Thursday, November 15, 2018

PJM Study Defends Markets, Warns State Policies can Harm Competition

By Suzanne Herel

A PJM analysis released last week concludes that the RTO’s markets are efficiently managing the entry and exit of capacity resources but warns their efforts could be hamstrung by policies to protect social, economic or political interests.

“Realizing the ‘investment efficiency’ advantages of PJM’s markets can require policymakers to accept tough choices because efficient market outcomes may inflict harm to other policy objectives,” said the 45-page report, titled “Resource Investment in Competitive Markets.”

“Policymakers must weigh these trade-offs, but understand that pursuing individual actions that ‘defeat’ efficient market outcomes will aggregate to a point they will altogether thwart effective operation of the market to the point it can no longer be relied upon to govern resource exit and entry and attract capital investment when needed,” it said.

Informed Decisions

Presenting the study in a conference call with the news media Friday, PJM General Counsel Vince Duane said, “It’s important to ensure that policymakers are making informed decisions when they decide to go with one approach at perhaps the expense of another.”

The report was commissioned by the Board of Managers last summer, following efforts by money-losing coal-fired generators in Ohio and nuclear generators in Illinois to win state-backed subsidies.

The Public Utilities Commission of Ohio is grappling with how to respond to a recent FERC order requiring federal review of power purchase agreements it granted to American Electric Power and FirstEnergy. (See related story, AEP, FirstEnergy Revise PPA Requests to Avoid FERC Review.)

Meanwhile, Exelon CEO Christopher Crane said in an earnings call on Friday that if Illinois legislators don’t step in and provide aid, it will decommission its money-losing Clinton and Quad Cities nuclear plants beginning next year. (See related story, Absent Legislation, Exelon to Close Clinton, Quad Cities Nukes.)

Local Consequences

“There’s no question that the retirements of legacy generation can create disruptive effects to local economies, job loss, loss of tax revenues for local communities,” Duane said. “Our markets are not designed — and really shouldn’t be designed — to account for those kinds of policy interests. But nonetheless they have to work alongside programs that are intended to advance social and political, environmental issues.

“The message is … let’s acknowledge there are trade-offs from time to time. Those trade-offs could be minimized perhaps if externalities can be priced and then the market can more readily digest those policy choices. … But that’s not always possible.”

The analysis is composed of two parts. The first “examines how markets drive resource investment decisions and compares generation entry and exit outcomes under both market and traditionally regulated constructs.”

Policy-Driven-Subsidies-PJM -capacity markets

The second section looked at “subsidies, regulations, policies and other requirements that may either reward or disadvantage generating resources and how such actions affect the performance of markets.”

On the first subject, researchers concluded that competitive markets are efficient when left alone to manage resource entry and exit, and that they do this on a more cost-effective basis for consumers than under a regulated model.

Bearing the Risk

At the same time that PJM is encouraging cost-effective new generation, it is avoiding investment in risky, capital-intense, experimental utility-scale projects such as Southern Co.’s Kemper integrated gasification combined cycle project and the Vogtle nuclear plant’s Units 3 and 4. The projects, backed by state and federal subsidies in traditional, rate-regulated states, are years behind schedule and billions over budget.

“Over the long term, markets can misallocate capital — we’re not saying it’s just a problem with regulators,” Duane said. “But markets also move very quickly” to correct their mistakes.

“We are operating … in very uncertain times in this industry right now,” he continued. “There’s a lot of concern about the disruption of the business model. Risk has a price, has a cost. In market environments like PJM’s, that risk is owned by the merchant investor. … Regulated entry is underwritten by the consumer/ratepayer.”

On a risk-adjusted basis, he said, “it seemed that new combined cycle entry was coming in to PJM on highly favorable terms relative to regulated models. Consumers of merchant generation in PJM were getting a pretty good deal.”

That, he said, raised two questions: Were regulated markets allowing returns on equity that were too high compared with what an investor would require? And on the other hand, was PJM providing sufficient revenues to support investments?

Given that 140,000 MW of natural gas capacity has entered the project queue since 2010, he said, “It’s hard to imagine that sophisticated investors are deploying their capital in PJM in that manner if they’re not expecting adequate returns.”

Resources Not Retiring Prematurely

The study also helps PJM rebut allegations that it is prematurely retiring resources that still have a useful life, Duane said.

“We were able to conclude with a high degree of confidence that both regulated models and PJM are doing a pretty good job in exiting coal resources that are really no longer competitive. But we were unable to see any meaningful statistical distinction that we were more aggressive or unduly aggressive or starving resources that still had an economic life but were unable, based on the market design, to earn the revenues that they should to support their operations,” he said.

PJM’s Tom Zadlo, who joined Duane on the media call, said PJM’s markets could accommodate a cap-and-trade system that would improve the finances of nuclear plants. “At a very simple level, if it’s something you can put a price on, it’s something that the market can then optimize for,” he said.

But the study did not make recommendations for how policy objectives can be designed in ways that don’t thwart market economics. “We leave that for another day,” Duane said.

 

1 Comment

  1. Rod Adams on May 12, 2016 at 10:23 AM

    Mr. Duane should understand that sophisticated investors know that they can make exception returns in situations that are not necessarily beneficial to customers.

    Many of the combined cycle and other natural gas fired power plants built under current market conditions are linked to entities that have interests in the natural gas fuel supply business.

    If coal and nuclear plants can be forced out of the market as a result of temporarily low natural gas prices, there is little chance that they will return to the market when demand increases without a corresponding increase in natural gas supply.

    That situation will drive natural gas prices back up, especially in an area where pipeline constraints still limit supplies from other areas.

    Costs for gas extractors do not increase when market price increases; they simply collect a larger margin on each sale.

    Rod Adams
    Publisher, Atomic Insights
    Host and producer, the Atomic Show podcast

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