In recent years, large amounts of natural gas-fired power generation capacity have been added to the nation’s portfolio of power generation assets. In addition, a variety of analyses and market projections imply this trend will continue for a variety of reasons, including large and growing supplies of natural gas due to the “shale boom,” and commensurate low natural gas prices, and imposition of increasingly stringent environmental regulations associated with coal-fired power generation. This potential increased reliance on natural gas power generation to meet our nation’s electricity needs is causing some concern among electric industry executives, electric power generation planners, electricity customers, and electricity market regulators.
Many market participants and observers are aware of recent times in history in which the electric sector in the United States became heavily reliant on a single generation technology for the dominant share of electricity production and/or capacity additions and the problems that may arise out of this situation. These concerns have led some industry observers to develop a concept referred to variously as “generation portfolio diversity” or “generation fuel diversity.” This concept implies that it is valuable to have a broad diversity of power generation technologies and fuels included in the mix of national and local power generation sources. This report discusses some operational and financial risks that may arise as a consequence of a lack of “generation diversity,” and how portfolio diversification can be used as a strategy to address this challenge.
This report describes analytic methods that can be used by electric industry participants to understand these operational and financial risks, and to improve decision making with regard to new generation capacity additions. This report argues that the decision problem faced by electricity planners with regards to “generation diversity” is similar to those faced in the past related to “capacity expansion.” The approach used is analogous to the use of portfolio diversification strategies to increase the expected gains and minimize risks in a stock portfolio.
In the past, generation capacity expansions decisions have been evaluated based on their impact to company profitability in the case of non-regulated generation companies, or the cost of serving customers for regulated companies. These criteria still apply, and are appropriate to be used to address capacity expansion in the face of concerns related to power generation diversity.
Because the future is uncertain, and many different “futures” may evolve from today’s vantage point, it is necessary to address generation portfolio diversity as a risk management or insurance problem. The effective way to manage these risks is to construct a portfolio of power generation capacity additions that performs “best” across the multiple expected future scenarios. This implies that a key feature of a good analysis methodology is that it will recognize the potential existence of many possible future scenarios that must be addressed through an analytically rigorous approach to risk management.