Wednesday, March 26, 2008

Let's drive electricity prices into the ground

Read this report. It's basically a big apology for why electricity prices have been going up.

On page 31, it shows the EIA estimate that a 10% increase in the price of electricity in 2006 would cause a 4% (175 billion kWh/year) drop in electricity demand in 2014, down from 4.2 trillion kWh/year. This is basic supply and demand, with the EIA doing the error-prone work of predicting the demand curve in the future. The first thing I'll note here is that a 10% price increase, coupled to a 4% sales drop, leaves a 6% revenue increase (at least $12 billion/year) coupled with decreased costs for the folks selling electricity. It's an inelastic demand curve. So, if the folks making electricity can do anything to reduce the overall supply, it's well worth their effort.

When the price of electricity goes up, some of that reduction in demand is accomplished by economic activity (buying a more efficient air conditioner), and some is accomplished by reducing economic activity (shutting down the night shift of a marginal plant). Overall, how much of each? My guess is that the reduction in economic activity is the main reducer of demand. Let's suppose I'm right, and that a 4% drop in electric demand is accompanied by a 1% drop in GDP. That's a $130 billion dollar drop.

You can see that price fixing among electricity producers would be seriously damaging to me and you. It is in the national interest that electricity prices not rise 10%. Note that this is true regardless of whether the utilities make or lose money, because as a nation we are making or losing quite a bit more money than the utilities are.

So let's consider a different investor, the U.S. government. Suppose that the electric demand curve slope is locally smooth. A 10% decrease in the cost of electricity, then, should lead to a 4% increase in sales, and a corresponding 1% increase in GDP. This is what Rod Adams is talking about when he calls electricity an economic lubricant.

How much is that 1% increase worth to the federal government? They tax the GDP at about 18.4%, so it's worth around $24 billion per year. To review:
  • A 10% decrease in the cost of electricity, from $0.07/kWh to $0.063/kWh, would lead, 10 years later, to
  • ...a 4% (175 billion kWh) increase in electricity sales, for a net revenue loss to the industry of
  • ...$12 billion/year. The federal government, however, would be raking in an extra
  • ...$24 billion/year, and the rest of us would be enjoying an additional
  • ...$130 billion/year in GDP.
Sounds good. Let's mandate a drop in prices! Who says we can't have a centrally controlled command economy?

Well, it's not that simple. First, we need to know much investment is required to drive electric prices down 10%. Presuming that the government has to somehow compensate utilities for taking a $12B/year hit for the team, that leaves $12B/year to pay for the capital required. The federal government currently borrows money for 30 years at 4.5% (they are a better credit risk than you), so the capital required for this investment had better be significantly less than $266B.

The Palo Verde nuclear power plant supplies power for $0.027/kWh, including operations (fuel), maintenance, and interest and depreciation costs. In 2002, the marginal cost (not including capital) was 42% less than that for coal in the area, and since then the difference has increased as coal costs have risen. This is the best lever we can use to drive down electricity prices.

To drive down wholesale prices by 10%, we'd need to bring the cost of production down approximately 10%. Using the Palo Verde area numbers from this report, and assuming we keep the same coal and hydro production (as they are both low cost), but reduce gas and increase nuclear, we'd need 49 gigawatts of new nuclear production nationwide. That's not going to happen by 2014, but we would probably see some fraction of the benefit for some fraction of the cost. Just incidentally, 49 gigawatts of new nuclear production scaled up from Palo Verde's employment base is 89,000 extra jobs here in the U.S., paying an average of 13% more than the average American salary.

Palo Verde cost $5.9 billion, was finished in 1988, and has a peak capacity of 3.72 GW and sustains a capacity factor in excess of 90%. We would need 13 more Palo Verdes to produce enough electricity to make that 10% cost reduction happen, at a present-day cost of around $120 billion [edited; thanks]. The generating utilities are not going to take this on, given that the "benefit" is a $12 billion/year loss to them. But for the U.S. government, looking at $24 billion/year in increased tax revenue, the cost of the plants is easily worth it. What remains is determining a way to have the government provide the capital and offset the revenue losses associated with a huge expansion of the nuclear reactor fleet, without getting ourselves further into the management disaster of a command economy.

I'll note that we're going into a recession, and interest rates are falling. This is a good (cheap) time for the government to borrow a bunch of money to invest in long term economic infrastructure. The reactor buildout I'm proposing would cost about the same as the $300/person economic stimulus package our leaders just conjured up. To my mind, the difference is very much teaching a man to fish versus giving him fish.