New Report Warns That State-Sponsored Power Generation Harms Consumers

A recent report prepared by Continental Economics for the Compete Coalition (Compete Report) finds that state-sponsored electric generating plants raise costs for customers and jeopardize reliability. The report's release comes at a time when parties are debating the merits of a potential new state-sponsored power plant in Massachusetts, and when the electricity grid operators in New England and the Mid-Atlantic have proposed tariff revisions to address how their capacity markets will handle offers from state-sponsored plants. The flurry of activity on the issue underscores the continuing struggle to balance the requirement that rates allow the opportunity for appropriate compensation in competitive wholesale electricity markets with state concerns about prices and the availability of generation capacity within their borders.

Compete Report          

The Compete Report considers the impacts of state measures that guarantee revenue for new generation resources that bid into wholesale capacity markets.  The intent of such state measures is to encourage the construction of new generation resources to increase supply, reduce wholesale capacity market prices and thereby reduce prices for consumers.   

Jonathan Lesser, author of the Compete Report, classifies this strategy as "free lunch" economics that "fails to account for market dynamics."  The report finds that while the strategy may appear attractive on its face, any price reductions are short-lived because lower prices will drive away potential new generation resources that do not have state subsidies, cause existing plants to shut down prematurely and deter planned expansions of existing plants.  As the supply of generation dwindles, prices will rise and consumers actually will pay more than they would have without the subsidized generation.  Lesser asserts that private investors will not respond with investment when additional capacity is needed because they will fear the impacts of additional government intervention and more state-sponsored generation will be the only way to increase capacity in the market. The report contends that this cycle will continue until the industry ultimately returns to a monopoly utility structure, thus eliminating the benefits of the competitive market. 

Developments in New England

These issues currently are being considered in New England, both at the state and regional level.  In Massachusetts, the state is considering implementing a long-term contract providing guaranteed revenue for a new generator similar to the type examined in the Compete Report.  The New England Power Generators Association, Inc., among others, commented that this type of long-term contract would "distort"¦competitive market price signals, cause higher than otherwise costs and expose consumers to risks."  In support of the potential long-term contract, Footprint Power LLC, argued that a long-term guaranteed revenue contract is necessary because the capacity market administered by New England's grid operator - ISO New England, Inc. (ISO-NE) - has failed "to generate a revenue stream that will support financing for necessary generation in New England." 

Related arguments have been raised in the context of a December filing by ISO-NE (ISO-NE Proposal) with the Federal Energy Regulatory Commission (FERC).  The ISO-NE Proposal would preclude resources from using revenues from state initiatives like those examined in the Compete Report to justify their ability to offer capacity at prices lower than minimum benchmarks unless the initiatives are "economic development incentives that are broadly offered by state or local government and are not expressly intended to reduce prices." 

PJM Proposes to Mitigate Offers from State-Sponsored Resources

PJM - the grid operator for the Mid-Atlantic region - has rekindled a similar debate in its market with a December FERC filing that proposes to mitigate uneconomically low price offers from resources that receive state revenue linked to clearing in the PJM capacity market auction.  The tariff changes proposed in the filing (MOPR Amendments) would revise PJM's Minimum Offer Price Rule (MOPR).  The MOPR automatically increases some uneconomically low offers in PJM's capacity market auction to mitigate the buyer-side market power of entities that may have an incentive to depress capacity market prices with uneconomic offers.  The MOPR Amendments are intended to ensure that resources receiving revenues from the types of state measures examined in the Compete Report are subject to the MOPR.

On December 28, 2012, numerous entities filed comments on the MOPR Amendments, with many echoing the arguments in the Compete Report.  For example, in support of the MOPR Amendments the PJM Power Providers Group argued that "the results of the 2015-1016 [capacity market auction], because of the presence of new units receiving substantial, guaranteed out of market revenues, did not accurately reflect the true price of capacity in PJM" and that such an artificial result "undermines the very confidence that all market participants, whether they are buyers or sellers, must have in order for a market to function rationally."  In opposition to the MOPR Amendments, CPV Power Development, Inc. submitted comments in the same vein as Footprint Power's in Massachusetts, arguing that states are responding to the PJM capacity market's "failure to incentivize the development of new power generation...needed to enhance reliability" and that long-term contracts with guaranteed revenue are "necessary to ensure that"¦resources [can] be financed and constructed."

The continued debate on this issue will have major impacts on the nation's electricity markets and market participants should keep a close eye on how resulting policy changes will impact their businesses, now and in the future.