Proposal to subsidize coal and nuclear reverses 20 years of regulatory restructuring.
The EPA’s recent moves to euthanize the Clean Power Plan (CPP) have generated a lot of news. However, ever since last November’s election many who work in the energy and climate arena have been mollified by the belief that even without the CPP, or membership in the Paris accords, carbon emissions in the US power sector would continue to decline.
This confidence in a continuing emissions decline stems from the fact that power-market prices have posed at least as great a threat to coal (and nuclear) plants as have environmental regulations. What we didn’t foresee was the prospect that the administration might reject markets altogether. Not only is the Trump administration trying to lessen the burden of carbon regulation (a move that hurts nuclear as much as it helps coal), a related move by the Department of Energy is attempting to shield large and costly plants from the competition that threatens their future viability.
Such a move is a striking reversal of twenty years of regulatory restructuring in the industry. In the late 1990s, much of the country moved towards adding market incentives for electricity producers. Texas is the poster child for these changes which base the compensation for electricity production upon market prices rather than upon regulatory measurement of the producer’s cost. Much of the motivation for the change sprung from a belief that regulation had provided bad incentives for the investment in, and operation of, power plants. Operators who are guaranteed payments at least as high as their costs have little incentive to reduce those costs.
By the late 1990s, regulated utilities that had invested heavily in capital-intensive technologies like nuclear and coal appeared at the time to have made bad decisions. Ratepayers were on the hook for the cost of those investments, however, because the choices were made by regulated firms with the blessing of their local regulators. Much of the potential benefit of electricity restructuring sprung from the prospect that the changes would shift the risk of bad management decisions away from ratepayers and onto the companies who made them.
Now it appears that the industry has come full circle. This month the Department of Energy (DOE) proposed a rule that would allow many of the nation’s largest and most expensive power plants to reregulate themselves, at least when it pays more to do so.
Many of these plants were teetering on the brink of financial solvency for the basic reason that market prices were too low to cover their high operating costs. In order to save these plants from the cruel vicissitudes of market competition, the DOE has instructed the Federal Energy Regulatory Commission (FERC) to implement a rule that would direct Independent System Operators (ISOs) to essentially tax all power consumers in order to allow these plants to recover their costs of operation, effectively returning these plants to the warm bosom of cost-of-service regulation.
This policy is being justified as necessary to provide more “fuel security” to our power supply, a claim that everyone other than coal and nuclear plant owners considers to be a solution in search of a problem. There is a still-developing argument that there are certain capabilities which conventional power plants offer that are insufficiently rewarded in today’s energy markets. While there may be some merit to this argument, this proposal ignores those merits.
Two aspects of this proposal expose it as a targeted subsidy for a specific set of power plants.
First the DOE proposal would apply only to deregulated power plants, almost all of which were transferred from regulated to non-utility status over the last fifteen years. These are the same plants that 10 years ago were earning large margins as deregulated operators because higher natural gas prices were elevating market-wide electricity prices. Back then, states like Maryland and Illinois even explored trying to reregulate their power sectors in order to recapture those excess profits. But doing so would have meant buying out nuclear and coal operators at what were then high market prices. Deregulation of electricity looked like a great deal for producers and bad for consumers when gas prices were high. Now that gas price have fallen and the electricity market has turned, those roles are reversed.
For those states and plants that have operated under traditional cost of service regulation all along, the DOE proposal would change nothing. DOE is expecting ratepayers of regulated utilities to continue supporting their coal and nuclear plants even where they are uneconomic. This is one of several logical inconsistencies in the DOE order. If baseload (coal and nuclear) generation are somehow being undercompensated by the market, then let’s identify the source of the alleged “missing money” and rectify it for all resources and not just the deregulated ones. Such changes would reward all plants that provide the desired services, not just the ones that, kinda, really need the money right now.
By forcing electricity market operators to subsidize these plants, the DOE is essentially proposing that they tax all of their consumers in order to pay above-market compensation to a set of targeted plants. Customers of regulated utilities operating in these markets could end up paying twice, once for their own uneconomic plants and then for the supposedly deregulated, and now uneconomic, plants.
This is one of the subtle and important ways the proposal threatens the future of markets in the industry. Power market operators pool power from regulated and deregulated producers alike. These ISOs typically charge uniform user fees that pay for infrastructure and services that the ISO’s have determined provide actual reliability benefits. Utilities participate in this process because they believe the cost and reliability benefits are real. The DOE wants to make all ISO customers pay for the revenue shortfalls of plants in certain states. This is an important, and serious, difference from previous efforts by individual states to bail out their power plants. At least those efforts, some of which have been rejected by FERC, would allocate the costs of the bailouts to the communities that supposedly benefit from them.
Almost 15 years after bitter fights over a FERC led standard market design proposal, proponents of ISOs have finally been able to convince most local regulators that ISOs provide benefits to regulated, municipally owned, and deregulated utilities alike. However, the attempt to recover subsidy costs through ISOs risks undermining the value proposition that ISOs provide. If I were a customer in a regulated region, one that was already guaranteeing the costs of my utility’s coal and nuclear plants, how would I feel about having to chip in for the costs of some other utility’s once-and-now-future regulated plant also? Conversely, states like Illinois may want to reconsider their decision to subsidize their baseload plants with local charges if they can get their ISOs to do it instead.
The second “tell” that this is not about reliability is the fact that ISOs (and the FERC) have been working for years to identify the reliability needs of their systems, and to fill any gaps in compensation that remain in their market systems. The types of plants they worry about losing are nimble, fast, and reliable – not attributes commonly associated with nuclear and coal generation. The most valuable plants usually burn natural gas. Ironically, the DOE proposal could put the continued existence of these more flexible plants at risk.
There is almost nothing a nuclear and coal plant can do that a modern natural-gas power plant can’t do, with the possible exception of providing power at the end of a congested gas pipeline during an extreme cold snap. This fuel reliability story, calling upon anecdotes from the 2014 polar vortex, provides pretty much the entire basis for calling coal and nuclear more reliable. The DOE proposal identifies the ability to store 90 days-worth of fuel on-site as the key attribute that is not rewarded in today’s market. Why 90 days? Are we really planning for a 3-month polar vortex now, or is that long enough to disqualify gas plants with on-site oil reserves, an obvious alternative solution to the “problem”?
Even setting aside very real debates over the relative reliability of pipelines vs. piles of coal, to say the markets don’t reward reliable fuel supply is like saying it’s not rewarding to have the only bottled water for sale in the desert, during a marathon. If these plants ever actually did find themselves as the only available supply for anything more than an hour or two, today’s markets would pay them upwards of $2000 a MWh for their production and they could pay for all their costs pretty quickly.
During the height of the 2014 Polar Vortex, prices at the Chicago Hub reached over $1700/MWh and averaged over $500/MWh on January 7th. A 1000 MW plant with fuel
would make about half a million dollars an hour under such conditions. The prospect of such large rewards should attract capital if anyone thought this was much of a real possibility. Apparently DOE doesn’t trust the market’s judgement about the probabilities of such an outcome.
It is fair to say that the CO2 emissions implications of the proposal are complicated. Nuclear generation does offer a valuable attribute that is under-appreciated in much of the country: electricity production with no greenhouse gas emissions. There are many better ways to capture those benefits, like pricing GHGs to reward zero-carbon sellers through a market mechanism. And this proposal would do nothing to change the fate of plants like PG&E’s Diablo Canyon, which, because it is still operated by a regulated utility, would not qualify for DOE’s special treatment.
One of the many ironies to this initiative is the fact that nuclear generation is one of the most notable success stories to emerge from electricity competition. Lucas Davis and Catherine Wolfram have shown that plants that chronically under-performed when their payments were based upon their costs, showed a remarkable improvement in performance when put under market incentives. While many of these plants have made great progress, it may not be enough for them to be competitive if we ignore the carbon benefits they provide.
There was always a risk that electricity deregulation could become a heads-I-win, tails-you-lose proposition. As a seller, I would love the opportunity to get paid by the market when prices are high, and instead get paid my costs when prices are low. If the political and regulatory process allows producers – or consumers – to bounce back and forth between markets and regulation whenever supply conditions offer a better deal from one or the other, then we will likely experience the worst of both regulation and deregulation.
There are many within the industry who seem to believe that this proposal is so crazy, and so at odds with the last 20 years of FERC policy, that it could never become a reality. I hope they are right. At least one state is likely to escape this trap. Texas is not subject to FERC jurisdiction, and the leadership of Texas has a longstanding commitment and belief in letting markets work, unlike the Texan currently leading the Department of Energy.