2015 time frame. Most people believe that something is going to be done after the next election. The rough outlines of it have come into view for people. They talk about it being binding and market-based and having a long-term target and so forth.

So without knowing the details of that, where we find ourselves is that the evidence is pretty clear. People are retreating a bit from commitments, particularly on big, long-lead-time capital intensive projects, like I said, with all those coal cancellations. And until this thing settles out, I think we're going to see a return to an awful lot of short-lead time, gas-fired combustion turbines (they're not capital intensive) just to kind of shore up power systems until people have a better idea of what the rules of the game are.

Q: Are they waiting to order new plants until Congress passes legislation?

Makovich: The challenge here is that given supply and demand trends in the power business, people really, in most parts of the country, do not have the luxury of being able to delay these decisions for a year or two or more until things start to settle out. So we are going to get this move to a default toward more natural gas. The consequence here is that the logic of fuel diversification never really was wrong. We've got a very troubling, increasing dependency in the power sector on natural gas, which has been quite volatile in its price pattern. And, as we move forward, an increasing amount of that gas is going to be imported from overseas from a lot of places that are politically troublesome.

So the power business seems to be on a path that the whole country was on two, three decades ago -- wanting to decrease dependency on a fuel.

Q: Are companies backing away from building all types of coal plants?

Makovich: That's right. Because even with clean coal, the challenge there is any reasonable assessment of the timelines required -- for example to build and demonstrate a utility-scale [system for] capture and storage of carbon, it's going to take quite some time. I think we're talking about 10-year kind of time frames to build, operate, demonstrate and understand the results of that research, development and deployment before you can realistically expect any widespread deployment of that technology. So the problem here is not that clean coal isn't possible. The problem here is that clean coal is not really possible in the numbers and at the scale that's necessary to meet this current investment wave.

Q: Environmentalists say that if the utilities invest in a whole lot more energy efficiency measures and renewable sources, they won't have to build big new coal or natural gas plants.

Makovich: There's a lot of power in that idea because it's something that people really want to believe is true. Unfortunately from our analysis, it doesn't look like that is true. Take renewables for example. When we look at renewables, about 90 percent of all the renewables that have been built in the U.S. have been wind. Eighty percent of what's in the pipeline to be built and added in the future is wind.

Wind is an intermittent source of power. So on cost, wind looks competitive. But when you integrate an intermittent resource into a power system to where people want power, it very much matters when they get the power. Then what you'll find is, in order to back up the intermittency of wind with a resource that you can run when you need it -- well, when you do the full economics of firm wind, which is what a power system needs, what happens is, wind costs about 40 percent more than conventional generation.

You cannot have a power system that's wind without having this backup capacity. So you can't just go wind alone. We've required [electric companies to install more wind power] in so many places -- in 28 states in the United States, all the provinces of Canada and in many countries in Europe. What's happened here is the demand for wind turbines is outstripping the supply and the ability of the manufacturing supply side to ramp up. This is also an area that's not just more expensive, but becoming increasingly so.

Q: Is it getting more expensive because the wind manufacturers are having a hard time making the equipment?

Makovich: Right. So we've seen in the past three or four years about a 60-percent increase in the cost of a wind turbine. Conventional power plants have gone up about 20 or 30 percent, but wind is going up faster right now. So we've got a problem of economics. We've got a problem of performance characteristics. This intermittency is a real challenge.

Conservation and efficiency -- it's going to cost money to do that. There are a lot of people who think that conservation and efficiency don't have a [net] positive cost, that it has negative costs. And the evidence suggests that that is simply not true. So you can do more conservation and efficiency. But it's going to cost money to do it. Going forward, when you look at the potential for conservation and efficiency and what it's going to cost you, any realistic assessment, even with a greater focus in this area and getting policies to support it, you simply can't stop the growth in electricity demand in the U.S. In fact, there is no state or country on earth that's been able to use conservation and efficiency to stop growth in electricity.

Q: Can it slow down the growing demand for electricity?

Makovich: Yes. In fact it's going to be a very important part of the power business going forward. To get conservation and efficiency right, to slow growth down and to balance the cost of conservation and efficiency against the cost of additional supply -- that's the real problem going forward. But it's not a world in which [investing in] conservation, efficiency and renewables means you don't have to expand power supply.

Q: How important is it to electricity companies' long-term planning for Congress to quickly pass global warming legislation?

Makovich: What you're seeing in the data is very clear evidence that investment programs are dramatically affected by the uncertainty over the carbon issue. You have to remember that when you look at sectors of the U.S. economy, the power sector is one of the most capital-intensive sectors that you have within the whole U.S. economy. An uncertain investment environment is a challenge to any sector in the U.S. economy. But when you are as capital intensive as the power sector is, you are really affecting the core of the business. If investment doesn't happen in the right amount and in the right ways, you've got some pretty important consequences down the road.

Q: What kind of consequences?

Makovich: For example, we've seen in the power business what happens if you don't set up a power market correctly, as in the case of California. People will not make the amount of investments at the right times, and you'll end up short. South Africa is going through a power shortage right now because their investment climate wouldn't support the right amount. We've seen shortages crop up in Ontario recently. If you don't get the investment climate right in this business, you can get in trouble and it's not something you can solve quickly.

So there are two problems that we've pointed to. One is shortage. We've seen power shortages and they're tough. And [the second is] this over-reliance on imported natural gas, the risk that that poses. These are very important consequences from this current investment climate.

Q: You sound very concerned about U.S. companies building so many natural gas facilities.

Makovich: It's a question of what is it going to cost. What risk will we create in the power business to the volatility in the price of natural gas? And, there's also a question about physical deliverability. We are reaching limits on the liquefied natural gas imports and on the pipeline systems and the storage in this country. In Florida and a few other places, we're worried that we'll get into a winter peak demand period for power, and it won't be just the price that will be the problem.

Q: Does the U.S. have enough LNG import terminals?

Makovich: Yes, a lot. The major problem is other places [in the world] are competing for that LNG.

Q: Nonetheless, some studies show that a lot of coal plants are on the drawing board right now. True?

Makovich: It's a very interesting mixed story there. We are building more today than we have in decades. And yet we've also canceled an enormous amount of coal plants under development. It's a very mixed story. But the direction I think is pretty clear. There was a lot of enthusiasm to use coal as a way to reduce the risk that the bigger reliance on natural gas was posing. That has completely shifted now to the concern on climate change.

Q: What does Congress need to do to respond to climate change?

Makovich: I think what is needed more than anything else right now on global climate change is a realistic assessment of what it is going to cost to stabilize or reduce CO2 in the U.S. My real fear here is that people are not being realistic about that. And as a result, we're going to get policies that will be unrealistic. We'll be frustrated. There will be a lot of blame to place. And this will be a very, very troubling area for the power sector going forward.

Q: Do you favor a cap-and-trade approach?

Makovich: The conventional wisdom is that we are going in the direction of some kind of cap and trade. To a true, pure economist, a carbon tax would be best. But it's not really a question of what would work best. Right now I think it's clear that most people are expecting the approach to be cap and trade. The real devil in the details is what matters here. What will be the level that we cap [greenhouse gas emissions] at? Will we have any kind of controls on the allowance price -- a ceiling or a floor? How will the allowances be distributed? Will there be grants or will it all be auctions? Those are the type of details that are going to become very, very critical going forward. So, timing, amount and how the allowances are priced and allocated. Those are the real questions.

Q: Some in the environmental movement are fighting every last coal plant being proposed in the U.S.

Makovich: This is global issue. China is adding a Texas-sized coal-fired power system every year. What I mean is, the amount of energy generated by the entire Texas power sector. That's how big a coal addition we're seeing year after year in China right now. And so what we are arguing about here in the U.S. really is quite small in the whole scope of this problem as we look at the kind of carbon releases associated with the coal build-out elsewhere in the world.

If CO2 stabilization or reduction is expensive, and I think that's the truth -- it's more expensive that most people expect -- then it's going to affect the competitiveness of the goods and services we manufacture in the U.S. We'll have higher energy costs and the need to compete with countries that do not have similar kinds of carbon policies or costs in their manufacturing sectors. Because of that, I think there is a very high potential for political conflict here. So it's not just a question of, "Well, gee, we're killing ourselves and everything we do is getting offset by the Chinese." This is very real. You can't just say, "Well they should do the same thing." Because it is costly, it is going to affect trade and economic growth and so on. So that's where it becomes a very difficult issue to expect that the U.S. is going to go down this road alone and create economic problems for itself.

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