The Real Meaning of Kewaunee’s Demise

A commentary by Michael Vickerman, Director, Policy and Programs at RENEW Wisconsin: 

 Shock waves reverberated across the Upper Midwest when Dominion Resources announced in late October that it would permanently shut down its Kewaunee nuclear generating station in early 2013. Operational since 1974, the Kewaunee station, located along Lake Michigan 30 miles east of Green Bay, currently generates about 5% of the electricity that originates in Wisconsin.

Virginia-based Dominion, which bought the 560-megawatt Kewaunee plant in 2005 from two Wisconsin utilities, attributed its decision to its inability to secure long-term power purchase agreements to keep the plant going. Without securing purchasing commitments from utilities, Dominion would have to sell Kewaunee’s output into the regional wholesale market at prices well below the plant’s cost of production.

While the pricing environment for all bulk power generators is nothing short of brutal these days, Kewaunee carries the additional burden of being an independently owned power plant, since the entities most likely to buy electricity from that generator—utilities--have power plants of their own that compete for the same set of customers. And a growing number of these utility-owned generators burn natural gas, which is currently the least expensive generation source in most areas of the country.

Dominion’s decision comes down to simple economics. Wisconsin utilities believe that over the foreseeable future natural gas will remain cheap and supplies will remain abundant. That would explain their unwillingness to enter into long-term commitments with Dominion, even though Kewaunee recently acquired a 20-year extension to its operating license and does not need expansive retrofits to comply with environmental standards, unlike a host of utility-owned coal plants in Wisconsin.

But even if Dominion’s managers were convinced that natural gas prices have nowhere to go but up in 2013 and beyond, the company, lacking a retail customer base in the Midwest, could not risk producing power below cost while waiting for the turnaround.

Wisconsin utilities have placed heavy bets on natural gas in the expectation that it will remain the price-setting fuel for years to come. Over the last 12 months, they have bought several combined-cycle generators from independent power producers. Buying power plants enables them to pass through their acquisition and operating costs directly to their customers while generating returns to their shareholders. I suspect these utilities are anything but broken up over the impending demise of a nonutility competitor that could have supplied electricity to Wisconsin customers for 20 more years.

But there is another side to this story; the low-price energy future that Wisconsin utilities are embracing can only materialize if natural gas extraction companies continue to sell their output below production costs. This expectation is unrealistic, given the massive pain being inflicted on these companies in the form of operating losses, write-downs, and credit rating downgrades.

Don’t just take my word for it, ask Exxon Mobil ceo Rex Tillerson, whose company spent $41 billion during the shale gas boom to acquire XTO, a large gas producer that is now yielding more red ink than methane. As reported in a recent New York Times article, Tillerson minced no words in assessing the impact of its recent misadventures on the company’s bottom line. “We’re all losing our shirts today,” Tillerson said. “We’re making no money. It’s all in the red.”

Much of the industry’s woes are self-inflicted. The lease agreements that drillers eagerly signed during the height of the shale gas boom obligate them to extract the resource by a certain deadline, regardless of whether such activity is profitable. That these companies cannot disengage quickly from existing leases is greatly diminishing their appetite for exploring new natural gas prospects. Until a pricing turnaround occurs, they will refrain from spending money on exploring new resource provinces like Ohio and Michigan.

Sooner or later, this slowdown in exploration activity will tip the supply-demand equation in the opposite direction, resulting in lower-than-average gas storage volumes. Barring a repeat of last winter’s unusually mild weather, the crossover point should occur around January 1st . But with so many balance sheets in tatters from this highly unprofitable market environment, nothing short of a strong and sustained price increase will be required to persuade drillers to start taking risks again.

When this corrective price increase begins rippling through the electricity markets, it will be interesting to observe how the customers will respond. Right now Wisconsin utility managers are convinced that they are making the right call on natural gas. So completely have they swallowed the shale gas “game-changing” mystique that they were willing to let a 560 MW nuclear plant fall out of the supply picture for good. In this brave new world of theirs, gas is the new coal, and resource diversity is passé.

In the aftermath of Dominion’s announcement, a few commentators have defended the impending closure as a textbook example of how markets work. But this view ignores the delusional thinking that sent shale gas extraction into overdrive, causing prices to plunge below the cost of production. The real game-changer, as it turns out, here was not the emergence of “fracking” technology but the industry-generated public relations campaign that implanted the narrative of a nation awash in cheap natural gas into virtually every American cranium. But as we now see, this narrative has boomeranged on the natural gas industry, and they are paying for their current woes in ways that guarantee a pronounced pendulum swing in the direction of higher prices.

The question going forward is: will this narrative also boomerang on Wisconsin electricity users, after the last employee leaving Kewaunee turns out the lights?

 Michael Vickerman is program and policy director of RENEW Wisconsin, a sustainable energy advocacy organization. For more information on the global and national petroleum and natural gas supply picture, visit previous posts Madison Peak Oil Group’s blog: http://www.madisonpeakoil-blog.blogspot.com. This commentary is also listed on RENEW Wisconsin's blog: http://www.renewwisconsin-blog.org/

Natural Gas: Wrestling With Reality

August 10, 2012
A commentary by Michael Vickerman, RENEW Wisconsin

Wholesale natural gas prices are once again flirting with the $3.00/MMBtu mark after the Energy Information Agency (EIA) reported this week that working gas in storage increased by 24 billion cubic feet (bcf) over last week’s totals. Compared with the five-year average of 45 bcf for the first week in August, the volume injected is modest. The August 9th report marks the 15th week in a row where the weekly injection volumes trailed the five-year average by a minimum of 20 bcf.

On the trading front, the trend this summer has been a steady upward drift punctuated by sharp sell-offs whenever gas prices momentarily settle above $3.00. The last week in July was a case in point. Though the reported number for that week (28 bcf) was only half the five-year average for that date, the announcement triggered a pullback of nearly 10% down to $2.80 from $3.10. It turns out that EIA’s number came in 5 bcf higher than the traders’ own estimate, triggering a wave of serious unloading of positions by those who had bet long.

Everyone in the energy industry, including the traders themselves, knows that $3.00/MMBtu is well below the cost of producing natural gas, and cannot support exploration and extraction activity at the level we saw in 2008 through 2010. Producing shale gas, the so-called “game-changer” that industry flacks contended would loosen King Coal’s grip on the electricity sector, is an even more expensive proposition. High-profile exploration and production (E&P) companies like Chesapeake Energy tried to maintain a jaunty look while wholesale prices were scraping along the $2.00 floor, but they can no longer conceal their distress. Consider the following developments that occurred over the last fortnight.

• Chesapeake Energy announced plans to reduce domestic gas production in 2013 by 8%;
• BHP Billiton wrote down $2.84 billion on the value of Fayetteville shale gas assets it had acquired in 2011; and
• The most recent count of rigs drilling for natural gas in the United States is 498, nearly 70% off the levels seen in September 2008, when prices were above $10/MMBtu.

“Write down” is a fairly bloodless way to describe the loss of $3 billion; “carnage” is better at conveying the pain that now grips the natural gas sector. This begs the question: why do wholesale natural gas prices appear to be trapped for now at the $3.00/MMBtu level?

I believe that there are two reasons for this phenomenon. The first is that energy traders, like virtually everyone else in this country, are truly convinced that the U.S. is awash in shale gas. The industry-led campaign to persuade Congress, state legislatures, Wall Street, Big Media, utilities, and Joe Sixpack that the United States possesses a 100-year supply of natural gas has been a stunning success. Federal energy agencies like EIA have also bought into this view of the supply picture big-time, leaving little room for skeptics and agnostics to influence public perceptions.

This overaching belief has been unintentionally reinforced by local and regional controversies over the practice of hydraulic fracturing solid rock to obtain the shale gas trapped inside. Virtually unheard of four years ago, “fracking” has vaulted into the public consciousness, and in doing so, sustains the society-wide belief that natural gas can be accessed almost anywhere in the United States.

Ironically, the myth of abundance that E&P companies so carefully cultivated (and bankrolled) is now clearly working against their short-term interests.

The other factor that keeps prices so low is the traders’ fear of large demand swings. This is a more legitimate if somewhat overblown fear. The two main reference points for traders here is the demand destruction that occurred in 2008 from the one-two punch of double-digit gas prices and worldwide recession, and the abnormal bulge in storage volumes that occurred earlier this year.

Supply Overhang

As late as September 2011, natural gas inventories were tracking closely with the five-year average for storage volumes. Then came the phantom winter of 2011-2012, which brought us the usual dose of darkness but not the snowstorms and frigid air masses that make life in the Upper Midwest distinctly unpicniclike until April. In addition to disrupting seasonal cycles and ruining the maple syrup harvest, the extended stretches of anomalous warmth cut demand for heating fuel between 25% to 30%. Withdrawals of natural gas were substantially lower than the five-year averages during the heating season, creating a colossal bulge that briefly sent wholesale prices skidding below $2.00/MMBtu. By late April, the difference between 2012 storage volumes and the five-year average stood at 931bcf, about 60% larger than normal.

On May 1st, the pendulum started swinging the other way, whittling down the supply overhang to a more manageable 377 bcf compared with the five-year average for this week. Assuming present trends continue in future weekly storage reports, inventories should be in line with the five-year average by mid-December.

Traders attribute the ongoing reduction in inventories to a hotter than normal summer, prompting utilities to switch on more gas generators to meet system peaks. But weather isn’t the only thing that influences the storage picture; output does as well. But as long as traders and speculators subscribe to the myth of nearly limitless supply, they will discount the possibility that declining output is also responsible for lagging storage volumes. It is this mindset, coupled with the fear of weather-driven demand swings, that compels traders to focus on the supply overhang that remains, rather than gain a fuller appreciation of why it has shrunk so dramatically in only 15 weeks.

Old paradigms die hard. But in the not-very-distant future, the reality of reduced drilling activity and capital spending, along with rapid decline rates in shale gas plays, will bite deeply into the supply of natural gas and cause yet another overturning of expectations in this sector. Given the damage being inflicted on E&P companies as well as their renewable energy competitors, the intrusion of reality into this picture can’t happen soon enough.

Sources: Master Resource Report, Ravenna Capital Management http://www.ravennacapitalmanagement.com/mrr/

“Chesapeake to cut natural gas production,” NEWSOK, Adam Wilmoth, August 8, 2012. http://newsok.com/chesapeake-to-cut-natural-gas-production/article/3699062

“Billiton in $3.3 billion write-down as gas prices plunge,” BBC News. August 3, 2012. http://www.bbc.co.uk/news/business-19107135

Michael Vickerman is program and policy director of RENEW Wisconsin, a sustainable energy advocacy organization. For more information on the global and national petroleum and natural gas supply picture, visit "The End of Cheap Oil" section in RENEW Wisconsin's web site: www.renewwisconsin.org. These commentaries also posted on RENEW’s blog: http://renewwisconsinblog.org and Madison Peak Oil Group’s blog: http://www.madisonpeakoil-blog.blogspot.com

Sand mining surges in Wisconsin

From an article by by Jason Smathers, Wisconsin Center for Investigative Journalism, posted on WisconsinWatch.org:

State feeds national fracking boom; health, environmental concerns rise

TUNNEL CITY — Retiree Letha Webster’s voice briefly cracks when she talks about leaving the town she and her husband have called home for 56 years. But she says selling her land to an out-of-state mining company was the best move she could have made.

The 84-year old was approached in late June by a Connecticut-based company, Unimin, that planned to build a sand mine in the area and was paying a good price for houses in the way.

Webster’s struggle to maintain her home and 8.5 acres of land while caring for her husband, Gene, who has Alzheimer’s, meant she would need to move soon anyway. Webster, whose property was valued last year at $147,400, says she has agreed to sell for more than double that amount: $330,000.

Others in the area are selling, too. . . .

This western Wisconsin community is in the midst of a land rush — call it a sand rush — fueled by exploding nationwide demand for fine silica sand used in hydraulic fracturing. In this process, nicknamed “fracking,” sand, water and chemicals are blasted into wells, creating fissures in the rock and freeing hard-to-reach pockets of oil and natural gas. . . .

[Fracking has been a contentious issue in most states that have fracking operations. Critics argue that chemicals used in fracking may be contaminating water supplies. And it's the subject of a documentary titled Gasland.]

Health effects feared
Residents in several Wisconsin counties say they have been alarmed by the speed with which mining companies have snapped up land.

Some communities lack local land-use controls such as zoning that would allow them to manage the land rush. And despite concerns about the health and environmental impacts of such facilities, the state Department of Natural Resources has only a few regulations for sand mining operations.

Mining companies must file a reclamation plan with the county that spells how much land will be disturbed and how it will be rejuvenated once mining is completed, and they apply to be covered under a general DNR permit covering stormwater and wastewater. Other permits regulating air emissions and groundwater use may be required from the DNR.

But none specifically limits how much crystalline silica gets into the air, the main health worry for those living near the facilities. Drew Bradley, Unimin’s senior vice president of operations, says that while the risks of crystalline silica are well known in an occupational setting, there’s no evidence that ambient exposure poses any threat.

Customers seeing savings on heating

From a blog post by Tom Content in the Milwaukee Journal Sentinel:

Winter heating costs remain below last year, helped by both the weather and natural gas prices.

Customers of Wisconsin Power & Light Co., based in Madison, saw heating costs fall 30% in December, compared with December 2008. December's weather was colder than normal but it was warmer than the prior year.

For the last three months of the year, customers also saw heating costs fall 30%, compared with the same period last year, the utility said in its "natural gas update."

For October through December, a typical customer paid about $269, but that was $116 lower than the prior year.

Reedsburg Hardwoods lumber mill process now powered by renewable energy

From a news release issued by Alliant Energy:

MADISON, WI – April 17, 2009 – In the middle of 2008, Reedsburg Hardwoods decided it wanted to reduce its energy cost by taking advantage of a plentiful by-product of its own manufacturing process: wood waste. At the time, the company was using two natural gas-fired boilers and one wood waste boiler to process steam for its kilns, steamers and dryers. While the lumber mill was already powering about two-thirds of its processing operation with the wood waste boiler, it had more wood waste available to do more and wanted to effectively eliminate the use of natural gas for its wood processing energy demands.

“We really saw a great opportunity for our company to move toward completely using a renewable resource to power our lumber mill process,” said Doug Hilber, Reedsburg Hardwoods Facility Manager. “With the excess wood waste we generate and had available on and off-site, it made sense to look at purchasing a larger capacity wood waste boiler that could handle processing steam for all of our lumber mill process now and into the future.”

As with any business, cash is important and paying for the new wood waste boiler and the other upgrades needed to support it, would take upfront dollars before the long-term energy-efficiency gains could be realized. That’s where Wisconsin Power and Light’s (WPL’s) Shared Savings program stepped in to assist the company.

The Shared Savings program is an initiative that assists industrial, commercial and agricultural customers with identification and implementation of energy efficiency projects - and invests the capital to finance them. The program’s low-interest financing, and ability to repay the loan using the energy savings, is attractive to many businesses.