Fuel Switching Is Not So Easy

on October 15, 2012 at 8:30 AM

In the United States, utilities have been switching fuels for the power generators. While many commentators believe the motivation to switch is regulatory, the primary incentive is economics.

Of course, the Environmental protection Agency’s (EPA) new coal and coal-fired power plant rules influence a utility, but the markets are the primary driver behind utilities to seek fuel options. EPA’s rules are not the prime mover, at least not now.

The issue is the profitability. Most power plants are unprofitable some of the time. The owner’s challenge is to manage the financial spread between fuel costs and power prices.

It’s All About the Spread

In energy economics, the spread is a power plant’s gross income produced by the sale of a unit of electricity, less the cost to produce that electricity. Production costs include the cost of coal and other marginal costs to take the plant from standby to energy production mode. All other maintenance, capital and operational expenses must be earned from the spread.

It is not just financial; it is also physical. The power plant’s efficiency is critical to competitiveness. Inefficient plants use too much fuel to produce electricity. As such, they destroy the spread.

With a zero or a negative spread, generators would incur higher costs than any revenues they would receive and they would be subsidizing the market. As such, if the spread remains too low, plant managers keep generating assets on standby and they refrain from producing.

For many coal plants, market prices for wholesale power have remained too low. The difference between their production costs and market prices for their product have been thin to nothing. For them, the dark spread has remained unacceptably low.

Unfortunately, owners of coal-fired power plants cannot easily switch fuels. A coal boiler is designed to burn coal, not natural gas. Even if a coal plant was modified to accept natural gas, the resultant fuel efficiency would be horrible and production costs would remain elevated.

If they want to switch fuels, most utilities only have two options. They can build new power plants, or they can bias their fleet to favor one type of plant over another. The latter assumes the utility already has a fleet of diverse power plants; most do not.

If the new plant option is selected, there will be significant capital expenditures and time delays before a new power plant can be added to the fleet. From concept to commercial operations, it would take most utilities about four years to build a new power plant.

Location, Location, Location

But it may not be economic to switch fuels. According to the Energy Information Administration (EIA), the average price of delivered coal varies widely across the country. When the average electric US utility paid $3.49 per million British thermal units (MMBtu) for delivered natural gas, hundreds of generators in dozens of states paid much less for coal:

Source: EIA

Finally, it is not only about fuels. It is also about efficiency. Most coal-fired power plants use inefficient boiler technology. They convert the energy in coal to steam energy, reconvert steam energy into mechanical energy and reconvert mechanical energy into electric energy. Every conversion costs energy, and as such, boiler technologies are inherently inefficient.

In fact, EIA reports the average US-based coal-fired power plant has an efficiency of approximately 10,500 Btu per kilowatt-hour. The multi-step process of converting coal into electricity loses almost 70 percent in the process. Until they can harness coal gasification, the coal industry is hopelessly tethered to inefficient boiler technologies.

Alternatively, General Electric and Siemens have developed new combined cycle gas turbines, which eliminate several steps and their gas turbines can efficiently convert natural gas into electricity. GE has on-the-shelf gas turbines (MS9001H/MS7001H) that can achieve 5,690 Btu/kilowatt-hour, or almost 60 percent efficiency. Siemens offers competing gas turbine technologies.

So the spread between fuel costs and power prices is influenced by plant efficiencies. It is possible for efficient plants, which use expensive fuels, to outperform inefficient plants using cheap fuels. The power markets sort all this out and reward cost leaders with profitable margins.

This explains why most fuel switching taking place today is on the margins. The very inefficient coal plants, those on the upper ranges of the 10,500 Btu per kilowatt-hour average, are motivated by market forces to consider retiring permanently. At the same time, regulated utilities in the nation’s high-cost coal regions, such as Dominion Resources, Duke Energy and NextEra Energy are motivated to invest in new and efficient gas turbine projects.

Over the long term, switching will take place slowly. But there is a limit. Efficient and low cost coal will remain in the power production mix, particularly in regions where there is limited access to natural gas.