Can America Blow Away Nuclear Power?

Imagine if you opened up your electricity bill next month and it showed that your energy provider owed you money for sending you your monthly allotment of kilowatts. Think negative prices sound farfetched? Think again. Several Texas and Midwestern utilities, such as Exelon (NYSE: EXC  ) and Dominion Resources (NYSE: D  ) , are facing just such a predicament in several markets during off-peak hours.

OK, so customers don’t actually get paid by their providers since off-peak prices represent a small piece of the amount paid each month. Nonetheless, negative prices are a real problem facing utilities relying on nuclear and fossil-fuel generation -- and they have little to do with cheap natural gas. The main contributor to off-peak negative prices is actually wind power. If the problem persists, energy companies such as Exelon and Dominion, which focus on nuclear and coal, respectively, may be forced to retire their less competitive plants. Can America really blow away nuclear power?

Good news, bad news
Last year, the power industry sprinted to capture what was expected to be the last opportunity for a federal tax credit for new wind farm construction. The credit was eventually extended through 2013, but that didn’t stop a record 13 GW of capacity from being added to the nation’s grid. In fact, 8.38 GW were added in the fourth quarter alone.  

That’s great news for renewable energy-minded power generators such as NextEra Energy (NYSE: NEE  ) . The company owns more than 10 GW of wind capacity, or one-sixth of the nation’s total. The subsidy has enabled NextEra to create an impressive fleet of wind farms:

Source: NextEra Energy. Powered by Google Maps.  

Say what you want about the federal tax credit for new construction, but that isn't the government subsidy fueling negative prices. The owners of wind farms receive a production tax credit, or PTC, of $0.022 for every kWh of wind energy produced. That may not seem like much, but consider this: Wind speeds, on average, are inversely proportional to demand from the grid. When the grid needs the least amount of power -- during the night and in spring and fall -- wind speeds are at their peak.

Generally, providers curtail their power production during off-peak times to obey the law of supply and demand. Flooding the grid with juice that has nowhere to go results in negative prices, thus forcing providers to pay the grid to take the power they created. No business aims to sell products with negative values.

A question of fairness
The PTC for renewable-energy generation creates an artificial incentive for owners of wind farms. Why shut down turbines during the grid’s off-peak hours when it’s the best time to maximize production and therefore subsidy revenue? For instance, wholesale electricity prices for off-peak hours sank to negative-$0.0411 per kWh in October 2012. A recent report (link opens PDF) from the Northbridge Group, an electricity consultancy firm, showed that the problem is becoming more profound every year:

Source: The Northbridge Group.

Although natural gas has done its part to lower electricity prices, gas-fired generators usually come online in full-force during peak hours and as needed. Taking that into account, there does seem to be a correlation between wind capacity and negative prices. Is it fair for the government to subsidize renewable-energy generation at the expense of more established providers?

Competitive disadvantage
The splurge on wind turbines is certainly good news for renewable-energy advocates, customers, and the nation’s energy future. Carbon-fiber manufacturer Zoltek  (UNKNOWN: ZOLT.DL  ) reported a record 2012 thanks to the mad dash. The company states that its carbon-fiber wind turbine blades can capture three times the energy of their fiberglass predecessors. All good news for renewable energy. There couldn’t possibly be any negative long-term effects. Right?

Well, if negative prices persist for longer periods of time, it could force generators to make some potentially toxic long-term moves to protect margins. Exelon could be in particularly rough shape in the near term with much of its 19,000 MW of nuclear capacity serving the Chicago metropolitan area -- prime wind territory. I recently argued that nuclear energy shouldn’t be considered more expensive on new construction costs alone, but there's a different problem at play here.

The company's CEO, Christopher Crane, recently told Bloomberg that if the subsidy continues, "there is a very high probability that existing safe reliable nuclear plants will no longer be competitive and will have to be retired early." That could be a potential problem for prices in the long run. Why? Nuclear power plants operate for months at a time without interruption, thus stabilizing the grid and prices. Consider this comparison in utilization rates:  

Generation Source

2012 Capacity

% of 2012 Electricity Supply

Wind

51,620 MW*

3.4%

Nuclear

101,409 MW

19%

Source: EIA.
*Excludes 8,380 MW installed in 4Q12, which didn’t contribute to grid.

Whereas it took wind energy 15,200 MW to generate 1% of the nation's electricity, nuclear needed only 5,337 MW to create the same share. Lower utilization rates alone don't make wind energy obsolete. After all, it's tough to beat free fuel inputs. It does, however, highlight the importance of more consistent generation sources. In other words, should nuclear capacity be taken offline because of pricing concerns, it would be unlikely for wind power to fill the void -- not exactly how the market is supposed to work. Natural gas plants could fill the gap, but that isn't necessarily good news for consumers. More volatile fossil fuel plants can lead to higher costs.

Foolish bottom line
It appears that American wind farms really could blow away nuclear energy's share of electricity production, although it will need big help from renewable-energy subsidies. While that may be considered a catalyst for companies such as NextEra, consider what would happen if the PTC were slashed or taken away. It's the only reason wind farms send power to the grid when demand is low. 

Therefore, I see the PTC being adjusted at some point in the near future to more accurately reflect the market. Any funds not handed to wind farm operators should be invested into grid-sized battery farms that could store cheap renewable energy generated in off-peak hours and send it to homes when demand is highest. Utilization rates of wind energy could then match those of nuclear energy, effectively tripling the nation's share of wind generation without adding a single kilowatt of capacity.

Until that happens, energy providers may be moving away from coal and nuclear and toward renewable energy and natural gas. With the swelling of the global middle class, energy consumption will skyrocket over the next few decades, so long-term investors know that you want exposure to this space now. We've picked one incredible natural gas company that presents a rare "double-play" investment opportunity today. We're calling it "The One Energy Stock You Must Own Before 2014," and you can uncover it today, totally free, in our premium research report. Click here to read more.

 


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