Ashby Foote III , President, Bigger Pie Forum | 18 July 2013
To Civil War buffs the irony is clear – on the 150th anniversary of the Battle of Vicksburg, Mississippi Power (MP) is a company under heavy siege. In the past two months MP has seen a $540 million dollar write-off, key executives canned by its parent, Southern Company, document disputes with the Public Service Commission (PSC), rising discontent from customers over new rate hikes and formidable legal challenges before the Mississippi Supreme Court.
The source of this trauma is MP’s experimental and cost plagued lignite gasification plant in Kemper County. Brandon Presley, the one PSC Commissioner who has consistently voted against Kemper said recently, “This is the greatest transfer of wealth from customers to a monopoly in the history of the state.” Them are fighting words for citizens of the ‘Free State of Jones’ and 22 other counties in Mississippi Power’s service area – and those folks don’t forget easy! In what may be an omen, the hasty exit of MP’s president in mid-May came almost exactly 150 years after Mississippi Governor John J. Pettus was chased out of Jackson by General Grant’s Union troops. In the days that followed, Jackson burned until only the chimneys were left standing.
How did an 88 year old company with monopoly status, selling a service everyone needs get in such deep trouble? That is the $4.6 billion question.
Some context on the electricity business is helpful. The electrification of America began in the 1880’s with Thomas Edison’s memorable quote, “We will make electricity so cheap that only the rich will burn candles.” Edison understood that low prices are the best way to grow new markets with bigger volumes and greater profits. Edison’s vision has been validated. The inflation adjusted price of electricity declined by 97% as electrification transformed the 20th century economy. Such is the nature of progress – advances in technology and innovation create new abundances which in turn bring lower prices and greater prosperity.
But the narrative from MP and Southern Company since the beginning of the Kemper project has been just the opposite. In a March 2010 media interview, Anthony Topazi, then president of MP, stated, “Rates are gonna go up about a third. They are going up a third whether I buy somebody’s gas, whether I build gas or whether I build Kemper.” What Mr. Topazi and MP missed, or chose to ignore, was the biggest breakthrough in the energy field in the past thirty years. In 2010, innovative drilling techniques in shale were already unleashing vast new reserves of natural gas and, with them, sharply lower prices in this important fuel. Due to this shale gas revolution, the price of a kilowatt hour has been little changed since 2010 and the U.S. Energy Information Administration expects it to rise by just 10 to 15% over the next thirty years.
Two pivotal hurdles now face MP, the PSC and MP’s customers – the Seven Year Rate Plan and ‘prudency approval’ for the billions of capital invested in Kemper.
The Seven Year Rate Plan covers the first seven years of operation of Kemper and the system wide rate increase being proposed is 22%. One would assume that the 22% will cover all the costs over those 7 years, but read the fine print and you’ll find some gnarly details for rate payers. Any Kemper costs above the new rate over the 7 years go into a special “accrual account” on which MP earns 7%. In year 8, the “accrual account” and its earnings roll over like a mortgage balloon to be added to the next rate plan. The effect of this arrangement is to make the proposed 22% rate a “teaser rate,” not unlike many of the below market mortgages of 8 and 9 years ago that lured home-buyers into buying more home than they could really afford. Those teaser mortgages further inflated the housing bubble and made the ensuing busts in housing and banking even more catastrophic. Will the Kemper “accrual account” balloon bust the budgets of rate payers when it rolls over in year 8? It is quite likely.
The prudency hearings were originally scheduled for the first half of 2013, but, due to the litany of MP problems already mentioned, they have been postponed. This is good news, but better news would be to postpone prudency until the plant is complete and MP can prove it will work as advertised. The real world experience of two similar plants suggests that start-up will be challenging and costs will continue higher.
The Red Hill Power Plant in nearby Choctaw County is also owned by Southern Company, although it produces power for TVA. It was built in 2002 and, like Kemper, uses local lignite, although the plant is much simpler – there is no gasification. Red Hill’s operating record has been spotty and woefully below the reliability necessary for the base-load status expected of Kemper. Even now, ten years after start-up, Southern Company is investing millions more in Red Hill to improve its meager performance. A key lesson from Red Hill is that lignite is cheap for a reason. Processing low grade coal comes with its own set of difficulties in the areas of operation, maintenance and up-time.
In 2012 Duke Energy brought online a coal gasification plant in Edwardsport, Indiana. Duke’s plant had similar cost overruns to Kemper and Duke was forced to write off $900 million. Even though the plant uses higher grade coal, it has only run continuously for four days during its first six months of operation. The rate increase for Duke was 14-16%, much smaller than Kemper’s proposed hike because the capital expense deemed prudent was less and costs are spread over a 700,000 customer base, more than three times MP’s 186,000.
Diversification of fuel types is a justification offered for Kemper’s experimental and expensive effort to turn lignite into electricity. But the high cost of Kemper violates another tenent of diversification – not concentrating too much capital in a single investment, especially if it is a first of its kind project. As it now stands, MP has approximately 80% of its equity in an experimental plant that in the best case will only account for 18% of MP’s megawatt capacity. This is a dangerous concentration that threatens the solvency of MP. In fact, were it not for $1 billion in recent equity infusions and another $540 million write-off by its parent, Southern Company, MP would be in violation of loan covenants and possibly in bankruptcy today. Would a MP bankruptcy turn off the lights in south Mississippi? No, during the post Katrina period Entergy New Orleans went into bankruptcy with no effect on the availability of electricity.
The inescapable problem with the Kemper project is that it is an extremely expensive way to make electricity. Gasifying lignite, while novel is not the cutting edge breakthrough some suggest. The Germans gasified coal during World War II, but primarily as a way to ensure a captive source of fuel. Think of gasification not as the next big thing, but rather as a last resort.
A simple look at the kilowatt cost at the busbar (where the electricity comes out of the plant) tells the tale. According to the latest SEC filings and verified by MP president, Ed Holland, MP is seeking prudence approval for $3.75 billion. With that upfront cost and assuming no start-up problems, 7 years of electricity from an approved Kemper IGCC plant would cost $2.61 billion. Compare that with a same capacity natural gas plant that costs just $600 million. The cost of 7 years of electricity at the natural gas plant would total $819 million. The difference between the two options for the same everyday electricity is a stunning $1.79 billion or $255 million per each of the 7 years. Profit wise, an approved Kemper IGCC plant would generate $715 million in total profits for MP over 7 years while the profits from natural gas plant would total $240 million. That helps explain MP and Southern Company’s determination to see the Kemper plant through.
The Kemper project was not economical or prudent when first proposed and is even less so now – by billions of dollars. MP has spent way to much to produce way too little electricity to be paid for by far too few customers. In so doing they have breached their duties as proscribed in Mississippi Code 77-3-2, to provide “adequate, reliable and economical service to all citizens and residents” of its service area.
A logical solution to this perilous predicament is to burn natural gas in the Kemper turbines for electricity and to turn over the ownership, responsibility and costs of the experimental side of the Kemper project to the Southern Company. Such a move should negate any need for rate increases for MP customers.
Such a plan would not be well received by Southern Company CEO, Tom Fanning, who has been an ardent and outspoken advocate for the Kemper project, promoting it as “21st century coal”. The folks in south Mississippi have heard that siren song before and recognize it for what it is. Kemper isn’t 21st century coal, its 21st century carpet-bagging.