Curbing Construction Costs

November 13, 2009

Ken Silverstein, EnergyBiz Insider
Editor-in-Chief

Recession is over and recovery is here. And while there's an economic lag, it isn't expected to permanently weigh down the utility industry.

In recent years, power companies have paid increasingly higher building costs that have been largely predicated on volatile fuel prices as well as escalating raw material and skilled labor costs. Bleaker economic times, however, have blunted the trauma and led to a relative decline in construction-related expenses.

Is this downward drift tied directly to the recession or is it a longer-lasting phenomenon given that the costs of raw materials hit peak in 2008? If reduced prices are linked to tough times, then it would stand to reason that they would rise once the demand for goods and services picks up. After all, long term projections indicate that the nation is short power and that a critical swath of qualified workers will soon retire.

Despite an inevitable movement toward economic growth, the cost of the steel, concrete and copper won't automatically bounce back to their all-time highs. Such materials, which are used to build everything from nuclear plants to natural gas combined cycle facilities to wind turbines, have begun piling up as projects have gotten delayed. Manufacturers will therefore have to sell them before those prices would spike again.

Economic productivity is unlikely to head straight up. Rather, it is expected to be gradual. Some utility projects have therefore become uneconomical, for now. Consider Sempra Energy's plan to build 600-megawatt natural gas facility in Maryland: It was approved in 2005 and scheduled to go into operations in 2011. But the utility was unable to secure the long-term power contracts that would have paid for the plant.

Hard times, however, are making certain prices more attractive. According to Cambridge Energy Research Associates, the cost of constructing new plants has fallen by at least 3 percent in 2009 in a trend that began last year. Still, a power plant that cost $1 billion in 2000, for example, would run on average $2.17 billion today.

All types of power generation are affected by the cost of raw materials. Beginning in the first quarter of 2008, nuclear plants saw some price relief. In the intervening months, falling prices touched all utility investments. Now -- and for the first time in a decade -- the cost of building coal, natural gas and wind plants has also dropped.

"The current three percent drop may appear modest compared to the sizable global decline in new construction orders but in this case it represents a true turning of the tide," says Candida Scott, director of Cambridge's cost and technology. "We can expect the downward pressure to continue to build as falling costs work their way through the supply chain."

Further Escalations

The Cambridge firm goes on to say that wind energy has benefited most from the fall in prices -- 11 percent because of a drop in wind turbine and tower costs in combination with a slowdown in orders. As a result, those specific costs should remain depressed in the near term. And while the federal government is now rewarding all renewable energy projects with stimulus funds, the financial uncertainty that preceded that influx of money did take a notable toll on the sector.

Costs for combined cycle and simple cycle gas plants, meantime, have also declined. They had been down as much as 6 percent largely the consequence of reduced commodity prices and materials costs. Less energy demand has also put more power projects on hold, which will place further downward pressure on construction costs. Duke Energy, for example, has been forced to delay a 640-megawatt combined cycle plant, although once it commits, the utility expects to reduce its building expenses.

Coal plants, meanwhile, have also fallen by the same levels. Cambridge notes that increased regulatory oversight may make those facilities less desirable and thus bring down their construction costs even more. The firm also says that the decline in nuclear plant costs slowed during the year, falling by 1 percent because of reduced materials costs and additional manufacturing capability for key components.

The reprieve, generally, won't last long. As developing nations grow their economies, they will try to secure all the necessary raw materials to build power plants. Meantime, the developed world will be replacing older generation units with newer ones, which will drive up the prices for cement, cooper and steel.

Labor costs, meantime, are destined to increase as older and more experienced skilled employees exit the workforce. A shortage of electrical engineers, for example, would increase their value.

"Construction costs are projected to fall further this year (4-6 percent) but as the economy rebounds we will see costs recovering in the first and second quarters of 2010," says Pritish Patel, director of capital cost analysis for Cambridge. "Recovery would be a few percent to begin with but as the economy strengthens and oil demand improves, upstream construction markets are projected to see further escalations."

While the current demand for power has stalled, the government is projecting the need for new energy supplies to be at least 23 percent greater in 20 years than they are now. According to the Energy Information Administration, the nation needs about 50,000 megawatts by 2014 and 258,000 megawatts by 2030. That will cost about $412 billion through 2030.

The continued rise in the cost of materials has halted for now. But those prices will invariably stabilize and then head back up. Better times are ahead, meaning that the need for cleaner, cheaper and more reliable electricity will expand as the international community develops and progresses.

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EnergyBiz magazine is the thought-leading, award-winning publication of the emerging power industry. This article originally appeared in the November/December 2009 issue.