How wholesale power markets and state environmental policies can work together
Analysts from The Brattle Group lay out three paths for making state energy goals work in electricity markets
The following is a guest post from Sam Newell, Johannes Pfeifenberger, Judy Chang and Kathleen Spees of The Brattle Group, a consultancy. To submit a viewpoint article, please review these guidelines.
FERC’s Technical Conference in May brought together a variety of perspectives on how state environmental policies and wholesale electricity markets can affect each other. A common refrain was that wholesale markets have to “accommodate, achieve, and adapt to” state policies.
Many of the state regulators and policymakers appeared to recognize the value of the wholesale power markets and the benefits of harmonizing their policy initiatives with these markets. At the same time, most of the generator representatives recognized the reality of the states’ policy objectives and the need to harmonize them with the wholesale markets.
Our view remains that well-designed wholesale electricity markets and clearly-specified state environmental policies can work together to maintain reliability and decarbonize the electricity sector at lower cost than less-market-based approaches.
The organized wholesale power markets have a strong track record of meeting reliability objectives at lower-than-expected costs, while helping to meet environmental objectives cost-effectively. They have done so in combination with cap-and-trade programs limiting SOx and NOx emissions and, to a lesser extent, CO2 emissions (through RGGI and in the Northeast and AB32 in California).
The organized markets have also shown that they can cost-effectively replace the capacity lost from recent coal plant retirements. However, these markets have not been designed to meet certain state policy objectives, and therefore will not automatically or naturally meet those objectives.
Many states’ decarbonization goals are more far-reaching and will require much greater transformation of the generation fleet than other prior policy objectives. Indeed, several states aim to reduce state-wide carbon emissions by 80% by 2050, which amounts to transforming almost the entire generation fleet to clean energy within roughly one investment cycle from now and possibly electrifying the transportation and building sectors.
The investment needed to achieve these goals will involve many choices that should be guided by market forces to harness both competition and innovation.
Policymakers can enable market forces by integrating decarbonization or clean-energy objectives into the wholesale electricity market design so that these markets — in combination with existing energy, capacity, and ancillary services markets — can help us find the most cost-effective overall solutions to serving customer demand cleanly and reliably.
A spectrum of potential approaches is available:
The most market-oriented approach to implementing a decarbonization policy is to put a price on carbon emissions. Whether through cap-and-trade, carbon taxes, or ISO-implemented carbon charges, carbon pricing stimulates competition and innovation for reducing emissions most cost-effectively.
The political acceptability may depend on customer cost impacts, which can be mitigated by returning the collected carbon-related charges to electricity customers. Some market design advances are needed, however, to most effectively implement carbon pricing and prevent emissions “leakage” to neighboring states that do not wish regulate carbon emissions.
We currently are developing an approach for RTOs with differing state policies, building on CAISO’s proposed improvement to the Western Energy Imbalance Market.
Clean energy markets
The second most market-oriented approach is to deploy broad-based clean energy markets. Renewable energy credit (REC) markets can spur competition for clean energy, but they generally do not involve all forms of non-emitting generation, such as nuclear or hydro power.
Ideally, clean energy markets allow participation by both new and existing resources of all clean-energy technologies to maximize competition and innovation. Combining clean-energy markets with a carbon price can extend the price signal to distinguish fossil resources that produce electricity at different emission rates.
Targeted procurement and support
Targeted procurements and direct financial support are less market-oriented. Some states are addressing immediate problems, such as the retirement of nuclear plants.
Targeted actions may be more expedient or politically easier than other approaches, but their rationale may be similar: addressing the current market’s failure to price carbon emissions.
Such actions can avoid retiring resources prematurely and increasing emissions or else replacing them with major investments in new clean resources. If such targeted actions are consistent with meeting decarbonization objectives cost effectively, they should be considered a partial correction, not a distortion.
Nevertheless, such targeted measures may be perceived by other market participants as interfering with wholesale markets — “picking winners” rather than relying on market approaches to identify the most cost-effective solutions. Developing a well-functioning market approach and attracting investment can take some time, however. While states develop market-based approaches (as soon as practical) temporary targeted actions can avoid losing major clean resources in the interim.
Toward a market-based clean energy future
When considering how to develop the right market-based mechanism, states would want to define their policy objectives with clarity and staying power.
Without clarity, market designers will lack the guidance they need to define appropriate products to meet the objectives. Without staying power, investors will perceive great regulatory risk surrounding future revenues for clean energy resources, supporting resources, and non-clean resources alike. Regulatory staying power reduces that risk and enables the policy objectives to become a predictable factor in which investors can commit financially more easily than otherwise, and thereby reducing the ultimate cost to customers.
Market-based approaches and the merchant generation model can likely remain vibrant even in a future with large amounts of clean-energy resources. In this future, energy prices may often fall to zero, and the variable generation from wind and solar will require increasing support from flexible and dependable resources to help balance the system.
Wholesale power market designs will have to adapt to recognize the value of flexibility and dependability. There may also be a more widespread need for new ancillary services products, such as the ramping products recently introduced in California and MISO. Energy and ancillary services prices will have to be allowed to rise to high levels when the available resources to provide those services become scarce. Further, market participation rules will need to be modified to fully enable storage, demand response, and other new technologies.
We envision a future with many different technologies receiving revenues less from the energy-component of electricity market and more from the ancillary services, capacity, and clean-energy components of these markets.
The Brattle Group analysts
That future will still be market-based, and the revenues from the market will be sufficient to attract and retain the necessary resources to cost effectively meet reliability and clean energy objectives.
In summary, the states’ increasingly stringent clean energy policies can be integrated into wholesale electricity market designs to harness competition, spur innovation, and guide technology choices to help meet both environmental and reliability objectives most cost effectively. If these markets are relied upon explicitly to support state policies, they can also remain consistent with a vibrant merchant generation model.
The prospects for a sustainable and efficient outcome are most promising if states are willing to rely on market-oriented approaches, such as carbon pricing or broad-based competitive markets for clean energy resources.