Michael Giberson
There was a time when the economics of public utilities was probably the sleepiest of back corners of practical economics. People went into utility economics for the same reasons that widows invested in utility stocks: so they could sleep soundly at night.
No so much anymore.
As luck has it, retail price caps on electric power in Maryland ? part of the state?s power industry restructuring package of 1999 ? are set to expire at a time in which fuel prices are relatively high and still rising. (See Lynne?s earlier post.) Politicians, regulators, and members of the industry in Maryland have been staying up late trying to find some way forward. (Or, in the case of some, backwards.)
If it is true, as I once wrote in too-extravagant prose, that consumers are the sleeping giant of electric power markets, the ending of price caps would be the wake up call. But many consumers want state regulators to hit the snooze button on real prices, and now it looks like consumers in Maryland will be able to get that extra 18 months of slumber.
The wholesale side of Maryland?s electric power market, as coordinated by regional transmission system operator PJM, has also been keeping folks up late. Yesterday FERC provided some support for PJM?s ?Reliability Pricing Model? ? an alternative to PJM?s currently unsatisfactory capacity market ? and encouraged regional players to finish the new market design.
FERC Commissioner Nora Brownell made the connection between capacity market alternatives and the expiration of Maryland?s retail rate cap. She said that capacity markets were artificial answers used when existing power markets were not fully developed. She expressed support for the alternative concept of an energy-only approach, but said energy-only markets required a willingness to take the political fallout for the resulting prices. The reaction in Maryland to the prospect of real prices suggested to Brownell that ?we are not willing to make that decision.? (The ?we? in that quote is explicated as ?the people who have to answer the questions of consumers.?)
Like retail rate caps, capacity markets are a kind of snooze button preventing the real awakening of consumer demand. Sure, capacity markets can be designed to ?foster? consumer participation, but the more fundamental issue is that a capacity market shifts price and quantity risks associated with generation investment away from dynamic, international capital markets and onto captive retail power consumers.
It is time for energy consumers to wake up and smell the coffee.
(The sleepy theme of this post was likely induced by some combination of income-tax-payment-related sleeplessness, my own staying-up-too-late last night writing too slowly about yesterday?s FERC meeting, and James Grimmelmann?s recent discussion of the book Where Wizards Stay Up Late at The Laboratorium.
You can find Commissioner Brownell’s remarks in the archived webcast of the April 20, 2006 meeting beginning at about the 50th minute.)
I haven’t made this speech in a while, so if I may…
I hate to hear/see discussions of capacity markets versus energy-only markets without any reference to the deep behavioral differences between the Eastern Interconnection and the Western Interconnection. These differences derive from the amount of hydro capacity and energy in the systems and hydro variability. Hydro is huge in the West, and its variation is large and complex. The variations are not long-term predictable, and they play out over periods of time that can be longer than market memory or political terms in office. And as we have observed during and since 2000-2001, the public cannot see a hydro shortage, and has little capability to judge its effect on the power system. They don’t understand the physics, so they don’t understand the available data. Consequently, the last deep hydro event has been explained away as being Enron’s fault. This, I believe, is exactly what Brownell was referring to recently when she said that being able to blame Enron means that people are able to avoid learning from their mistakes…
“Not only is there deep mistrust of power suppliers and marketers, she says, but there has emerged a convenient whipping boy — Enron — that can be blamed for everything. “That way, you never have to learn from your own mistakes,” she says. That, she says, has left energy markets with structural flaws that haven’t been corrected.” Rebecca Smith, WSJ, 3/16/06
The more comfortable people get believing that Enron caused the Western Energy Crisis of 2000-2001, the more likely they are to think that an energy-only market in the West will work just as well as it could in the East. Not only that, but people with that notion think that the California problems could suddenly drop in on Connecticut or Maryland. Wrong. In the East you’ll more likely get a series of price spikes around hot summer weeks, and then it goes away until next year. The price signal is exposed, but there really isn’t all that much economic damage. In the West, the hydro shortage allowed price spikes to go on for 18 months! As then-Commissioner Massey said, “The price signal has been delivered in spades.” [imprecise quote] The duration of the price signal was such that tremendous economic damage and transfers of wealth occurred. Without that stroke of luck, Enron might have folded a year earlier. But what is observable in the data from the crisis shows that Enron didn’t cause it.
Returning to capacity markets, again I hate to see people generalize about them without at least mentioning the difficulties in hydro-dominant systems, which might make administrative capacity requirements necessary over the long-term.
Regulators and utility planners must make the distinction between “source of opportunity” power and “reliable” power. As part of that process, they must assess the portion of hydro capacity which is “reliable” vs. the portion which is “source of opportunity” power.
CA is setting itself up for another major fall, with its combination of low conventional capacity reserve margin and aggressive RPS. While some hydro is “source of opportunity” power, all wind power is “source of opportunity” power. As the fraction of “source of opportunity” power in the portfolio approaches the conventional (or “reliable”) capacity reserve margin, the CA power grid will become unstable.
Ed Reid (D.O.U.G.2)