A commentary by Michael Vickerman, Director, Policy and Programs at RENEW Wisconsin:

Shock waves reverberated across the Upper Midwest when Dominion
Resources announced in late October that it would permanently shut down its
Kewaunee nuclear generating station in early 2013.
Operational since 1974, the Kewaunee station, located along
Lake Michigan 30 miles east of
Green Bay, currently
generates about 5% of the electricity that originates in

Virginia-based Dominion, which bought the 560-megawatt Kewaunee plant
in 2005 from two
Wisconsin utilities, attributed its
decision to its inability to secure long-term power purchase agreements to keep
the plant going. Without securing purchasing commitments from utilities,
Dominion would have to sell Kewaunee’s output into the regional wholesale
market at prices well below the plant’s cost of production.

While the pricing environment for all bulk power generators is nothing
short of brutal these days, Kewaunee carries the additional burden of being an
independently owned power plant, since the entities most likely to buy
electricity from that generator—utilities–have power plants of their own that
compete for the same set of customers. And a growing number of these
utility-owned generators burn natural gas, which is currently the least
expensive generation source in most areas of the country.

Dominion’s decision comes down to simple economics. Wisconsin utilities
believe that over the foreseeable future natural gas will remain cheap and
supplies will remain abundant. That would explain their unwillingness to enter
into long-term commitments with Dominion, even though Kewaunee recently
acquired a 20-year extension to its operating license and does not need
expansive retrofits to comply with environmental standards, unlike a host of
utility-owned coal plants in

But even if Dominion’s managers were convinced that natural gas prices
have nowhere to go but up in 2013 and beyond, the company, lacking a retail
customer base in the
Midwest, could not risk
producing power below cost while waiting for the turnaround. 

Wisconsin utilities have placed heavy bets on
natural gas in the expectation that it will remain the price-setting fuel for
years to come. Over the last 12 months, they have bought several combined-cycle
generators from independent power producers. Buying power plants enables them
to pass through their acquisition and operating costs directly to their
customers while generating returns to their shareholders. I suspect these
utilities are anything but broken up over the impending demise of a nonutility
competitor that could have supplied electricity to
Wisconsin customers for 20
more years. 

But there is another side to this story; the low-price energy future that
Wisconsin utilities are embracing can only materialize if
natural gas extraction companies continue to sell their output below production
costs. This expectation is unrealistic, given the massive pain being inflicted
on these companies in the form of operating losses, write-downs, and credit
rating downgrades.

Don’t just take my word for it, ask 
Exxon Mobil ceo Rex Tillerson, whose company spent $41 billion during
the shale gas boom to acquire XTO, a large gas producer that is now yielding
more red ink than methane. As reported in a recent New York Times article,
Tillerson minced no words in assessing the impact of its recent misadventures
on the company’s bottom line. “We’re all losing our shirts today,” Tillerson
said. “We’re making no money. It’s all in the red.”

Much of the industry’s woes are self-inflicted. The lease agreements
that drillers eagerly signed during the height of the shale gas boom obligate
them to extract the resource by a certain deadline, regardless of whether such
activity is profitable. That these companies cannot disengage quickly from
existing leases is greatly diminishing their appetite for exploring new natural
gas prospects. Until a pricing turnaround occurs, they will refrain from
spending money on exploring new resource provinces like Ohio and Michigan.

Sooner or later, this slowdown in exploration activity will tip the
supply-demand equation in the opposite direction, resulting in
lower-than-average gas storage volumes. Barring a repeat of last winter’s
unusually mild weather, the crossover point should occur around January 1st
. But with so many balance sheets in tatters from this highly unprofitable
market environment, nothing short of a strong and sustained price increase will
be required to persuade drillers to start taking risks again. 

When this corrective price increase begins rippling through the
electricity markets, it will be interesting to observe how the customers will
respond. Right now Wisconsin utility managers are convinced that they are
making the right call on natural gas. So completely have they swallowed the
shale gas “game-changing” mystique that they were willing to let a 560 MW
nuclear plant fall out of the supply picture for good. In this brave new world
of theirs, gas is the new coal, and resource diversity is passé.

In the aftermath of Dominion’s announcement, a few commentators have
defended the impending closure as a textbook example of how markets work. But
this view ignores the delusional thinking that sent shale gas extraction into
overdrive, causing prices to plunge below the cost of production. The real
game-changer, as it turns out, here was not the emergence of “fracking”
technology but the industry-generated public relations campaign that implanted
the narrative of a nation awash in cheap natural gas into virtually every
American cranium. But as we now see, this narrative has boomeranged on the
natural gas industry, and they are paying for their current woes in ways that
guarantee a pronounced pendulum swing in the direction of higher prices.

The question going forward is: will this narrative also boomerang on Wisconsin electricity
users, after the last employee leaving Kewaunee turns out the lights?
Michael Vickerman
is program and policy director of RENEW Wisconsin, a sustainable energy
advocacy organization. For more information on the global and national
petroleum and natural gas supply picture, visit Madison Peak Oil Group’s blog: http://www.madisonpeakoil-blog.blogspot.com.