With CPP on ice, utilities seek organized market reforms to save baseload plants
Utilities in the Midwest are concerned retiring coal and nuclear plants too early leaves the grid vulnerable to price spikes and reliability problems.
In the power sector, as in life, nothing brings people together like a common enemy.
Last year at the annual convention of the Edison Electric Institute (EEI), the trade group for U.S. investor-owned utilities, that common enemy — or at least a point of common critique — was the EPA’s Clean Power Plan.
The five utility CEOs that comprise EEI’s board panned the plan to cut carbon emissions from the power sector 32% by 2030, saying they wanted the agency to come up with something more “workable” for the power sector.
A year later, the tune has changed.
After the extension of crucial tax breaks for renewable energy at the end of last year, Clean Power Plan compliance for many EEI members is looking much more manageable than before, and the judicial stay on the regulation has meant states and companies have more time to plan for it.
With the EPA now out of the spotlight, utilities are turning their attention to a new front: Reforming the nation’s organized markets.
While they are generally working to lower prices for consumers, some utilities believe markets — like the one run by PJM Interconnection — are not properly valuing baseload generation, especially nuclear plants, forcing them to shut down prematurely. The concerns were compounded by an announcement from Exelon earlier this month that it would retire two uncompetitive nuclear plants in Illinois after a subsidy proposal to save them did not pass the state legislature.
“Merchant energy generation is struggling in the U.S.,” said Gerry Anderson, CEO of DTE Energy, the utility that serves Detroit. “We see some signs of things that leave me sitting back and asking, ‘What are we doing?’ — like the announcement of two nuclear plants in the prime of their productive careers potentially being put out for retirement at the very time where we say we value low carbon electricity production.”
Without reforms, utilities like DTE and AEP Ohio are concerned the low prices of natural gas and renewable energy will continue to push higher-cost coal and nuclear plants to shut down in organized markets, leaving the grid vulnerable to price spikes and reliability issues, and hurting decarbonization efforts.
Grid operators like PJM say they are constantly working to improve market structure, and that some of the retirement worries have been overblown. Even so, it appears the utility sector is preparing a concerted campaign to alter market structures for their baseload plants — either by working in the market, or changing it from the outside.
“I think it’s something that the [utility] CEOs are likely to put a whole lot more focus into because the outcomes are beginning to absolutely not make sense, and we’re going to press in,” Anderson said.
The battle over organized markets
The nation’s organized electricity markets, set up in the late 1990s and early 2000s, serve about two-thirds of the U.S. population. Unlike certain regions such as the Southeast, where vertically-integrated utilities still own the entire power system, non-utility independent power producers are encouraged to play in organized markets, with the idea that more competition will lower prices for consumers.
By some measures, that’s happening. The latest PJM capacity market auction, for instance, returned unexpectedly low prices for generators due to the low cost of natural gas and energy efficiency measures that have slowed demand growth.
In a sense, that’s evidence the markets are working. But while good for consumers, persistently low prices for generation are putting pressure on some power plants that are still in the prime of their careers. According to Anderson, they are contributing to the “slow roll bankruptcy” of the competitive generation industry, with only plants owned by regulated utilities and those with special income supports safe from market forces.
“You see some plants formerly owned by Ameren out [of the markets],” Anderson told Utility Dive after the panel. “You have plants from FirstEnergy and AEP either saying we get relief or these go out. You see prime nuclear plants by Exelon and others who are just saying either these have to be fixed or we're out.”
Nick Akins, the CEO of American Electric Power (AEP), agreed with Anderson. Since 2013, AEP has sought income guarantees from Ohio regulators for a group of coal plants it says are essential for reliability and price stability, but which have come under pressure in the PJM markets.
“You have baseload assets, whether coal or nuclear, that are retiring or are being forced to retire because of a market structure that does not pay for the sustainability of these long-term assets,” Akins said. “These markets are driven by short-term solutions and we're actually putting a system together that we’re going to depend on marginal generation resources — natural gas, which isn’t completely built out yet from an infrastructure standpoint.”
From the utility perspective, the concerns are two-fold — price and reliability. While natural gas prices are low now, they have been volatile in the past, which could make customers vulnerable to price spikes if the system relies on gas generation. And if gas delivery to plants is interrupted, as it was during the 2014 Polar Vortex, some utilities worry reliability could be compromised if coal and nuclear plants aren’t there to provide power.
Additionally, retiring nuclear generation raises concerns that the U.S. will not be able to meet its decarbonization goals, said Mike Howard, CEO of EPRI, the electric power research nonprofit funded by the utility industry. While the U.S. can likely comply with the Clean Power Plan, he told the panel audience, the potential retirement of nuclear generators could create problems as the nation looks to cut carbon deeper to meet goals under the Paris agreement, which seeks to virtually zero out carbon emissions by the end of the century.
“When we go from 2030 to 2050 and we continue to focus on decarbonizing, how do we do that, especially if we run the risk of shutting down our largest carbon free source right now of baseload generation, which is nuclear?” Howard said. “By taking the long view and going to 2050, you realize the important need that these assets continue to operate not just 60 years, but 80 years and beyond.”
Vince Duane, senior vice president for law, compliance and external relations at PJM, said that while some of the utility industry’s concerns are legitimate, the conversation has ballooned into exaggerated worries that virtually the entire coal and nuclear fleet in the U.S. is at risk.
“We don't see the whole threat that the fleet of the nuclear resources or the fleet of the coal resources are going to disappear,” he said, calling the notion “not just far-fetched but virtually impossible.”
“We have taken steps with some aspects of our market design, notably the capacity performance rules, to reflect the value of dependable and available resources,” he said. “Some of the concern about natural gas is its delivery is a just-in-time delivery for a real-time electricity market, and we at PJM acknowledge that by putting a premium on resources that were dependable and available, and that has already resulted in natural gas resources taking steps to shore up the delivery concern, either through the procurement of firm transport contracts or by adding dual fuel.”
Ohio: Ground zero for organized market fights
If there’s one state regulator familiar with the issues surrounding baseload generation and organized markets, it’s Asim Haque, chair of the Public Utilities Commission of Ohio (PUCO).
Appointed in June 2013 to the PUCO, Haque served just a few months on the commission before AEP filed its first request to subsidize uncompetitive coal generation in December of that year. FirstEnergy followed with a similar proposal in 2015, and both issues are now back under PUCO jurisdiction after FERC blocked their approval by state regulators.
“I've literally lived these cases,” Haque told Utility Dive in an interview after the panel discussion.
The PUCO chair did not dispute claims of the “slow roll bankruptcy,” saying that Akins and Anderson know their businesses best. But he did point out that not everyone sees the situation as so dire.
“There are companies out there that are buying generation right now whose investors understand exactly what they’re getting themselves into, which is frankly quite a bit of volatility,” Haque said.
While these generators, such as Dynegy, have an appetite for risk in the organized markets, regulated utilities, with their reputation as safe investments, have a much different taste, a point echoed by PJM’s Duane.
“What I have come to find is there are companies whose investors want very stable output from the companies in terms of dollars. They want stable, assured prices, they want stability in growth. They do not want volatility,” Haque said. “There are companies that are focused on regulated, paced earnings and guaranteed earnings, and then there are companies who are focused on trying to capitalize these markets, and those are two completely different business models.”
That observation does not mean Haque dismisses concerns about organized markets. In March, he voted along with the rest of his commission to approve eight-year income guarantees for seven coal plants and one nuclear plant owned by AEP and FirstEnergy. Since being blocked by FERC over competition concerns, both companies have amended their proposals significantly, leaving the PUCO to look over them again.
From Haque’s perspective, “there are some objective metrics you can look at to say these wholesale markets are working,” such as adequate reserve requirements and the latest PJM capacity auction.
But those metrics only show that the market is working under its own terms, he said. A market will deliver outcomes based on its structure, and the question is whether the market rules and pricing mechanisms deliver the optimal outcome.
“When you start to dig even a layer deeper than just how these facilities are constructed and the long term investment, then you start thinking about fuel diversity and the necessity and desire to have fuel diversity, that's when you start to develop concerns,” he said.
Like the utilities, the PUCO chair expressed concern with the price and reliability vulnerabilities associated with a gas-heavy generation system. Any increases in gas prices on such a grid could have significant impacts on residents and businesses, and Haque expressed concern that gas delivery issues addressed by FERC and grid operators after the Polar Vortex haven’t been completely sewn up.
“One, you don't want to be reliant on one — particularly in the past — volatile commodity, and two, there have been delivery problems in the past,” Haque said. “So, unless we feel confident that all those bugs have been worked out, I can't be fully confident for the business and consumers in my state that we'll be okay.”
PJM, for its part, says it undertaken significant reforms to raise prices for generators in its capacity market in an attempt to keep more of them online and ensure reliability, pointing to its putting a premium on dependable and available resources.
Even so, the grid operator says there’s still room for improvement.
“It's fair to say we would hope to have seen more long-term contracting between suppliers and wholesale consumers in the capacity market; in other words, contracts over a longer period,” Duane said. “It hasn't materialized in the bilateral world sufficiently.”
One way grid operators like PJM could help address the utility industry’s concerns is by carving out portions of baseload generation and valuing them differently than natural gas and renewables. It’s an idea that AEP’s Akins has floated.
“I’ve been saying for years that they need a long-term capacity product,” Akins said. “Let's look at the market and separate out a piece of the market that says we need — I don’t know what it is — maybe 30% of our capacity needs to be long term, the rest of it can be these other options.”
Given the absence of sufficient long-term bilateral capacity contracts, PJM’s Duane said some market reform could be beneficial.
“We have been on record as saying perhaps the market design needs to evolve to having some form of a longer-term contract for at least a portion of the portfolio to give a little more stable pricing over the long period,” he said, adding that the grid operator would work with utilities on that structure.
But Akins, whose company has retired a quarter of its coal generation in recent years due to low gas prices and EPA air regulations, said PJM is not moving fast enough.
“We've retired 25% of our coal generation, [Exelon CEO Chris Crane] is saying nuclear plants are going to retire — those are clear indications that something is wrong in these markets,” he said, “because the longer term you look at it, the more value that is produced by these types of assets.”
Paying baseload generation more does raise some environmental concerns, Haque acknowledged, particularly if coal plants are included in that baseload mix. But there’s less of an argument for doing it for nuclear plants.
“Nuclear is seen by many as being a zero carbon solution for power generation. I understand the policy consideration associated with the coal fleet, but then what's the argument for the nuclear fleet?” he asked rhetorically.
Duane called the focus on preserving nuclear generation “a very valid concern.” While grid operators typically do not create market structures based on environmental concerns, he said there are ways for the market to accommodate protections for the nuclear plants, such as buying tranches of the resource.
“We can also even probably more easily accommodate things like carbon taxes and other price mechanisms that can get rolled into offers and be a part of the clearing function,” he said.
But at the same time, Duane cautioned companies and state regulators from asking PJM to take on carbon concerns.
“I think it's a little unfair for executives at some of these companies to suggest PJM should wade into the area of environmental policy and say we are going to make judgments as to how much nuclear resources we need, how many zero emission resources we need,” he said, “and it's a very slippery slope to start doing that.”
Cooperation or confrontation?
Throughout the discussions about market structure at EEI, a tone of frustration ran through the utility comments, though, notably, it was not present in Haque’s interview. AEP’s Akins called a recent PJM white paper on resource investment “the craziest thing I have ever seen.”
“It tells you a little bit about how they're thinking about things and it's very different from how the financial markets and investors are thinking about things relative to these assets,” he said. “So there's a real disconnect that needs to be resolved.”
If organized markets don’t fix their structure — and fast — both Anderson and Akins said they will pursue further legislative efforts to reform the markets from the outside. In the aftermath of FERC’s block of AEP’s subsidy proposal, the company floated a plan to return Ohio to a fully-regulated market, and DTE is currently supporting a bill that would alter market structures in Michigan, doing away with the 10% portion of the state’s load that is open to retail choice.
Both executives said similar bills are in the offing, and that the industry can expect more proposals for income supports for certain plants, like the AEP and FirstEnergy proposals.
For Duane, the acrimony is understandable.
“Nick [Akins] is frustrated and if I was in his shoes, I would be too, because he owns a lot of legacy coal assets and whether he was in PJM or anywhere else in the country, those assets are right now just not favored,” he said. “I don’t know how to respond to him, but to beat up on PJM is just a convenient stalking horse.”
Still, Duane acknowledged that PJM has to ensure that market prices can support reliable generation.
“Prices out of the market need to be sufficient not just to deliver value to consumers, but they need to be sufficient to support necessary assets that provide services to consumers,” he said. “So low prices, while they’re desirable, can't be any lower than they need to be to support investment.”
But, he quickly added, that’s not where PJM is today.
“There are shareholders and investors that are very happy in PJM,” he said. “They may not be Nick's shareholders and investors, but we are attracting a lot of investment in PJM, it is coming from merchant companies and private equity and they are quite happy, as evidenced by the over 5,000 MW that came into PJM [in the recent capacity auction].”
Going forward, PJM says it is open to dialogue with states and utilities about how they can support baseload generation, whether by reforming the market or integrating new pricing mechanisms like a carbon tax.
“We are open and we are considering ways to allow states to consider those objectives and do that in ways that do not harm… market signals,” Duane said, adding that it would be a “shame” for consumers if states revert to the fully-regulated model.
“The question of a steady stream price — that's the hallmark of a regulated environment. A price that moves around needs to be managed and there's risks associated with it,” he said. “What we're saying is the risks are the same, but in one case the ratepayer is underwriting that risk and in another case you have investors that are actively managing that volatility risk through the tools that are provided in the markets. That's a very big difference.”
In Ohio, Haque said he would comply with any legislation passed to return the state to a regulated model, but hopes stakeholders can hammer out the issues more collaboratively. After the subsidy dockets close, top on his list of priorities is to open a utility reform docket and put on a series of technical conferences to generate an iterative blueprint for Ohio’s energy future.
“If in the end the legislature says, ‘This is what we want you to do,’ then we need to implement what they've requested of us,” he said. “Now having said that, conceptually you would have to think [market structure] would be a part of the docket about the future of the state of Ohio, but what I’m proposing is informal enough where that can be part of the dialogue but we wouldn't be decisionmakers in that dialogue.”
“My hope is it’s not forced participation,” he said. “My hope is we can have this collaborative discussion about where the industry can go and how our utilities and other stakeholders can also have a seat at the table to profit from this."
Correction: This post has been updated to clarify statements from PJM's Vince Duane. An earlier version stated that Duane said PJM added 5,000 MW in recent years. In fact, it attracted 5,000 MW of capacity in its recent auction.
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