S&P Global Ratings says renewables are 'disrupting' the merchant power sector

The proliferation of renewables is changing the supply stack, often making it cheaper for independent power producers to buy power than to produce it, an S&P Global Ratings report released Dec. 3 said.

Load serving entities and retail power providers now have a choice between generating power from owned assets, or contracting for it, the report said.

In a report titled, "Power Market Update: For Independents, Rising Renewables Remains The Primary Challenge," S&P Global Ratings credit analysts said that retail power continues to be "the best defense" against disruption in the merchant power sector.

"We now see a different long and short discussion arising: Is it better for a load-serving entity/retail power provider to have a long generation position relative to its retail obligation, or to have a short position and then contracting for the balance?"

The power industry is undergoing "the largest fuel-switch in its history," the report said, and the COVID-19 pandemic has "put new hazards on the course."

For IPPs, the long and short games "continue to focus on the advancing renewables proliferation."

Conventional business 'changing rapidly'

The report, whose primary author was senior director of S&P Global Corporate Ratings, Aneesh Prabhu, said the ratings agency "had long argued" that weather-influenced demand and natural gas inventory levels largely dictated power prices in the short term, while secular demand trends, energy efficiency, growth of distributed generation/storage, and cost propelled structural power prices.

"Our credit assessments were focused on how effectively merchant generators hedged in the short-to-medium term, and if the market offered them any efficient hedges in the long term."

The report, however, said that the conventional wholesale power business is "beleagurered" and "changing rapidly."

It said that more renewables are resulting in lower power prices, and lower commodity prices "mean less opportunity for IPPs to earn energy margins from relative fuel differences."

It was noted that increased energy efficiency has resulted in declining demand for electricity, and that "renewable portfolio standards, or RPS, are "contributing to declining load growth expectations."

The report said that climate change will "intensify" what are already unpredictable weather patterns, altering the long-term need in different regions for heating or cooling.

The analysts said there is increasing confidence among industry policy experts for a solar investment tax credit, or ITC, extension to be passed in 2021, "irrespective of Senate outcomes, or potentially split Congress."

If there is an extension, the analysts said, they expect 15-20 GW of annual solar deployments through 2025.

They said that, for example, that would add to the Electric Reliability Council of Texas region's supply and, potentially, "to the backwardation in its power prices."

NRG and Vistra

Power prices have been declining because of renewables, the analysts contended, and as a result they said they expect regional markets in the US to become "long energy,"-- in other words, supply higher than demand -- in most months, and the opposite -- short generation -- during the summer and winter.

Retail power continues to be the best defense against disruption in the merchant power sector, yet, the report notes, the two major IPPs -- NRG Energy and Vistra Corp -- are "pursuing contrasting strategies."

"While NRG is pursuing an asset-lite strategy, Vistra is still asset-heavy in its major markets," the report said.

NRG is "deemphasizing generation," with that business pivoting "decisively" in favor of its retail platform.

The report said NRG has shed "legacy assets" in areas with no retail presence, "most notably about 3.5 GW of its South Central portfolio that included large assets like the Big Cajun and Cottonwood power plants. We expect the Midwest to be divested too."

"Power generation is a capital-intensive business and, at a time when much of the new capital is going into renewables, NRG decided to exit this space."

NRG "guessed correctly" on the timing of the renewable cost curve decline, the report said.

The analysts noted that while Vistra has started revamping its generation mix, "it still believes in owning assets compared to contracting for generation."

"In this regard, the company's strategy has departed from that of NRG, which has instead chosen to contract for renewable generation to serve its retail load."