II. What is the local economic benefit of the proposed power plants?

A. Would electricity become cheaper?

The proposed power plants are not likely to cause prices to decline. Electricity prices in Vermont may or may not decline in coming years, but these future prices will not be affected by the fate of the proposed power plants. In the short term, prices may be affected by renegotiated contracts with Hydro Quebec or alterations in contracts with Vermont Yankee, should that plant be sold. In the long run, prices will follow the marginal cost of new capacity and reflect wholesale prices throughout the New England power market. Therefore, potential lower prices in Vermont in the future will not depend on these proposed plants.

First, let us consider the components of current electric rates. Typical unbundled rates for an electric utility in Vermont might be similar to what is shown in the table below, which in this case totals 11.2 cents/kWh, the actual average retail price of power in Vermont in 1998. The price of generation currently makes up much more than half of the total rate. However, the rate component that the proposed power plants would "compete" against in the future would only be a portion of the current generation rate - the market price portion - because the rest would be collected as stranded costs if restructuring of the electric utility industry were to occur in Vermont.

Price Component	Cents/kWh
Customer charge	0.5
Distribution	2.5
Transmission	0.5
Generation	7.7
TOTAL	11.2
Market price of generation	4.0
Stranded cost	3.7

The lower portion of the above table shows how the current 7.7 cent/kWh cost of generation might be divided between the market price of generation (4.0 cents/kWh) and the remaining stranded costs (3.7 cents/kWh).

Vermont Energy Park Holdings (VEPH) claims that they could sell electricity for 3 to 3.5 cents per kilowatt-hour. Since this figure is lower than the current average generation charge for Vermont electric utilities, it may seem like the economic benefit of the proposed plant is obvious and that electricity prices would be lower in Vermont if the plants were built. This will not be the case. There are five main reasons for this:

1. There is no reason to believe that the price of power from these new units would be less than that offered by other new generating plants. New gas-fired combined-cycle capacity can be built anywhere in New England and still have essentially the same effect on market prices in Vermont, since there is a regional wholesale electric market in New England. In fact, other new gas-fired combined-cycle units in New England are already under construction and could provide power to Vermont much sooner than the VEPH plants. The Independent System Operator for New England is performing a mandatory system impact study for a large number of proposed power plants. The combined generating capacity of these proposed plants under review is in excess of 27,000 MW, which exceeds the current peak load in New England. Most of these plants are to come on line in next two years, and all before the end of 2002. Of this amount, system impact studies for little over 6,100 MW of capacity have been completed. Since the system impact study for the VEPH plants were withdrawn, sponsors of the project would have to submit for a new study and thus fall to the back of the line as all studies are performed by the order in which they are received by the ISO.

2. Prior to restructuring there is little need in Vermont for the power from the proposed VEPH units. Most of the current electric load in Vermont is served by existing generating plants, owned by the utilities, or by external purchased power contracts. About a third of all electricity comes from Hydro-Quebec and those contracts are scheduled to be in effect for another 12-15 years, unless the contracts are changed. Another third comes from Vermont Yankee, which has an operating license in effect until the year 2012. In fact, only a small portion of Vermont's total load could be served by new plants in the short term because of existing long-term electricity supply commitments.

As long as restructuring does not occur utilities will need to continue to sell their own generation to local load. Without restructuring, no other suppliers can serve this load. Therefore, new generating capacity can only serve additional demand as it grows over time. Serving this small portion of total load will not be enough to lower the average cost of generation significantly, even if the cost of that new output were considerably lower than current prices. For example, if 10 percent of the state's total load could be served by new generation at 3.5 cents/kWh in place of 4.0 cents/kWh out of a total rate of 11.2 cents/kWh, the average system-wide savings would be only 0.4 percent (0.5 cents/kWh savings on generation for 10 percent of energy purchased). But, again, any new gas combined cycle plant in New England would have the same effect.

Current talk about possible renegotiations of the Hydro-Quebec contract would not change this. If the contract obligation is suspended, the power from Hydro-Quebec will still be highly competitive on a cost basis with any alternative sources since Hydro-Quebec could probably under-bid new generation. The low inherent cost and the fact that the transmission lines built to carry HQ power enter New England via Vermont makes this energy source very competitive in Vermont for the long-term, despite the current high contract prices. Whether the current contracts prevail or are renegotiated, Hydro-Quebec power is likely to remain a sizable share of the Vermont electricity supply.

If Vermont Yankee is sold to AmerGen under the terms of the agreement pending before the PSB, the long term power contracts contained in the agreement will continue to commit Vermont utilities to purchasing approximately one-third of their power from the reactor. If for whatever reason the sale does not go through, the status quo will remain.

In reality, Vermont already is in the middle of a deregulated market and a new owner of Vermont Yankee, in the absence of a special contract for the output of the plant, would be free to sell its output elsewhere. Most importantly, the owners of the proposed power plants in Rutland and Bennington would have the same freedom to sell electricity in the competitive wholesale market without regard for the needs and interests of consumers in Vermont. Therefore, building those gas-fired plants would not alleviate any potential problems that might arise from the sale of Vermont Yankee and the sale of the plant would not make the proposed gas plants more attractive.

3. Even if the wholesale price of electricity from these plants could be as low as 3.0 to 3.5 cents/kWh, the average retail price of electricity in Vermont would be higher. When VEPH suggests that it can sell electricity at these prices, they are referring to wholesale prices for baseload power. These price projections are not unreasonable in that context. However, the price would have to be adjusted for the average load factor of the area being served to estimate the actual price facing consumers plus transmission losses. It is possible that a large industrial facility would be charged little more than 3.5 cents/kWh for electricity from the proposed plants if its load factor were very high. However, residential customers would have a much higher load factor, and that fact would have to be reflected in the wholesale price to those customers. For example, if the capacity cost of the plant turns out to be $65/kW-year, the wholesale price to residential customers who collectively had a load factor of 45 percent, would have to be at least 0.7 cents/kWh higher than for an industrial plant with a load factor of 80 percent. Therefore, the baseload power (at 3.5 cents/kWh) is always going to be less expensive than the average cost of power for serving the entire load including peak demands. The modest 0.4 percent savings referred to in the example above are dependent on a price of 3.5 cents/kWh. At a higher price that reflects average load factors, the savings would be even smaller.

4. If restructuring occurs, electric rates will not be lower, on average, because stranded costs will also be recovered from ratepayers. If Vermont decides to restructure the electric industry and institute retail competition, consumers would have a choice among supplies of electricity from other sources than those owned by the utilities. In this instance, a greater portion of the proposed plants' output could be sold in Vermont in the near term than under the current regulatory structure. If the owners of the proposed plants were to offer highly competitive prices for generation, this might appear to reduce the average price of generation. But it is not that simple. All consumers of electricity in Vermont would be obligated to pay some, or all, of the stranded costs of the regulated utilities. Therefore, consumers might not see any savings for years to come, even though the proposed plants would provide electricity at a price that is well below the current statewide average for generation. (Stranded costs, by definition, just make up the difference.) This effect is demonstrated in a simple fashion in the table above, leaving the customer with no net benefit, at least until stranded costs are recovered. In other words, restructuring would allow more local load to be served by the new plants, but they would not affect the price paid by consumers much because existing utilities would collect the difference in the form of stranded costs. Also, other new plants would charge the same wholesale prices as the proposed plants.

5. Even if restructuring occurs in Vermont, most of the power from the proposed plants would not be able to serve Vermont. Electricity demand growth in Vermont is not large enough to absorb much of the added capacity of the proposed plants in the near future. The combined capacity of the new plants would be about 60 percent greater than current total statewide demand. The state would require less than 20 percent of the output of the new plants to meet the entire growth in electricity demand over the next 15 years, at current estimates. Apparently, the proponents of the projects have not offered any support for their claim that new industry and commerce will be attracted to Vermont due to these particular plants, as opposed to other new combined-cycle gas plants built in New England in coming years. Industry in Vermont would probably be indifferent to where in New England the electricity is generated. Other considerations would have to determine whether to locate new industrial operations in Vermont. Even if VEPH offered industry electricity at lower prices than current rates, provided retail competition were initiated, these industries would not be able to escape paying for stranded costs. The only way to avoid paying for stranded costs is to self-generate power.

In the context of displacing other forms of electric generation, it is important to keep in mind that large amounts of gas-fired capacity would possibly replace the current supply of hydropower from Hydro-Quebec, or other sources, once those contracts expire. However, for economic reasons, this could be risky. If natural gas prices were to rise substantially in the future the state would have few options to shield itself from the price impact. Electricity price stability and security depends on having a diversified mix of generation sources.

B. How does the supply of fuel and other generating plants affect this project?

The great number of proposed natural gas power plants in New England reflects the fact that low gas prices, coupled with the efficiency of such plants and low emissions, make them the only viable option, at the moment, for large-scale electricity generation. However, there is practically no probability of all this capacity being built. The obvious reason is that the almost 28 GW of proposed new plants in the region far exceed demand, in fact it exceeds total current capacity of 25 GW. Another reason is that natural gas-fired electricity generation consumes vast amounts of fuel. Gas supply in New England will increase in coming years to meet the demand of new gas-fired generation capacity being built. However, it is possible that gas prices may rise somewhat, making each marginal generating plant less profitable, as the market gets more saturated with generation supply and perhaps more tight on gas supply.

This last point relates to the overall viability of the proposed power plants. It is clear that the sooner a natural gas plant is built in New England, the more profitable, and thus economically viable it will be. First, because it can take greater advantage of the current relative shortage of capacity in NEPOOL. Subsequent new plants will be less profitable as this shortage dissipates. Second, with more gas-fired plants in operation, increased demand for natural gas will likely nudge prices upward, and thus increase operating costs of new plants, further reducing their profit margin. Since the VEPH withdrew its mandatory transmission study at ISO New England, the project would fall to the very end of the ISO-NE schedule, behind every other proposed power plant proposed in New England, if the application were to be submitted again. All other considerations aside, this simple fact reduces the probability of the plants being built.

C. Would Vermont benefit from increased direct use of natural gas?

The scale of the proposed power plants is critical to the viability of the natural gas pipeline itself. It would not be cost effective to build the pipeline unless large-scale users were in place to consume a large portion of the natural gas supplied. Once this threshold of cost has been overcome, other potential users of natural gas would have access to fuel that would never have become available without the proposed power plants. While it is wrong to assume that the project would bring lower electricity prices in Vermont anytime soon, some benefit may be derived from the presence of natural gas, for industrial processes and space heating. It is important in this context to distinguish between the potential benefit to residential households and to commercial or industrial customers.

1. Residential households would probably not benefit much from access to natural gas. There are two main reasons for this:

1. Initial cost of expanding a distribution grid is high.
2. Oil and gas are good substitutes for each other and prices move in tandem.

The cost of connecting each customer to the distribution network would be high. It is also unclear whether a distribution utility would be in place to serve residential customers. Even if such a utility were to be established, the question will emerge how to allocate the cost of grid expansion. Charging each customer the marginal cost of connection, which would be several thousand dollars, would almost definitely preclude expansion of the distribution grid in residential areas. Alternatively, a policy of spreading the collection of distribution-related costs over time would attract more customers. The risk is that an insufficient number of households would sign up for gas service, making it impossible to provide continued service to early customers without an economic loss.

This kind of analysis is beyond the scope of this paper but the lesson here is that the citizens of Southern Vermont should not assume the availability of residential gas supply if the power plants are built. A residential gas project may be implied by the proponents of the larger project but a commitment should be required, detailing what the cost would be and how the cost of a residential grid and individual connections would be allocated.

The power plant developer could chose to subsidize the distribution grid in an attempt to sign up enough customers to overcome the economic threshold that otherwise would deny market transformation. Even if this were to occur, it is uncertain whether the current price of natural gas is low enough to make widespread conversion to natural gas a likely prospect in the Rutland and Bennington regions. The cost differential with current heating fuels (predominantly oil) would have to be large enough to justify the expense and risk to a distribution utility and to give residential customers the incentive to convert to a new fuel.

There has been no study, that we know of, to seek the answer to the questions of whether economies of scale would allow a large-scale conversion to natural gas for space heating in Rutland and Bennington. Two facts indicate that the prospects for a regional gas distribution grid are bleak. First, oil and natural gas are highly substitutable fuels for large industrial uses and electricity generation. The effect is that oil and gas retail prices tend to move in tandem due to market interactions. Second, because natural gas prices are not likely to be significantly lower than oil prices over long periods of time, the cost differential may be too small to make a large-scale conversion likely.

Even in a very densely populated area like Boston and surrounding communities, where the gas grid is highly advanced, a large portion of households still use fuel oil for heating. According to the Energy Information Administration, the price of natural gas in Vermont delivered for residential service carried the price of $6.54 per thousand cubic feet in 1998. This is equivalent to a heating oil price of $0.97 per gallon. The average price of No. 2 oil to residences in Vermont in 1998 was $0.87 per gallon excluding taxes. Obviously, natural gas for residential service is not cheaper than fuel oil per unit of energy delivered. This is despite the fact that natural gas for residential supply is less expensive in Northern Vermont, than on average in every other adjoining state.

2. Some industrial customers might benefit from access to natural gas but that may not be enough to site operations in southern Vermont.

The assumption seems prominent among project supporters that industry will be attracted to Southern Vermont in the wake of the proposed power plants. There has been little discussion of exactly what kind of industry would be tempted by access to natural gas and whether any specific companies have expressed interest in siting their operations in the region. The critical question to ask is whether any industry has particular interest in locating in Vermont when ubiquitous supplies of natural gas can be found elsewhere at lower prices than are likely in Vermont. Leaving details aside, it is clear that any industry that relies on access to natural gas would be more likely to locate in region where gas is bound to be cheaper, like Louisiana or Texas.

The lack of a port, rail links, and expanded highways is also a consideration. The governor seems to have linked this project to the expansion of highways for the general benefit of the region. However, that is only an indication of the kind of infrastructure expansion that is necessary to make large-scale industrial development in Southern Vermont more likely. The competing objectives of economic development through large-scale power projects and environmental preservation will be even further at odds when, or if, associated industries call for vastly expanded infrastructure. Eventually, the economic benefit of attracting new industry to accompany the new power plants must be weighed against the added environmental cost of such industry and associated infrastructure. The people of Southern Vermont must then contend not only with more local air pollution from power plants but also increased process emissions of industry. They must also evaluate the cost of pollution from associated infrastructure and transport, and further absorption of land under such infrastructure in addition to that already lost to power plants, natural gas pipelines, and electric transmission lines.

If large industrial users were to start self-generating more in coming years, removing their demand from the common pool of purchases, the cost structure for the remaining customers might change. A change in the average load shape, and later, the sharing of stranded costs by fewer customers or units of energy sold, might increase the price of electricity to residential customers. However, the large number of new generating plants that are under construction or about to be built will turn a relative shortage into an ample supply, reducing the economic incentive to self-generate. Moreover, if the people of Vermont must face market rates any time soon, the competitive retail market will reflect the real cost-structure of supplying them power. Residential customers will therefore pay a higher price than industrial customers just like they do now, but the price differential may be even larger than it is currently. That, however, is an issue that pertains to the implementation of restructuring, if Vermont chooses to introduce retail competition, rather than the specific impact of the VEPH's proposed power plants.