Historically cheap natural gas prices drove down coal-fired generation in 2011 in the Midwest Independent System Operator region, and at Consumers Energy, and are expected to do so again at least well into 2012, said Consumers Energy official Richard Blumenstock.
Consumers Energy, a unit of CMS Energy (NYSE:CMS), on Feb. 20 filed supplemental testimony from Blumenstock with the Michigan Public Service Commission to describe changes in the Midwest Energy Market that have occurred since the original filing of the utility’s 2012 Power Supply Cost Recovery (PSCR) plan in September 2011. Blumenstock is the utility’s Director of Electric Sourcing & Transactions.
“Prices for electricity in the Midwest Energy Market over the last three months of 2011 fell to their lowest level since the inception of the Midwest Energy Market,” Blumenstock wrote. “The average electric price in the fourth quarter of 2011 was $28.08 per MWh. The lowest average electric price for any prior fourth quarter was $29.51 per MWh. The month of December 2011, in particular, had the lowest average electric price of any prior December since the inception of the Midwest Energy Market. The average electric price in December of 2011 was $28.05 per MWh, which is 17% below the previous lowest December average of $33.80 per MWh.”
The primary driver for these depressed electricity prices was the low price for natural gas, he added. According to the U.S. Energy Information Administration (EIA), the monthly average Henry Hub Spot Gas prices for September through December of 2011 were $3.90, $3.57, $3.24, and $3.17 per Mcf, respectively. Industry analysts attribute the price drop to a recent growth in natural gas production resulting from shale gas plays with high concentrations of natural gas liquids and crude oil. With such low fuel costs, gas-fired generators have incremental and average costs below generators having coal or oil as fuel sources. This results in MISO, the entity responsible for administering the Midwest Energy Market, committing and dispatching lower cost natural gas-fueled generators before higher cost coal-fueled and oil-fueled generators.
Consumers Energy expects prices for gas will continue to be depressed in 2012, Blumenstock added. The NYMEX futures for natural gas used in the company’s September 2011 filing of the 2012 PSCR plan were effective as of Aug. 29, 2011, and showed an average natural gas price for 2012 of $4.39 per MMBtu. The NYMEX futures for natural gas used in this Feb. 20 supplemental filing were effective as of Dec. 28, 2011, and showed an average natural gas price for 2012 of $3.35 per MMBtu. The EIA’s latest forecast issued in February calls for an average 2012 price of Henry Hub spot gas of $3.35 per MMBtu, which is 16% lower than the actual 2011 price of $4.00 per MMBtu.
Through September 2011, the Zeeland gas plant of Consumers Energy had a year-to-date utilization factor of 31%. The monthly utilization factors in October, November, and December of 2011 were 39%, 55% and 70%, respectively. Through September 2011, the company’s coal-fueled fleet of generators had a year-to-date utilization factor of 79%. The monthly utilization factors in October, November and December were 72%, 58% and 55%, respectively. “These trends in utilization factor clearly demonstrate that MISO utilized lower cost natural gas-fueled generation to meet electric demands,” Blumenstock said.
Consumers to bump up PRB coal use, take unit de-rates
One Consumers Energy response to this cheap-gas situation is that its coal-fueled generators will be operated using different blends of fuel depending on the variable cost of production and the relative value of energy. Second, the company’s coal-fueled generators are expected to experience increased cycling operations.
Prior to 1988, Consumers Energy operated its coal plants using eastern coal. Beginning in the mid 1990s, after considerable testing of the effect of western (i.e. Powder River Basin) coal on the operation of some of the company’s generating plants, the utility utilized a blend of eastern and western coal that reduced its cost of production while still achieving the maximum power output of each generating unit. From time to time, when market prices are below the cost of production for one or more coal-fueled generators, the company, on a temporary basis, successfully increased the amount of western coal in its fuel blends so as to lower its cost of production with a modest temporary reduction in maximum output The reason for blending coal in this manner is that the delivered cost of western coal, on a per MMBtu basis, is lower than the delivered cost of eastern coal.
“In 2012, during periods when electric prices are near or lower than the generating units’ cost of production, the company’s coal-fueled generators are expected to increase their use of western coal above the level where they can achieve full power output using only coal,” Blumenstock said. “This will have the effect of lowering the generator’s production cost and subsequently its price offer in the Midwest Energy Market for the operating range fueled by coal. Lowering the generator’s price offer makes the generator a more valuable resource to the Midwest Energy Market. Loss of the generator’s real power capability over the operating range fueled by coal will not be detrimental since electric demand during low electric price periods will be met by MISO through commitment and dispatch of lower cost generation resources.”
In 2012, on the other hand, during periods when electric prices are higher than the generator’s cost of production, the company’s coal-fueled generators are expected to increase their use of eastern coal to the level necessary to provide maximum output of the generating unit.
As for how Consumers will vary its coal blends, Blumenstock said that each day, by 11:00 AM, the company will forecast the next day’s market prices. If the forecasted prices are high enough to warrant the use of eastern coal at a given generator, the company will offer the generator based on a blend of eastern and western coal over the entire operating range of the generator. If the forecasted prices are not high enough to warrant the use of eastern coal at a given generator, the company will offer the generator based on 100% western coal up to the maximum real power capability achievable on 100% western coal. Some of the company’s coal-fueled units can produce additional real power in overfire operation. Where possible, the company will offer the additional real power from overfire operation to the Midwest Energy Market.
As for considerations for cycling of coal units, these units were originally designed for continuous, baseload operation. Consumers Energy intends to shut down coal units for extended periods when electric prices in the Midwest Energy Market are forecasted to be well below the cost of production for a unit. The company’s coal units are not feasible to cycle on a daily basis due to start-up times in the 24-hour range. MISO makes commitment decisions in the Day-Ahead Market based on a 24-hour operating outlook. This is not enough time to accommodate typical coal-plant start-up times.
Consumers works itself out of four eastern coal contracts
Also attached to the same Feb. 20 filing was testimony from Brian Gallaway, the Director of Fossil Fuel Supply in the Energy Supply Operations Department at Consumers Energy, on impacts of the U.S. Environmental Protection Agency’s Cross-State Air Pollution Rule (CSAPR) on the company’s coal-fired plants. CSAPR restrictions on SO2 and NOx emissions in eastern states were due to go into effect Jan. 1, but a federal appeals court has stayed the rule while oral arguments are made this spring on dozens of appeals of that rule.
The company’s SO2 emissions allocated under CASPR would require actual SO2 emissions to be reduced by about 15% in 2012 and 50% in 2014, Gallaway said. Because of the lack of time available to physically modify the power units to meet these requirements (through the installation of back end controls to remove SO2 after combustion), the company’s only option to meet the first stage emission reduction by Jan. 1 was to reduce the sulfur content of the fuel burned prior to the combustion process.
The only practical means to accomplish this is to reduce the fuel input in total, or by adjusting fuel blends to increase the use of lower sulfur western coal and decrease the use of higher sulfur eastern coal. Since the company already maximizes its use of western coal with the objective of achieving full unit capability when needed, any increase in western coal burn to comply with the CSAPR would result in generating units operating at a derated capacity, which Consumers Energy anticipated would translate into higher PSCR costs as the energy lost from that derated capacity is replaced with higher cost generation.
Prior to filing the 2012 PSCR plan in September of last year, the company had made contractual commitments for eastern and western coal at levels consistent with its normal purchasing strategy. To comply with the CSAPR, it would be necessary for most of the company’s coal fleet to operate at very high blends of western coal, greatly reducing the amount of eastern coal needed in 2012. This translated into an immediate oversupply of contract eastern coal and an undersupply of contract western coal.
To remedy this coal supply problem, Consumers Energy did not purchase fourth quarter 2011 spot eastern coal as it typically would have done. It also exercised an option with an unnamed eastern supplier to ship low sulfur coal rather than mid sulfur coal in 2012 by paying slightly more to reflect a difference in market price between the two coals. Another step was to mutually agree with an eastern coal supplier to discontinue all negotiations for an eastern coal commitment that had been planned for 2013 delivery. Consumers also delayed issuing a request for proposals for vessel delivery of eastern coal from Lake Erie ports to the B.C. Cobb plant.
After the September 2011 PSCR filing, discussions continued with the eastern coal suppliers with 2012 commitments in an attempt to reduce or eliminate the company’s contractual obligation to take the coal or to reduce its sulfur content. Items considered to accomplish this included: terminating the agreement(s) with the suppliers’ consent; converting a higher sulfur eastern coal to lower sulfur eastern coal; converting a higher sulfur eastern coal to a lower sulfur western coal (for suppliers that had coal to offer in both the eastern and western markets); sell coal back to the supplier; or, where suppliers were willing, sell the coal to a third party trader.
“As could be expected, this was a difficult task because the CSAPR was causing a great deal of uncertainty in the eastern coal market,” Gallaway added. “That market was becoming stagnant because of the uncertainty. Also contributing to the stagnation of the eastern coal market was the fact that the industry was beginning to get some indication of what SO2 allowance prices might be, even though the market was still developing. Speculation that SO2 allowance prices in 2012 could be several to many thousands of dollars per ton significantly impacted the price and trading volumes of eastern coal in the market. As a result, eastern coal spot prices have fallen from approximately $81/ton at the time the original 2012 PSCR plan was prepared, to under $70/ton as of the time that this supplemental direct testimony was being prepared, and are currently in the mid $60/ton range.”
Force majeure not an option for targeted coal contracts
Gallaway said he has been told by company counsel that all of the Consumers Energy eastern coal contracts have force majeure provisions that, under certain circumstances, would excuse the performance of a party under the contract in the event of the occurrence of certain stated events that are completely outside of the party’s control that prevent performance. These events are typically natural events or so-called “Acts of God,” but the definition of force majeure may also include government-imposed rules and regulations.
“I am further informed by counsel that force majeure clauses typically do not extend to circumstances that only lead to less than desirable economic consequences for either party,” Gallaway added. “For example, if the EPA through the CSAPR had outlawed the burning of the higher sulfur eastern coal, then it is possible that the company could have declared force majeure and may have been excused from performance under the contract. However, the CSAPR did not outlaw the burning of higher sulfur eastern coal, but instead made it more expensive to burn it. Hence, coal suppliers could argue that the company’s efforts to reduce or eliminate higher sulfur eastern coal burn is a negative economic consequence rather than a valid force majeure event.”
Of the five eastern coal deals identified to be in effect for 2012, Gallaway said the company was successful in negotiating termination arrangements with four of them. The total eastern tonnage removed from the 2012 PSCR plan affected by these agreements is 803,000 tons and the contractual purchase obligation eliminated is about $58.9m. To be excused from this contractual obligation, the company agreed to pay termination fees totaling $1.7m. The agreement with one of the suppliers also required the company to purchase 187,500 tons of western coal in 2012 as part of the settlement.