Why The Country Is So Power Mad

Duke Energy CEO Richard Priory explains brownouts and soaring prices

Only yesterday, it seems, Duke Energy Corp. was a sleepy regional utility content with the tepid pace of a regulated market. Then came deregulation. Practically overnight, the Charlotte (N.C.) company chucked the past to become one of the toughest dogs among an aggressive new breed of independent power producers.

Led by Chairman and CEO Richard B. Priory, Duke has spent more than $15 billion in recent years to pad out its portfolio of power plants and expand into new areas, including natural gas, energy trading, telecommunications, and construction and engineering services. Annual turnover has been compounding at double-digit rates, from less than $10 billion in 1995 to $21.7 billion last year (chart). And this year alone, revenues may nearly double, Priory predicts, to $40 billion.

On the dark side, blackouts and brownouts have hit cities from coast to coast this summer. And this winter could see a rerun of last year's heating-oil crisis--but in natural gas. Priory addressed these issues in a recent conversation with Adam Aston, BUSINESS WEEK's industrial management editor.

Q: Why are power prices so high this summer?

A: They're high in certain parts of the country and low elsewhere. In the Midwest, where there was a power emergency last summer, you'll find that a number of power companies, including ourselves, have built new capacity that came online before this summer's peak. California is different. Because it hasn't built any new plants in some time, the state has a capacity shortage. Unfortunately, hot weather blanketed the West, so the surrounding states needed the power they used to export to California. This forced generators in California to buy electricity on the spot market--the most expensive source of power.

Q: Why hasn't California been building new generating capacity?

A: It's very hard to build anything there. There's a long wait in the permitting process in California, because a whole series of special-interest groups has to be satisfied. We estimate four to five years from the time you decide to invest to actually putting the plant on line. In other parts of the country, we have done that in as little as 11 months.

Q: The sharp price rises led some politicians to call for a return to regulation. What would that accomplish?

A: There's been a lot of talk about market manipulation, about passing through price volatility to residential customers. That's what created the political firestorm in California. Here was a residential customer suddenly being exposed to the pricing volatility of the wholesale power market. In some cases, their prices doubled in an hour. Power is 21 times more volatile than oil. So power pricing must be managed by people who understand how to hedge.

Q: Are other states doing any better?

A: The problems are actually pretty locally focused. Texas is inviting outside suppliers to build generating facilities to make sure they have ample supply. Maine and the New England Power Pool are also trying to make that happen. The Carolinas have been smart. They're simply watching deregulation unfold in a variety of ways in different states, and they'll choose the best.

Q: How can policymakers get it right?

A: You need a robust wholesale market with reasonable demand-and-supply balance. And also a series of distributors that can buy power wholesale, manage the associated price volatility, and deliver power to customers for less than under a regulated system. Above all, the market has to be free and unconstrained. The market must be able to send the proper signals. When pricing rises, you want a generator to see the incentive and build new supply.

Q: And why are natural gas prices high, too?

A: In 1998, the price of crude oil was $10 to $12 a barrel, substantially below the cost of lifting it out of the ground. Natural-gas prices were also low. As a result, banks wouldn't loan money for new wells, so supplies shrank. In 1999, prices began to turn around, and money started going back into exploration and production. But we're not yet seeing the output of that drilling, so prices remain high.

Q: What's the outlook for winter?

A: Ordinarily, gas distributors stock up during the summer, when prices are low, and then pull it out of storage to serve the heating load in the winter. This summer, electricity demand has been quite high, so generators have been burning gas to meet that demand. That has kept pressure on gas prices, and many gas companies haven't stocked up because the gas is too expensive. As a result, we anticipate a fairly tight supply picture going into the winter. But that could change. We might have a very mild winter--we've had a few of them. If so, the market will drop off. But if we see early indications of a rough winter, the price will be driven up.

Q: How did you manage to double your half-year revenues to $18 billion?

A: Partly it has to do with with continued building of plants and placing them into service. But the biggest driver is the expansion of our trading and marketing business. We've traded more electricity through July of this year than we traded through all of 1999.

Q: Are there technologies on the horizon that will significantly alter your business?

Why the Country Is So Power-Mad

A: Combustion turbines, coal plants, and nuclear power will continue to provide the bulk of electricity. But there will be a batch of new technologies--microturbines, fuel cells, and photovoltaics--with niche applications. Overall, they'll only have a minute impact on the system over the next decade. Most new technologies have not been deployed because of economic or technical problems. They might work in the lab, but not in your backyard. Fuel cells work, but can they be put in homes without worries about long-term maintenance or the threat of explosion? Still, a lot of new capital is going into fuel cells. That will advance these technologies and bring them on quicker.

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