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Factors Driving Rate Increase
Dairyland Power Cooperative-January 2009
What factors are driving the recent rate increases?
While each utility is impacted differently, there are five significant factors that are the major drivers behind the cost increase for Dairyland. Taken individually, each of these factors is significant, but collectively they present Dairyland and all utilities with substantial challenges.
1. Coal fuel costs, including:
A) Expired long-term coal contracts. The expiration of one of Dairyland's long-term coal supply agreements at the end of 2008 played a large role in driving up 2009 costs. Current market prices are well above the expired contract price.
B) Demand for coal. Foreign demand and continuing domestic demand, as well as market discipline by the coal companies desiring top dollar for their coal reserves, have kept coal prices high. These factors have increased the price and impacted availability of certain coal types used at Dairyland facilities. However, even with falling natural gas prices, it is still generally less expensive to produce electricity from coal.
2. Fuel transportation costs, including:
A) Higher costs to deliver coal by barge. Barge freight costs are being impacted by declining southbound barge agricultural shipments from the Upper Midwest, which in turn increases costs to ship northbound coal. Carriers have traditionally shipped coal one way up the river, then grain on the way back. The market has seen more agricultural products stay in the upper Midwest, such as corn being used in recently constructed ethanol plants. Without the return grain shipment, the coal carrier-and therefore, the receiver- must absorb the full round trip cost of moving empty barges south.
B) Continuing issues with railroad monopolies. A lack of rail competition and little or no regulatory oversight maintains rail companies' market power over customers who have no real alternative for shipping. Dairyland continues to work with member cooperatives, legislators and other industries to establish just business practices between railroad companies and their customers. Senator Herb Kohl (D-WI) and Rep. Tammy Baldwin (D-Madison) have introduced legislation which would help level the playing field and make rail service more competitive, but railroads are expected to fight the bill in Washington.
3. Nationwide economic downturn and the accompanying "credit crunch." Dairyland and other utilities must still cover business costs, while seeing reductions in the amount of electricity used by consumers during the recession. Additionally, creditors are limiting loans out of caution or an inability to provide the funds.
4. Major emphasis on investments in environmental controls, renewable energy resources & conservations programs. Dairyland has committed over $350 million for a 10-year program of upgrading existing facilities to meet state and federal environmental laws. Dairyland is also aggressively expanding its renewable facilities and increasing the funding for energy conservation. While renewables and energy efficiency are positive additions relating to our environment, these projects often cost more than traditional fuels, causing immediate upward rate pressure. Dairyland also needs to add transmission and other facilities to deliver the energy.
5. New generation. Dairyland's 30 percent ownership of the new 525 MW Weston 4 power plant is critical to ensure an adequate supply of electricity to our members. Weston 4 came online in the summer of 2008, adding needed energy into the Dairyland system, along with the associated additional capital costs. On the other hand, it helps Dairyland avoid having to purchase even more expensive energy from the wholesale power market.
Are all utilities facing these rate pressures?
Yes, to one degree or another. Take the recent increase in coal and transportation costs. Obviously the amount and mix of a utility's generation resources will have a direct impact on the effect that these coal costs increases will have on a utility's rates. For example, since Dairyland's generation mix is predominately coal-fired, the coal mine and delivery cost increases have a large impact on Dairyland's wholesale rates, both from the cost of fuel standpoint and from the large investments required for environmental controls. Contrast these impacts with those of a utility that has a larger share of natural gas-fired generation. In a period of less than a year, this utility would have seen natural gas fuel costs more than double only to quickly fall back to earlier levels.
Notably, it is still more expensive to generate electricity using natural gas, even though the costs to do so have come down recently. Some utilities have been able to hold down rate increases this year because of that natural gas cost relief, but they likely had significant increases in the recent past as the price of natural gas went up.
This simple example points out the differences between fuel sources that utilities must carefully manage with the use of long-term supply contracts and risk mitigation techniques to avoid undesirable large swings in fuel costs. Also, some electric utilities still have lower-cost, older coal rail contracts in place, which are bound to go up significantly when they expire. Dairyland had advantageous rail contracts which expired by 2006. Dairyland's below-market coal and barge contracts expired at the end of last year, presenting us with significant cost increases.
Additionally, it is safe to say that all utilities, large and small, are dealing with the impacts of the nationwide economic downturn, including the significant reduction in electric demand and power sales as well as the increase in borrowing costs brought on by limitations in the credit markets. This means that they have to cover their fixed costs with fewer sales, creating potentially higher rates.
Why have oil & gasoline prices declined and electricity has not?
Much of the fossil fuel complex (including oil, gasoline, diesel fuel and natural gas) can be bought and sold on world wide commodity markets. While these markets permit broad transparency and liquidity, they are also subject to the same volatility and irrational behavior as other capital markets.
The coal and coal transportation markets on the other hand are mostly purchased from suppliers on longer term contracts. While these contracts can be less volatile than the commodity markets, they tend to "lock in" a position for a longer period of time. And, since about half of the electricity produced in the U.S. is from coal-fired generators, retail electricity will not respond to market forces as quickly as oil or diesel fuel. It is commonly understood that between 80-90% of the coal delivered in the U.S. last year was actually contracted for and priced one to five years ago.
Are these impacts temporary or long term?
Along with all Americans, Dairyland is certainly hopeful that the recession will subside and a strong economy will once again emerge in the near term. However, history has proven that the impacts of serious recession can be longer-lasting than anticipated. Therefore, to protect our membership, Dairyland is planning conservatively. A capital project budget review process was formed in 2008 to determine where Dairyland could curb costs to help minimize a rate increase to members. As a result, Dairyland has prioritized construction projects and is delaying many projects that, although beneficial, are not absolutely critical.
In terms of the environmental control equipment expenditures, it is anticipated that these will be long-term investments which will likely only increase as new regulations come into place. All utilities are planning for increased renewable energy resources and increased spending on environmental control equipment far into the future. This is a business reality for all utilities, as legislators and the public embrace renewable energy resources and the growing concern for global warming potentially encourages new regulations, which add cost.
What is Dairyland doing to address these cost challenges?
As noted above, Dairyland has established an aggressive capital project budget review process, which has led to significant savings in a variety of areas for 2009. Dairyland's government relations team, joined by Board members, cooperative managers and distribution cooperative board members, has been lobbying the state and federal governments for reasonable environmental regulation and for more competitive rail and waterway policies to reduce our transportation costs. Management also continues to look for operational savings to cut costs in manageable areas.
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Chippewa Valley Electric Cooperative | P.O. Box 575 | Cornell, WI 54732
Phone (715) 239-6800 | (800) 300-6800 | Fax (715) 239-6160
Office Hours: Monday through Friday (7:30 AM - 4:00 PM)
Send any webpage comments or CONTACT us at cvec@cvecoop.com