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Credit crisis. Economic stimulus package. Housing slump. Infrastructure spending. Recession. There is both good and bad news on the horizon and unfortunately, 2009 will likely hold more bad than good for power utility-related construction. What is not in doubt is that 2009 will be a year of change.
"Change has considerable psychological impact on the human mind. To the fearful it is threatening because it means that things may get worse. To the hopeful it is encouraging because things may get better. To the confident it is inspiring because the challenge exists to make things better. Obviously, then, one's character and frame of mind determine how readily he brings about change and how he reacts to change that is imposed on him."
King Whitney Jr. President, Personnel Laboratory Inc.1
Contractors are optimistic and confident by nature. They have to be due to the volatility of our market. In 2009-2010, the power generation, transmission and distribution construction markets will face the following challenges that may shake the confidence of some contractors. These include financing availability, changing regulatory stance, very low new housing growth, distribution pipeline integrity emphasis, transmission grid upgrade, local funding constraints, infrastructure or stimulus package rollout (see cutout), market cycle/trough, and customer business model transition.
Perhaps the biggest short-term constraint is credit. While there is not yet hard evidence, FMI's experience and discussion with utility, engineer, and contractor professionals indicates that many owners are slowing the release of work and are slowing design activities. We anticipate the 2009 winter and spring bidding season, typically when large volumes of work are released for construction, to be reduced in both size and number of available projects. Currently, we expect the release of work to improve in the back half of 2009 but this will still result in reduced volumes of work for many contractors from their record years in 2007 and 2008.
While the credit crisis and economic recession weighs heavy on many utilities as they consider how to expend their precious capital, there remains a silver lining. All of the change and constraints placed on the utility owners or buyers of construction services will result in both softening growth and modest retraction from the blistering growth seen in the past five years, but not wholesale collapse. In addition, 2009 will exhibit a congressional shift toward economic investment to spur growth, as opposed to encouraging consumption. This equates to greater funding of infrastructure construction, which will buoy many of the utility markets.
Table 1: Utility Construction Put in Place, Historical Figures and Forecasts
All in all, regardless of which utility segment a contractor operates within, change is the order of the day.
Power Generation
Change in financing availability and regulatory policy will drive market conditions in the power generation market. One measure of the financing challenge facing power generators can be found close to FMI's Raleigh, NC, headquarters. Duke Energy, headquartered in Charlotte, NC, recently drew down its $1 billion credit line in part due to concern over the turmoil in the financial markets and availability of that credit over the term of their agreement. The problems in the financial arena and broader economic slowdown will lead to downward pressure on power generation construction. In addition, third quarter growth of U.S. Gross Domestic Product (GDP) was preliminarily forecasted at -0.3 percent; and while the final assessment is not yet in, many economist believe the U.S. has been in recession all of 2008. Unlike the financial crisis, a recession offers both challenges and opportunities for contractors.
Case in point, the stimulus bill will result in some pickup is the power generation segment but is unlikely to significantly affect this market in the near term. Looking five to 10 years down the road, however, funds directed toward developing clean coal technologies and a building an $800 million carbon capture facility may create new subsectors in this utility construction segment. Additionally, the renewal of the Production Tax Credit (as a part of the stimulus bill) will ensure wind, solar, geothermal and other renewable energy sources remain financially viable through at least 2012.
"We now find more owners are pushing work out into the future, shelving projects that are marginal, or choosing not to expend their scarce financial and credit resources. This is primarily affecting the capital construction side but we are seeing some bleed over into the O&M space."In the short term, FMI predicts a slowing of growth in power generation construction spending over 2009-2010 which will make contractor markets more competitive as backlogs for many contractors fall throughout 2009 (See Table 2). Power Generation construction had seen rapid growth over the period of 2006-2008 due to additional facilities, higher construction costs, labor shortages, resource/material availability, and legislative policy adding to the growth in spending on these facilities. The added pressure of difficult-to-obtain financing will exacerbate the affects of an already competitive and expensive outlook for all power generators and their respective contractors. Several possible escape valves include the economic slowdown addressing labor availability in the short term, rapidly falling construction raw material prices, and a potential end to regulatory uncertainty with the inauguration of a new president and a Democrat -- controlled Congress. Still, significant political hurdles remain before a legislative consensus can be reached on a regulatory stance.
Mike McMahon -- President, Day & Zimmermann Power Group
Table 2: Power Generation Construction Put in Place Historical Figures and Forecasts
Fossil Power Generation
There are a number of converging factors that have led to the rise in coal and natural gas power plant construction cost, including global competition for materials and the growing shortage of craft labor. According to PowerAdvocate's powerplant building index, the cost of building a 550MW combined-cycle natural gas plant has risen by over 10.0 percent in the 12months ending November 2008. This compares poorly to a consistent 3.0 to 7.0 percent increase seen in commercial building construction costs over the same period. Common equipment across the heavy industrial construction market (oil, gas, power, chemical and heavy manufacturing) has driven up construction costs in all segments, even as demand and growth differs among the various industrial segments. Volatile energy prices have also intensified the competition for heavy industrial materials common to both fields. Furthermore, transportation and until recently fuel costs comprised a higher percentage of the total bill of goods sent by the suppliers of these materials and equipment components.
"In my power plant construction management workshops over the last three months, attendance is very robust. It suggests to me that although there may be some postponements and cancellations of major power industry projects, there are still many others continuing forward. Gloom and doom it is not."
Peter Hessler, Author, Power Plant Construction Management: A Survival Guide
Coal-fired generation faces a different set of challenges than its fossil-fuel cousin, natural gas. Specifically, developers are having a difficult time simply getting approval to build coal-fired power plants. Aside from more stringent Environmental Protection Agency (EPA) air quality standards mandated by the Air Quality Act of 2006, local objections to coal-fired plants have accelerated in the past year. As a reference, in 2007 the U.S. Department of Energy listed 151 coal-fired power plants in various stages of the planning process. However, by 2008, 59 of the proposed plants had been refused state licenses or otherwise abandoned, with an additional 50 being contested in court.2 Kowalik, President of Burns & McDonnell's Energy unit, describes the challenges faced by utilities that are hoping to meet increasing consumer demand by adding coal-fired capacity: "Uncertainty in future potential carbon legislation and the inconsistent policies that states have arbitrarily instituted with regard to CO2 emissions have made building a coal plant more difficult."
"We have no time to experiment with visionary energy sources; civilization is in imminent danger and has to use nuclear -- the one safe, available energy source -- now or suffer the pain soon to be inflicted by our outraged planet."
Dr. James Lovelock, Scientist3
The virtual stand still on green field coal-fired power plant construction in many U.S. states has pushed developers to natural gas as a fuel source; thereby amplifying the bottleneck for materials and labor by reducing the options available. In states such as Texas that are moving forward with new coal-fired plants, developers may experience their own version of sticker shock; all-in costs for standard pulverized-coal-fired power plants have more than doubled from figures prepared as recently as 2004, according to Engineering News Record (ENR) and Eric Oldenhuis, director of proposals at Black & Veatch's energy division.
Long lead-time on materials will be crucial as many fabrication shops and equipment suppliers operate at or near capacity. Limited production materials such as high-nickel-alloy pipe have seen price escalation of 20.0 to 40.0 percent in the past four years, according to Oldenhuis.
Nuclear Power Generation
The past decade has seen a revival of interest in the use of nuclear power. Still, of the 36 reactors under construction worldwide, none are in the United States. According to the Department of Energy, the U.S. will need to add at least three new reactors per year starting in 2015 in order for nuclear energy to merely maintain its current 20.0 percent share of U.S. electricity generation. The aging domestic nuclear plants may buffet a downturn in new facility construction since higher maintenance and operating costs are associated with aging plants. According to Nuclear Safety Engineer David Lochbaum's recent report, "The Future of Nuclear Power: Renewal or Re-run?" prepared for the Union of Concerned Scientists, the risk of equipment failure or breakdown rise significantly and predictably as a nuclear reactor ages.
Table 3: New Nuclear Units with NRC License Applications Pending
"Nuclear has the power to move the needle in the fight against global warming. While the up-front costs of building new nuclear generation are not cheap, in the long run it's one of the most economical ways to make electricity."
David Crane, President and CEO, NRG Energy
While nuclear power generation is aligned with the new administration's plan to encourage carbon reduction and achieve energy independence, there is little actual policy support for nuclear generation. On the contrary, the new administration will likely reject any legislation enabling spent nuclear waste to be stored at the Yucca Mountain site. Still, firms are moving forward with plans to construct new nuclear facilities. NRG Energy is optimistic -- its plan to build two new nuclear reactors in the South Texas Project. The pair of new rectors, scheduled to come online in 2014 and 2015, would generate 2,700 megawatts or enough to power roughly two million homes.
As utilities focus on preservation of cash and liquidity, non-essential projects are likely to be pushed out into the future. Lower-cost upgrades and routine maintenance will continue in the nuclear sector, despite the tightening of credit.
Table 4: Existing Nuclear Generation Capacity by State -- 2008
Renewable Power Generation
One of the biggest constraints to long-term renewable power generation growth and construction is the ability to transport the energy to the grid. Renewable power generation construction received a much needed lifeline with the extension of the Production Tax Credit (PTC) as a component of the American Recovery and Reinvestment Act. This newest edition of the PTC extends tax credits for commercial wind generation through 2012, while extending a host of other renewable generation (including solar, biomass and geothermal) through 2013. Despite the passage of this bill, the availability of credit will hamper renewable energy developers as nearly all of these facilities rely upon liquid credit markets.
In 2007 wind generated 32.1 billion kilowatt hours -- a 21.0 percent increase -- and enough to power roughly 2.9 million homes. Wind energy is expected to jump an additional 45 percent in 2008 edging total US renewable generation to the 10.0 percent mark for the first time4. According to the American Wind Energy Association, the US surpassed Germany during 2008 to become the world leader in wind generation. (See Table 5)
Table 5: Global Wind Generation Capacity 2007
Transmission and Distribution
Transmission and distribution construction will be most significantly affected by one macroeconomic trend, low new housing growth, and two more focused trends, distribution pipeline integrity emphasis and transmission grid upgrade. The construction put in place for the electric, gas, and liquid transmission and distribution market increased nine percent to $29.6 billion in 2008 and FMI forecasts an additional increase of 5.0 percent in 2009. (See Table 6) This market is being hurt by very low new housing growth but the aging transmission infrastructure along with the growth in U.S. -- based gas and petroleum extraction and transportation is supporting growth. Funding from the stimulus bill will eventually find its way into this market, though largely in an indirect fashion -- such as through the tax incentives supporting new home construction or through the necessary movement of facilities due to road, highway, and transportation related stimulus spending. FMI anticipates a continuation but slowing of this growth throughout 2009 and then an acceleration in 2010 and 2011 as large transmission projects continue to take place and distribution oriented work picks up with a rebound in the housing markets.
Table 6: Electric/Gas T&D Construction Put in Place Historical Figures and Forecasts
Electric Transmission & Distribution
Power-related transmission and distribution, in comparison to other utility infrastructure segments, is somewhat resistant to downward pressure from the financial markets due to the size, cash flow, regulated rate recovery and relative good credit standing of many utility owners that put in place this work. However, this market is not insulated from continuing political gridlock surrounding legislation to encourage investment in the nation's rapidly aging infrastructure. FMI believes that the new administration will work to address the structural and regulatory flaws that make it harder and less financially rewarding to replace transmission and distribution infrastructure.
The recent signing of the omnibus economic stimulus bill into law carried with it a three-year extension of the production tax credit, which has been the primary driver of wind power generation construction in the U.S. Quanta Services explains the potential impact: "Over next three years we anticipate an uptick in transmission-related construction to support the build out of wind generating capacity in remote areas. While tempered, this growth should help electrical transmission and distribution contractors weather the economic slowdown."
Investment in transmission projects will continue at an aggressive pace, in part because of financial support from federal and state regulated rates of return but credit availability is a significant issue given the financial market turmoil. Electric transmission-related spending will be partly driven in the western states by renewable energy generation as new transmission lines must be built to for interconnection to the grid. The Federal Energy Regulatory Commission (FERC) has offered higher rates of return for some larger projects as well, to spur transmission construction. A recent study by grid operators estimates the nation will need to spend $80 billion to achieve 20 percent retail penetration for wind energy. (This estimate takes into account only Eastern Interconnection.)
Table 7: New Transmission Lines Needed for 20% Wide Power Generation in 2030
According to the Edison Electric Institute, U.S. transmission capacity has not kept up with rising electricity demand, which has increased 20.0 percent over the past decade. Despite the social and political pressure for utilities to upgrade their transmission infrastructure, there is relatively little financial incentive offered by such upgrades. Nonetheless, many large utilities and the regional authorities that manage the flow of electric power have announced several large capital campaigns. Several examples:
- In ERCOT's December 2008 report to the state regulatory body titled "2008 Constraints and Needs Report: 5 Year Transmission Planning Report", it proposes nearly $3 billion over five years in potential transmission spending in Texas.
- AEP announced on December 2, 2008, that it is evaluating the feasibility of building a multi-state, extra-high voltage transmission project across the Upper Midwest.
- Duke Power and AEP announced on August 8, 2008, the formation of a joint venture to build and own new transmission lines.
In contrast, natural gas production grew by 4.3 percent last year in the U.S. and was up 9.0 percent in the first quarter of 2008 due to new technology that allows firms to tap previously inaccessible gas trapped in existing coal and shale mines5. In the U.S., demand for natural gas continues and its availability in the North America makes it attractive for drilling, exploration, and ultimately transmission -- related projects to support getting the gas to market.
Table 8: Sources of Incremental Natural Gas Supply 2000-2025
Though important to the global natural gas market, Liquefied Natural Gas (LNG) has been slow to take hold in North America, delayed largely by the continent's already dominant local supply of natural gas as well as recent discoveries of additional gas wells (See Table 8). For example, the number of LNG shipments arriving at the Lake Charles terminal, owned by BG Group, fell from 48 in the second quarter of 2007 to just one in the fourth quarter due to diversion to other markets where pricing was higher.6
Escalating and highly variable materials costs will continue to alter all sectors of utility construction in 2009, just as they did in 2008. According to the Handy-Whitman Index of Public Utility Construction Costs, transmission and distribution costs have increased an average of 4.8 percent and 5.4 percent per year, respectively, since 2003. Just as copper prices peaked during 2007 and showed some signs of steadying in 2008, steel prices have become highly variable. From June to July of 2008, for example, the price of steel saw a 30.0 percent rise and, since that point, an almost equal drop.
Conclusion
"Change we can believe in." Barack Obama ran and won on a theme of change and it is what utility contractors will see in 2009. The disruption associated with the financial crisis will eventually abate; the Obama administration will eventually select and implement a regulatory stance; new housing growth will return; old and aging electric power infrastructure along with pipeline infrastructure for natural gas and petroleum products will all receive attention and construction spending to begin their replacement; and the economic recession will resolve to the benefit of all surviving business.
It is the interim that is the challenge for utility construction. The realities of the next six to 12 months do not require utility contractors to behave reactively. On the contrary, there are a number of proactive strategies that FMI believes successful contractors will pursue:
- Analyze your completed projects over the past three years and understand clearly what work you perform both well (profitably) and poorly.
- Use a "Bottom Up" budgeting approach that allows for "what if" analysis on various volumes and work mixes for 2009 and 2010.
- Use FMI's Dual Ratec overhead recovery method to ensure that you have clarity in your cost to perform work and the selection of an effective pricing strategy.
- Vary overhead recovery based upon project size -- smaller projects require a larger percentage recovery of overhead cost than do large jobs.
- Target the "right" clients and customers that are aligned to your business strategy and strengths.
- Create "your" customer value proposition and know what you bring to the table -- by the way, it is not meeting schedule, hitting budget, or delivering quality -- nearly everyone brings this or says they do!
King Whitney Jr. may have said it best: "To the confident [change] is inspiring because the challenge exists to make things better. Obviously, then, one's character and frame of mind determine how readily he brings about change and how he reacts to change that is imposed on him."
Select your own frame of mind for 2009 and make it an optimistic and confident one!
1.Blocked pipes: When banks find it hard to borrow, so do the rest of us," The Economist, October 2, 2008, pg. 75.
2.Brown, Lester, "U.S. Moving Toward Ban on New Coal-Fired Power Plants," Earth Policy Institute, February 14, 2008, pg 1 (www.earthpolicy.org).
3.Dr James Ephraim Lovelock, CH, CBE, FRS (born 26 July 1919) is an independent scientist, author, researcher, environmentalist, and futurist who lives in Devon, UK. He is known for proposing the Gaia hypothesis, in which he postulates that the Earth functions as a kind of "superorganism". Named after the Greek goddess Gaia, the hypothesis postulates that the biosphere has a regulatory effect on the Earth's environment that acts to sustain life.
4.2008 Green Jobs Report: Current and Potential Green Jobs in the U.S. Economy," The United States Conference of Mayors Climate Protection Center, pg 2.
5.A more liquid market," The Economist, October 2, 2008, pg. 70.
6.Ibid.