The Economics of Replacing Existing Coal Power Plants with Natural Gas

Executive Summary

Defying predictions that closing coal power plants would cause a substantial increase in electricity prices, U.S. electricity prices have declined in inflation-adjusted dollars since 2008. In the period between 2008 and 2016, coal’s share of U.S. electricity production declined from 48 percent[i] to 30 percent,[ii] yet electricity prices rose an average of less than one percent per year, which is less than the rate of inflation. Spurred by advances in fracking and directional drilling technologies, natural gas production has risen from just 21 percent of U.S. electricity in 2008,[iii] to 34 percent in 2016,[iv] and thus declining natural gas prices are largely responsible for the decline in electricity prices. The Henry Hub spot price for natural gas fell from $8.86 dollars per million British thermal units (BTUs) in 2008 to $3.20 dollars per million BTUs in 2016.[v] Most of that decline occurred between 2008 and 2009, when the benefits of fracking and directional drilling advances occurred on a widespread basis. Since 2009, natural gas prices have averaged $3.62 per million BTUs, a number less than half the 2008 price. As a result, the cost of electricity generation from existing natural gas facilities is now lower than that of coal facilities.[vi]

In comparison to coal plants, natural gas power plants are relatively inexpensive to build.[vii] For this reason, even with a repeal of some environmental restrictions on coal power under the Trump administration, the economics of low natural gas prices and political wariness regarding future potential restrictions on coal power will likely prevent any new coal plants from being built. Moreover, nearly half of U.S. coal power plants were built before 1970,[viii] which will likely cause additional coal power plants to close in the next ten years and be replaced by natural gas power plants. This will reduce coal power’s share of U.S. electricity even further.

Image courtesy of Pixabay.

Image courtesy of Pixabay.

Closing many older power plants and replacing them with natural gas power will likely put little pressure on electricity prices and may result in further price declines in inflation-adjusted dollars. Although building new natural gas plants to replace existing coal plants may be “paying twice” for a power facility, several factors make it economical to replace existing coal power plants with natural gas facilities; namely, natural gas plants are relatively inexpensive to build, natural gas itself is less expensive than coal, it is more efficient and often less expensive to turn natural gas into power than it is to turn coal into power, the newest technologies built into new natural gas facilities will accentuate the efficiency advantages of natural gas power over existing coal plants, and most coal power plants are quite old and will need expensive updating or complete replacement soon, anyway.

In short, not only is existing natural gas power less expensive than coal, but building new natural gas facilities to replace many old, existing coal plants is also likely to reduce U.S. electricity costs. This likelihood is borne out in electricity data during the past nine years, when coal lost 38% of its electricity market-share, primarily to new natural gas power plants, yet inflation-adjusted electricity prices are now lower than nine years ago.

 

History of the U.S. Electricity Mix

Coal power has historically dominated the U.S. electricity mix, and until 2015, always produced a greater share of U.S. electricity than any other source. For most of the time period between 1965 and 2005, coal produced more power than all other sources combined.[ix] The reason for this was simple: coal was the most affordable and widely available power source. Further, the United States is blessed with enormous coal reserves, which keeps prices low. Only large hydropower dams could historically compete with coal on a cost basis, but such facilities are limited by geography. Nuclear power and natural gas could also provide substantial power, but electricity from both sources has historically been significantly more expensive than coal power. Additionally, nuclear power has required the construction of large, expensive facilities subject to substantial federal safety regulations. Natural gas power has been hampered by volatile and often very expensive natural gas prices. Wind and solar power have fared no better, hampered by geographical constraints, expensive equipment costs, and an inability to store power economically when winds and sunshine are not favorable.

As recently as 2008, coal power produced 48 percent of American electricity, nearly equal to all other power sources combined. Accordingly, it came as a shock to many when presidential candidate Barack Obama pledged on the 2008 campaign trail to end the construction of coal power plants through expensive cap-and-trade restrictions on carbon dioxide. Obama himself openly acknowledged[x] that as a result of his proposed restrictions on coal power, companies that were building new coal power plants would go bankrupt and “electricity rates would necessarily skyrocket.”

President Obama was never able to implement his envisioned cap-and-trade system for carbon dioxide emissions. Nevertheless, his administration imposed several environmental restrictions that induced many coal power plants to shut down, rather than to bear the costs of compliance. At the same time, the cost of natural gas power dropped significantly. The federal government also ramped up renewable power subsidies and numerous states imposed or expanded renewable power mandates that shifted some of coal power’s market share to wind and solar power. For these reasons, by 2016, coal power generated just 30 percent of electricity in the United States.

 

History of U.S. Electricity Prices

As coal lost more than a third of its share of the U.S. electricity mix between 2008 and 2016, electricity prices failed to skyrocket as Obama and economists predicted. Instead, they rose an average of less than one percent per year, which was lower than the rate of inflation. In constant dollars, U.S. electricity prices actually declined between 2008 and 2016.

The costs of wind and solar power declined significantly in this period, but these power sources remained substantially more expensive than coal power.[xi] Electricity prices declined primarily because natural gas prices fell dramatically and natural gas gained the lion’s share of coal’s market-share losses.

Natural gas power was buoyed by advances in hydraulic fracturing (fracking) and directional drilling technologies that became widely available in the latter part of the previous decade. These advances allowed substantially more natural gas to be recovered at much lower prices. As a result, natural gas—which  powered only 21 percent of U.S. electricity in 2008—powered 30 percent of U.S. electricity in 2016, and natural gas power from existing power plants is, on average, less expensive than coal power from existing plants.[xii]

 

Comparative Costs of Power Sources

Wind and solar power present intermittency issues that are very real and problematic but difficult to quantify. Power output at wind and solar facilities can vary from zero to 100 percent of capacity. Most forms of bulk power storage remain uneconomical, so wind and solar variability forces other power sources to be available on backup, sometimes with short notice. Ramping power up and down throughout the day costs more and is less efficient than steady power production, so the variability of wind and solar power imposes extra costs on other sources of power generation. The imposition of inefficiencies on backup power generation also increases the emissions from backup power sources, which reduces the emissions benefits of wind and solar power.

However, typical cost-of-power estimates, such as those presented by the U.S. Energy Information Administration (EIA), assign the costs imposed by wind and solar power variability on the backup power sources rather than on the wind and solar power that impose such higher costs. The EIA estimates also fail to incorporate the costs of new transmission lines that are frequently necessary to transport wind and solar power from remote locations to urban population centers. However, the Institute for Energy Research’s study, “The Levelized Cost of Electricity from Existing Generation Sources,”[xiii] presents particularly strong data and analysis regarding both the high costs and integration problems presented by wind and solar power.

Further, the Brookings Institution’s 2014 paper, “Why the Best Path to a Low-Carbon Future Is Not Wind or Solar Power,” analyzes the costs of replacing coal power with other power sources, and concludes that: “[A] new wind plant could at least cost 50 percent more per KWH of electricity, and a new solar plant at least 200 percent more per KWH, than using coal and gas technologies.” By contrast, the Brookings paper reports that replacing existing coal power plants with new natural gas facilities reduces power costs and replacing existing coal plants with new nuclear or hydro plants is essentially cost-neutral. Thus, to replace coal with a combined cycle natural gas will significantly reduce electricity prices, to replace it with hydro power would break approximately even, and a wind or solar replacement would add substantial expense.[xiv]

 

Overview of the Electricity Industry and Competing Fuels

The structure of U.S. electricity markets is set largely at the state level. Federal policies impact energy-source availability, cost, wholesale market rules, and environmental requirements, but state governments determine the economic structure of each state’s electricity system. Most states have a state-government-created and state-government-protected monopoly system, whereby customers are assigned a particular electricity provider. State regulators establish a guaranteed rate of return on investments for electricity providers and in return, electricity providers must receive approval from state public utility commissions for major investment decisions and price structures. Historically, the primary concern of state regulators was to ensure low-cost electricity. In recent years, however, state regulators have placed a greater emphasis on environmental concerns and diversity of energy sources.

In the absence of market competition among multiple electricity providers, these providers have little incentive to reduce cost. On the contrary, when they invest in expensive capital projects, they reap greater profits because their guaranteed rate of return is applied to a higher bottom line. As a result, electric utilities have been among the strongest advocates[xv] for expensive renewable power and aggressive renewable power mandates. Electric utilities also tend to avoid purchasing power from independent power producers, even if the independent producers can generate power at low cost. This is because utilities that generate their own power receive extra guaranteed profits from the money they invest in building and maintaining their own facilities.

State policymakers best serve their constituents when they vigilantly oversee monopoly utilities that have an incentive to drive up capital costs and operate power plants inefficiently. Without market forces to spur innovation and keep prices low, state legislators and public utility commissions substitute their judgment for market forces. State legislators and public utility commissions, however, often give greater priority to political agendas than affordable energy.

In an ideal world, competitive markets would replace the state-protected monopoly power structure. Some states have embarked upon this path. Texas is a good example of a state that has provided more consumer choice through legislative action. Bolstered by consumer choice, Texas electricity prices fell 21 percent from 2008-2015.[xvi] Nevada also has just begun the process of providing more consumer choice through ballot initiatives, as it has suffered the highest residential electricity prices in the Energy Information Administration’s Mountain States Region.[xvii] In the 2016 elections, however, Nevada voters approved a ballot initiative to introduce consumer choice in electricity providers, which demonstrates a belief that consumer choice will lower electricity prices.

Following the leads of Texas and Nevada and absent free-market electricity reform, state policymakers should vigilantly ensure that affordable energy is the primary consideration in the operation of state-regulated electricity monopolies.

 

The Likely Future of Coal Power

Coal power’s declining market share is due to a combination of market forces and adverse governmental action. Low natural gas prices make natural gas economically competitive with coal power, and natural gas power is typically less expensive than coal power irrespective of environmental standards or mandates. Further, the more that government policymakers value environmental factors and impose environmental restrictions on energy generation, the more the pendulum swings away from coal and toward natural gas.

The Trump administration is unlikely to impose new environmental restrictions on coal power and may roll back some restrictions. Even so, utilities and state regulators must consider the possibility of future presidential administrations or a future Congress ramping up restrictions on coal. For this reason, it remains unlikely that any new coal power plants will be built in the United States in the foreseeable future. However, the more impactful issue is whether and to what extent existing coal power plants will or should be shut down and replaced with newly constructed natural gas facilities or other power sources.

Ninety percent of U.S. coal power plants were built before 1990 and are at least 27 years old.[xviii] Seventy-three percent were built before 1980 and are at least 37 years old, while 46 percent were built before 1970—making them nearly 50 years old or older. These plants run less efficiently than newer power plants and require costly and more frequent updates. Much like a person who attempts to maintain the shell of a car built in the 1970s by continuously replacing key parts, at some point it makes economic sense to scrap the older car entirely and purchase a new one. Much of the U.S. coal fleet is in a similar position, wherein the power plant has already been built and paid for, yet the economic benefit of keeping it operational is questionable, at best.

With natural gas prices so low and likely to remain that way, natural gas facilities will almost certainly continue to replace coal power plants, irrespective of government interference in electricity markets. This is especially the case given that new natural gas power plants cost less than half as much to build as new coal power plants.[xix] Thus, the replacement of aging coal power plants with new natural gas ones is close to an economic certainty in a free market. Indeed, natural gas power has replaced coal power at a more rapid rate in competitive markets than by monopoly utilities. The primary policy question, then, is at what point much of America’s coal power fleet should be converted to natural gas.

 

How Natural Gas Outcompetes Coal

Some coal advocates defend coal power on economic grounds by saying it makes no sense to prematurely close power plants we have already paid for. However, empirical evidence shows it can make economic sense to replace aging coal power plants with new natural gas plants. Specifically, the going-forward cost of building and operating new natural gas plants since 2008 has often been lower than continued operation of existing coal plants. Between 2008 and 2016, coal power lost 38% of its U.S. market share, primarily to new natural gas plants. Nevertheless, inflation-adjusted electricity prices declined.

There are several reasons new natural gas plants have provided lower-cost electricity than existing coal ones. For starters, natural gas power plants are relatively inexpensive to build. According to EIA data released in July 2017, the construction cost for natural gas power facilities built in 2015 (the latest year for which data was available) was $696 per kilowatt. Accordingly, a new 500 MW natural gas power facility costs approximately $350 million and powers approximately 400,000 homes. The per-household cost for building a new natural gas power plant is therefore approximately $875. Spread out over a projected 50-year lifespan, a new natural gas power plant costs the average household approximately $17.50 per year, or $1.50 per month.

The majority of coal power plants are more than 40 years old and on the downside of their projected lifespan. This means they will require substantial equipment upgrades or full replacement in the near future. Discounting the added cost of new natural gas facilities by 50% to account for the impending need to upgrade or replace existing coal power plants yields a per-household cost of approximately 75 cents per month, or less than 1% of the average household electric bill.

Prices vary by region and power plant, but producing natural gas and converting it to electricity is generally less expensive than the same process for coal. The brand new, cutting-edge technologies and equipment in new natural gas power plants will accentuate that efficiency advantage even more. The capital and construction costs of new natural gas plants may impose a less-than-1-percent added cost on electricity generation, but the efficiency gains in new plants burning inexpensive natural gas will quite often more than compensate for that added cost. This is illustrated in the Institute for Energy Research’s findings that electricity costs from existing natural gas power plants are 14 percent less expensive than those from existing coal plants. This explains why inflation-adjusted electricity prices have fallen during the past nine years even with so many new natural gas power plants being built to replace existing coal ones.

By analogy, a person who owns a 1977 automobile with 300,000 miles on it has already paid for the automobile in full. Buying a new car will incur an immediate additional expense. However, the 1977 automobile gets far fewer miles per gallon, needs more regular maintenance, has many parts that will need expensive repairs or upgrades and still won’t provide the comfort, performance, or amenities of a new car. Given all this, it often makes economic sense to purchase a new car even if it is physically possible to keep the 1977 car on the road. For this very reason, most consumers have automobiles that are less than 40 years old.

Fine-Tuning the IER Study

The IER’s “The Levelized Cost of Electricity from Existing Generation Sources[xx] presents particularly strong data and analysis regarding the high costs and integration problems presented by wind and solar power. There is room, however, to fine-tune the study’s comparison of costs from existing coal plants versus new natural gas plants.

For example, IER asserts that existing coal plants produce power at $39.9 per-megawatt-hour (MWh) and existing natural gas facilities produce power at $34.4 per MWh, whereas newly built combined-cycle natural gas plants would produce power at $55.3 per MWh. In the IER analysis, this suggests that to replace existing coal power plants before the end of their functional lifespans with new natural gas power plants will cause substantial (40%) increases in electricity prices.

However, properly fine-tuning IER’s underlying data and assumptions as follows, shifts the economic equation in favor of new natural gas facilities:

  • The IER study assumes very high capital and construction costs for new natural gas power plants. These asserted capital and construction costs comprise nearly the full difference in IER’s projected price premium for new natural gas power versus existing coal power. In reality, however, natural gas power plants are quite inexpensive to build, with capital and construction costs adding less than $2 per month to the average household’s electricity bill. Thus, capital and construction costs alone – even before reducing these costs for the benefits of newer, more efficient equipment and the fuel-price benefits of inexpensive natural gas – add only about 1% rather than IER’s asserted 25% to electricity costs.[xxi]
  • The IER study heavily front-loads these costs rather than spreading them out over the 50-plus year expected lifespan of natural gas power plants. For formal tax and accounting purposes with the Internal Revenue Service, such frontloading is appropriate and common. However, for calculating the per-year lifetime cost of electricity from new facilities, it is more appropriate to evenly distribute the capital costs over the lifespan of the new facilities. Indeed, it is largely because IER front-loads capital and construction costs that the study can claim natural gas power costs $55.3/MWh from new natural gas power plants. However, that price is only for the first year of operation. IER’s projected costs per MWh steadily decline after the first year, so the claim that new natural gas power costs $55.3/MWh can be misleading. Even if we accept IER’s front-loaded construction costs for the sake of argument, high price projections for natural gas fuel and high price projections for capital and construction costs, natural gas power will cost $55.3/MWh during only one year of each power plant’s 50-plus year lifespan, while it will steadily decline in price for all remaining 49 years.
  • The average age of existing coal power plants is more than 40 years old.[xxii] Ongoing replacement of key equipment can keep these power plants operating, but the plants become less efficient and more expensive to maintain with advancing age. Accordingly, many, if not most, existing coal plants will require replacement or substantial and costly upgrades in the near future. This means the 1% increase in electricity costs that new natural gas power plants add to customer bills should be cut at least in half. This is because most coal power plants and plant equipment have already reached the downside of their projected lifespans and will require replacement soon, anyway.
  • IER acknowledges the cost of electricity from existing coal plants is 16% higher than from existing natural gas plants. Nevertheless, it forecasts that, even after stripping away the capital and construction costs for new natural gas plants, old coal plants with yesterday’s technologies will produce power at a lower cost than natural gas power plants with cutting-edge technologies. This seems unlikely given that, as IER observes, coal power is already more expensive than natural gas power generated by yesterday’s less-efficient natural gas technologies.
  • IER assumes the price of electricity from new natural gas power plants will be 61% more expensive than natural gas from existing facilities, even though natural gas power plants are quite inexpensive to build and their newer technologies would be more efficient than those in existing natural gas power plants.
  • Importantly, real-world electricity prices validate the fact that replacing existing coal power plants with new natural gas plants will add little, if any, cost to electricity generation. Between 2008 and 2016, coal power’s share of the U.S. electricity mix fell from 48% to 30%. This occurred largely because of existing coal power plant closures (and replacement by new natural gas plants) before their planned retirement date. Not only did electricity prices fail to rise significantly, but electricity prices actually declined.

 

Additional Political Factors

As shown above, economics support replacing many coal power plants with inexpensive natural gas facilities. Political factors strengthen the case even further.

The Democratic wave elections of 2006 and 2008 ushered in renewable power mandates, massive subsidies for expensive wind and solar power, costly environmental restrictions, and the federal Clean Power Plan (CPP) that would impose a mandatory 30% reduction in carbon dioxide emissions. The wave elections also resulted in the approval of a significant expansion in expensive wind and solar power by appointees to state public utility commissions, and the imposition of additional impediments to new coal power plants.

The 2010, 2012, and 2014 elections somewhat blunted the impact of the 2006 and 2008 elections, and the 2016 election ushered in policymakers much more focused on protecting affordable energy. Between 2006 and 2010, however, elected officials and state public utility commissions put their thumbs heavily on the scale that favored expensive wind and solar power.

Politics move in cycles, and affordable energy advocates would be foolish to assume the current political equation favoring affordable energy will last forever. Inevitably, Democrats will benefit from another wave election. When this happens, policymakers are likely to force a rapid closure of coal power plants. Rather than trading in one affordable power source for another by facilitating the market-driven trend toward natural gas power, our power mix will be forced to shoulder the burden of more expensive and unreliable wind and solar power. In a political vacuum, keeping aging coal power plants functioning at the expense of efficient new natural gas plants makes little economic sense. Given the political pressures that will inevitably come when Democrats regain political power, it makes even less economic sense to ignore the current political opportunity to replace aging coal plants with affordable natural gas plants.

In many ways, moreover, trading aging coal power for new natural gas power decreases future political momentum for expensive wind and solar. It is harder to make the political case for wind and solar power to replace affordable and clean-burning natural gas than it is to make the case for expensive wind and solar power to replace high-emission coal power. Global warming concerns are the primary factor that motivates calls for more emission-free wind and solar power. Natural gas, however, emits only half as much carbon dioxide as coal power. Due largely to natural gas’ market-share gains at the expense of coal, U.S. carbon dioxide emissions have fallen to 1991 levels.[xxiii] Further replacing coal power with natural gas would reduce U.S. emissions still further. Accordingly, calls for government-imposed carbon dioxide restrictions and expensive renewable power mandates will gain less traction when the replacement of coal power plants with natural gas further reduces U.S. carbon dioxide emissions.

 

Conclusion

The inexpensive costs of building natural gas power plants, as well as the low cost of natural gas itself, make it economically wise to replace many existing coal power plants with natural gas facilities. Further, the apparent redundancy of building a new power facility to replace an operational existing one makes economic sense when the new one is inexpensive to build and is less expensive to operate than the existing one. This has been apparent empirically as inflation-adjusted electricity prices have declined since 2008 when new natural gas power plants began replacing coal power plants in large numbers. This trend will likely continue as new natural gas power plants continue to replace existing coal plants.

 

Endnotes

[i] U.S. Energy Information Administration (EIA), Electric Power Monthly, Table 5.6.B., March 2009. https://www.eia.gov/electricity/monthly/archive/pdf/02260903.pdf.

[ii] U.S. Energy Information Administration (EIA), Electric Power Monthly, Table 5.6.B. Feb. 2017. https://www.eia.gov/electricity/monthly/archive/february2017.pdf.

[iii] EIA March 2009, Table 1.1. https://www.eia.gov/electricity/monthly/archive/pdf/02260903.pdf.

[iv] EIA February 2017, Table 1.1. https://www.eia.gov/electricity/monthly/archive/february2017.pdf.

[v] U.S. Energy Information Administration, “Natural Gas,” October 18, 2017. https://www.eia.gov/dnav/ng/hist/rngwhhdA.htm.

[vi] Thomas F. Stacey and George S. Taylor, The Levelized Cost of Electricity from Existing Generation Resources, July 2016, Table 1.A. http://instituteforenergyresearch.org/wp-content/uploads/2016/07/IER_LCOE_2016-2.pdf.

[vii] Mayur Sontakke, “Natural Gas Power Plants Are Cheaper to Build,” Market Realist, Jan. 13, 2015. https://beta.marketrealist.com/2015/01/natural-gas-fired-power-plants-cheaper-build?utm_source=redirect5&utm_medium=auto.

[viii] Jack Fitzpatrick, “Coal Plants Are Shutting Down, With or Without Clean Power Plan,” Morning Consult, May 3, 2016. https://morningconsult.com/2016/05/03/coal-plants-shutting-without-clean-power-plan.

[ix] U.S. Energy Information Administration, http://instituteforenergyresearch.org/wp-content/uploads/2014/08/Screen-Shot-2014-08-29-at-4.44.02-PM.png.

[x] “Obama: My Plan Makes Electricity Rates Skyrocket,” YouTube, January 17, 2008. https://www.youtube.com/watch?v=HlTxGHn4sH4.

[xi] Charles Frank, “Why the Best Path to a Low-Carbon Future Is Not Wind or Solar Power,” Brookings Institution, May 20, 2014, https://www.brookings.edu/blog/planetpolicy/2014/05/20/why-the-best-path-to-a-low-carbon-future-is-not-wind-or-solar-power.

[xii] Stacey and Taylor. http://instituteforenergyresearch.org/wp-content/uploads/2016/07/IER_LCOE_2016-2.pdf.

[xiii] Ibid.

[xiv] Frank. https://www.brookings.edu/blog/planetpolicy/2014/05/20/why-the-best-path-to-a-low-carbon-future-is-not-wind-or-solar-power.

[xv] Travis Kavulla, “How Utilities Team Up with Greens Against Consumers,” The Wall Street Journal, Feb. 16, 2016. https://www.wsj.com/articles/how-utilities-team-up-with-greens-against-consumers-1456530275.

[xvi] U.S. Energy Information Administration, “Average Price by State by Provider 1990-2015 (EIA-861),” Oct. 12, 2016. https://www.eia.gov/electricity/data/state.

[xvii] U.S. Energy Information Administration, Electric Power Monthly, Table 5.6.B., Feb. 2016. https://www.eia.gov/electricity/monthly/current_year/february2016.pdf.

[xviii] U.S. Energy Information Administration, “Most coal plants in the United States were built before 1990,” April 17, 2017. https://www.eia.gov/todayinenergy/detail.php?id=30812.

[xix] Sontakke. https://finance.yahoo.com/news/natural-gas-fired-power-plants-210502117.html.

[xx] Stacey and Taylor. http://instituteforenergyresearch.org/wp-content/uploads/2016/07/IER_LCOE_2016-2.pdf.

[xxi] Sontakke. http://marketrealist.com/2015/01/natural-gas-fired-power-plants-cheaper-build.

[xxii] Jack Fitzpatrick, “Coal Plants Are Shutting Down, With or Without the Clean Power Plan,” Morning Consult, May 3, 2016. https://morningconsult.com/2016/05/03/coal-plants-shutting-without-clean-power-plan.

[xxiii] U.S. Energy Information Administration, “U.S. Energy-Related Carbon Dioxide Emissions, 2015,” March 16, 2017. https://www.eia.gov/environment/emissions/carbon.

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