Wind power for Dummies

What about letting other companies such as Connectiv bid on an off shore wind farm?

There are several reasons for, and several reasons against opening the process up for a new round of bidding.

Those who favor free markets, and believe that competition drives down all prices, may want Bluewater to take another chance at going before the board, this time bidding against other wind farm concepts instead of two carbon fuel plants.

The nice part of this argument is that quietly and without fanfare, the opposition hereby acknowledges that wind power is by far the cheapest and most cost-effective method yet to gain new power sources for us in Delaware. Since wind power growth is the obvious wave of the future, is it any wonder that they too want to get their company in on some of the action?

But there is one problem with placing Connectiv in charge of a wind farm. They wouldn’t know what they were doing. Because of their inexperience they would have to fabricate plans from scratch, which brings up the age old question: who would you prefer to change your oil? The neighbor who is this years senior team captain and will find time to do it for a fee, or one who will do it for free and is still in the first grade?

If you were one of the snarky few who said “one in the first grade” then you should work for Delmarva. (They are currently looking for people like you to represent them in the General Assembly.) But most of us would prefer some level of expertise when it comes time to build our cheap reliable local source of power eleven miles off of Rehoboth’s coast.

However there is also a sinister motive behind letting Connectiv bid. If Connectiv possessing inside information, bids too low, and is ultimately awarded the contract based on that low bid, it may have trouble finding outside funding from investors tending to be a little skeptical about getting their rate of return, and the actual start-up funding may become too hard to find, and dry up. This scenario actually happened on the Chinese mainland, where a consortium of coal companies came in with an extremely low-ball bid, were chosen, and effectively from the inside stymied any effort of allowing cheap power to come on line and compete against them. As of yet, their proposed wind farm is still without proper forms of investment; bottom line, it is not built.

However if that might be the case, what if we take Connectiv out of the running and open bidding to all wind power companies, both domestic and foreign?

One could then argue that with such a high number of contenders, we could see better pricing than what was given to us from just Babcock and Brown alone.

Perhaps. But whereas another foreign company could possibly have more experience in offshore wind generation, depending on exchange rates which today are grossly disadvantageous to us right now, foreign expertise at such a premium price would be far too expensive. Currently Babcock and Brown already has sufficient wind experience and likewise has more depth of assets than any other competitor.

Another disadvantage to re-opening the bidding, is that as time goes by, things get more expensive. By beginning now, we could save ourselves between 20 to 33 percent less than were we to wait one year. By acting now we can lock into the best deal for Delaware, at today’s prices.

Furthermore, if we were to wait, then every Delawarean will pay more for their electricity twice, as in two times. The first would occur over the period of that one year delay, as we paid through the nose for higher priced carbon fuels instead of cheap wind power, and secondly, because of the increase and osculation of higher costs, every year thereafter throughout the length of the contract, we would continue to pay that increase as well as the extra interest generated from it.

It appears that there is little to gain from reopening the bids and much to lose. Remember that the original bidding was completely open and transparent. Even Connectiv itself applied, just not for a wind farm. The bidding wound up being between 3 players: coal, gas, and wind. During the original bidding process, not one other wind company applied. It would certainly be un-American and improper to 1) not take the best bid, and 2) not reward the entrepreneurship that caused that low bid to be made in the first place.

What is a bid and how is it made?

Perhaps this would be a good point to digress and illuminate what a bid is and how it is made. Once understood, the other side’s argument becomes easier to unravel and their motives easier to understand.

We will begin with this example. Let’s assume your spouse has something that is quite unique. She brings it to parties, gatherings, and you….. are instantly the “hit of the day” whenever you distribute it around your office staff. After many compliments and requests for special editions, somewhere along the time line, the thought occurs that you could make some extra income by offering those products at a price higher than what it costs to make. The two of you invest in the necessary raw materials, and with the family’s cheap labor, you begin.

After years of trial and error you have a formula down that is relatively cost effective. But as your business expands, your simple homestead cannot produce enough to meet demand. You need a bigger shop. But you don’t need the aggravation: you know, the aggravation of dealing with banks, the aggravation of dealing with industrial realitors, the aggravation of dealing with insurance agents, the aggravation of dealing with state regulatory requirements…. All you really want is to run a business and let others get dirty making the product. So you franchise.

To do that, you visit existing companies making products similar to yours, convince them of the economic feasibility of your product, and cajole them to make your product for you for a small percentage. Basically you choose to split the margins you would have made by manufacturing them yourself, with them. It works for them, for the excellence of your product creates an increased demand and enough work orders to keep them busier than they would have been making their original inferior product. It also works for you, because you now have money coming in without worry about risk, business down slumps, or how to grow profit margins.

Suddenly with this new found freedom, you are free to make several of these deals, sign them, buy a yacht, and live in English Harbor, Antigua, drinking nightly at the Admiral’s Inn.

Basically you have become the Wal*mart of your product. Wal*mart does not make all of the products they sell. They are a distributor. They buy products from manufacturers and sell them slightly higher to you. Their revenue and profit comes from the difference between the two prices, minus their expenses.

This is what happened with Delmarva Power during de-regulation. When de-regulation was first passed by Delaware’s General Assembly in 1999, Delmarva and Connectiv split apart (although both are owned by Pepco Holdings) and whereas Connectiv became the “Manufacturer” of electricity, Delmarva became the “Distributor”.

Old timers down state remember when the Indian River Plant was a Delmarva entity. Likewise the giant gas turbine next to Valero (the current name of Delaware City’s refinery) was also Delmarva. So too was the power plant at Fox Point. Upon divestiture, all three of these became owned by different entities. NRG picked up Indian River. Premcor picked up the gas turbine, and Connectiv owns Fox Point.

Delmarva’s job was to buy power at its lowest, and sell it for as high as it could get. That is how it makes money. Before everyone gets mad at Delmarva for ripping us off, you must remember that they have to make some profit. Otherwise we wouldn’t have electricity, setting up this scenario.

(Hello? Hello? …… At least this phone is working. ………… Hello?…Delmarva Power?….Can you tell me why I don’t have any power?…………What?…….. He shut you down?……….Gary Stockbridge did what?…… And you can’t turn it back on?…… Why?……….The switch is in his office?………What?………..Well, can’t you just go in?…….He’s left and locked the door?………You don’t have any key?………… He took them all with him to Antigua?…….”)

Delmarva is guaranteed a 4% profit by the state. This means if they err, we pay the cost up to the 4% level. If they err and make 7% instead of 7.5%, then that is on them and we do not suffer the consequences for their bad luck.

So how does one buy electricity anyway. Since electricity by a simple law of physics is required to be used the minute it made (otherwise a lot of little electrical fires break out and until the infrastructure is completely rebuilt, we have no power), how does one purchase such an instantaneous product?

One does so by contracts. I pay you X amount of dollars and you will supply this much electricity for this length of time: sign on the bottom line, is how it works. Therefore Delmarva bids on power sources, and in doing so it must compete with every other power company buyer who wants the same low costing energy to maximize their own profit margins. Power suppliers on the other hand, want to jack their prices as high as possible to expand and enlarge their own profit margins.

Everybody is in it for the money……. Supposedly in this give and take, the “market” determines the optimum price. Power companies make as much as they can, and we pay as little as possible for our power.

That sounds good in theory, but didn’t de-regulation actually cost us money, 60% if I remember correctly? And doesn’t evidence show that electric prices soar and never come down as soon as a market becomes de-regulated?

Again you are right. Unlike the airline industry, which was the model used by all proponents of de-regulation, prices did not fall to the floor. Why? Apparently there are more airline companies in the market than power distributors. That was one factor. Power companies could charge what they wanted and no one could undercut them. As monopolies, unless we wanted to live without power, we had no choice but to pay their price. Secondly not only could they charge the amount they wanted, but there was no one was looking over their shoulder to tattle on them. Remember the surprise in May 2006 when the de-regulated power bill was no longer subsidized? Surprise? No one had been watching them for 7 years! …..Out of sight, out of mind.

That is why when the de-regulation bill was originally signed in 1999, everyone mindful of California’s energy problems, put a no-price-raise clause that lasted 7 years. This was to prevent Delmarva from gouging us early on while there was no competition. Over 7 years it was thought that several other entities would move in and when the price lid came off, we would have rock bottom prices as are sometimes found on flights coming out of Kennedy airport into Atlanta.

Electric Co-ops do the same thing. They buy up electric contracts too. So why did their prices not climb as high as Delmarva’s? Because they were on different contracts. Here is how it works. Delmarva and Co-op’s look at the options. You can buy power from any source, at any price, and for any length of time. It is sort of like playing Clue: (“I’ll take Col. Mustard, in the Conservatory, with the candlestick”.) More along the lines of ” I’ll take Hope Electric, at 7.7 cents a kilowatt, for the next three years.

If prices are high, you buy a year’s supply, hoping that prices will go down by next year. If they are quite low, you buy three years worth, knowing that the market is certain to rise, and at that price, your power purchase will be a bargain. So the price we pay for electricity is an average of all those contracts thrown together in one portfolio. And it stands to reason, as our gasoline prices rose steadily, the cost of making electricity did as well. So suddenly in May 2006 we quantum leaped 7 years forward. At that time the Co-ops were still covered under previously contracted prices. That is changing now as those contracts expire and they buy power supplied at today’s rates. Live in Newark? You already know what I mean.

Disclaimer: when you deal with human beings, nothing is ever as perfect as it is supposed to be theoretically. People have a flaw. They tend to be selfish sometimes. Occasionally they figure out a way that is legal, within the letter of the law, sanctioned by our government, to rip us off. Enron was master of that in California. During the brownouts of the Nineties, when power soared because there was not enough supply, we found years later, that the shortage was man made, caused by Enron itself to jack up the prices. If they had wanted they could have flooded California with more than enough power. In Delaware, since Connectiv and Delmarva are really peas in a pod of Pepco Holdings, Connectiv can jack their price higher than market, Delmarva signs the contract, and we pay. Delmarva is allowed to charge us cost plus 4%. So if Connectiv charges them double, then guess what? We pay double plus 4%!

It is really not hard to figure options out. And it has become easier with the “Renewable Energy” thresholds being passed by every state legislature and the Federal Government. Delaware is required to be at 20% of renewable energy by 2020. If not, the power company must pay a steep fine to the state, which it can then turn around and reimburse itself from its customers. Now if you were in charge of gathering energy, you would look at this and figure that you would stand to do better to make 4% of 40 cents a kilowatt, than 4% of 10 cents a kilowatt. Simply put, which would you rather have: 4% of 5 billion, or 4% of 20 billion?

Just as you would do, they are doing………As prices rise, so does their profit…..Anything they can do to raise costs, prices, and profits, they will try, as I’m sure you would if you were still in the distribution business. If knowing that there will NOT be enough land based wind energy sources to provide enough renewable energy to meet even this state’s demand, you argue that we should get wind energy cheaper from Pennsylvania. By the time the public finds out you lied, the contract is signed: costs plus 4%.

The only thing that can spoil this master plan, preventing you from retiring on a yacht in Antigua before you are thirty, is…………….. another power company competing with you….

And that’s where Bluewater Wind comes in. Instead of producing energy that will cost more over time, their costs will go down. Instead of achieving rising costs on a yearly basis, they will offer one price for twenty five years plus 2% inflation. Instead of artificially raising your costs, and then your prices to cover that inflation, you receive the same income year after year from the same source. From an economical standpoint, who would want to pursue such a thing.

And thats were politics come in, because quite frankly, we (Delaware’s citizens) want it. Homeowners and small businesses have not paid Delmarva in months. Delmarva in their history has never had as high of a default rate as they had this past January. Mostly due from the amounts of money paid for energy (and now its hitting food?) some small business have shut down. When the business gets sold, that’s when Delmarva will get paid.

As citizens we desperately crave cheap energy. Since economic factors will not propel Delmarva to lower prices, we must use our government to act for us.

Bluewater can provide more energy than the RFP allows. If under the “kavips Compromise” a full sized (600MW) wind farm is built, and anything over 300MW is sold on the open market, at wind’s cheap cost, anyone buying that wind at 2.3 cents a kilowatt, will feel the downward tug on the highest of prices. For why should Delmarva pay Connectiv 10 cents a kilowatt, when another entity, say Washington Gas and Electric, can buy Bluewater’s wind at 5 cents and sell it to Delawareans for 7 cents, far cheaper that that offered by Delmarva. Theoretically according to principles of economics, Washington Gas would make 2 cents per kilowatt off of every Delawarean, and Delmarva would make zero, since no Delawarean would be simple enough to pay Delmarva’s higher price by 3.4 cents per kilowatt, not even Gary Stockbridge! This tendency would force a drop in Delmarva’s price. As more offshore wind farms are built (the economics are too good to leave alone), the lower the prices within the PJM will fall when faced with downward pressure.

For those currently making cost plus profit, as costs go down, well guess what? But for those of us who are ultimately the end user, guess what again? Our costs go down too. Suddenly we have 60 dollars a month to spend on ourselves for a change. Yippee!

So this is essentially the economic battle being waged today. Can Delmarva survive the intrusion of Bluewater Wind? Yes. Can they get a higher rate of return by buying carbon fuels and charging us more for that, instead of supplying us with cheap wind? Again yes. This whole controversy has been a question of about one thing: about who is to benefit, them……. or us! And that…. is entirely a political decision, having little if nothing to do with economics.

So what happens when politicians don’t do what we want? …We fire them. (If you don’t quite yet know who they are……..just GoogleBang-up Four.”)