Are Green Regulations Destroying the U.S. Energy Market?

Environmental regulations combined with industry changes could cause a catastrophic event in the U.S. power market.

Jul 5, 2014 at 9:25AM

After this past winter, utilities like American Electric Power (NYSE:AES) are on high alert. That's because a mixture of industry shifts and environmental regulations have caused a fundamental shift in the power industry. And that shift could leave you without enough power to turn the lights on, or with painfully high bills.

We needed those plants
In testimony before the Senate Energy and Natural Resources Committee earlier this year, Nicholas Akins, CEO of American Electric Power, reported that this past winter, AEP needed nearly 90% of the power plants that it is set to mothball in 2015. He opined that, "This country did not just dodge a bullet -- we dodged a cannon ball."

And, to be honest, there isn't just one reason for what he called, "an early warning about serious issues with electric supply and reliability." There are environmental regulations pushing coal out of the utility picture, which is why American Electric Power is slated to close most of those plants called on this past winter. But there's also the issue of deregulation.

Source: ReubenGBrewer, via Wikimedia Commons.

Regions of the country have essentially split the delivery of power from the generation of power, opening the generation side up to competitive pricing. That, in turn, has led to an increase in the use of natural gas because fuel is trading at historically low levels, and gas plants are cleaner and cheaper to build than coal.

For example, the Northeast now relies on gas for around 45% of its power. That's up from just 15% at the turn of century and has caused the local grid operator alarm. That's not a big issue for a utility like Consolidated Edison (NYSE:ED), which operates as a conduit for power. However, customers usually don't understand their electric bill. Consolidated Edison pretty much gets a set rate for the use of its wires, with the cost of power fluctuating and driving bills higher and lower in often dramatic fashion. For example, New York State Senator Chuck Schumer slammed Consolidated Edison for a 20% year-over-year increase in February.

Only there are times when higher costs can't be avoided because of the increasing use of natural gas. That's particularly true if you can't turn to more stable cost options like coal because companies like American Electric Power are shutting coal plants down. But this isn't about one company's decisions; similar choices are being made throughout the industry. In fact, according to New England's grid operator, the entire country now relies on natural gas for around 40% of its power.

Open waters
And that will be increasingly important for American Electric Power because Ohio, one of its key operating regions at 27% of its customer base last year, is shifting to competitive pricing. Coal will still make up the lion's share of the company's generation (it was 75% of the pie in 2013), but it too is increasingly shifting toward natural gas. It has no choice if it wants to compete in Ohio.

But American Electric Power's Akins pointed out in the first quarter that, "Ohio retail customers receiving generation service from Ohio Power during the transition to competition avoided $132 million in costs this quarter, compared to what they would have paid" in the competitive market. Why? Because American Electric Power was able to fire up coal plants that will soon be shut.

Source: AEP, via Wikimedia Commons.

Consolidated Edison, meanwhile, just took whatever power it could get. And that highlights a big difference between competitive markets and regulated markets. Being a low-cost provider of power in competitive markets is a necessity if you want to survive, because high prices during peak periods aren't enough to keep underwater plants running.

And that has increasingly meant more cheap gas plants even though there's a systemwide risk inherent to relying too much on just one fuel. Companies in regulated markets aren't under that kind of price pressure and can focus more on providing reliability across their entire operation. So, the biggest risk may actually be the unintended changes taking place across the industry, which American Electric Power and Consolidated Edison's bills prove is taking shape before our eyes. You might be better off sticking to regulated utilities if you want to sleep well at night.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

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Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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