End Market Distortions to Keep Energy Sector Competitive

To call U.S. power sector developments of the last couple weeks “interesting” would be an understatement. Two weeks ago, the Department of Energy issued a Notice of Proposed Rulemaking (NOPR) that aims effectively to bring back or keep online some of the less competitive coal and nuclear power plants. That proposed rule was followed this week by the announcement of a proposal to repeal the Clean Power Plan, a centerpiece of President Obama’s climate agenda. Obviously, if one or both of these plans reach the finish line, in one form or another, it will mean big changes for the sector. But for time being, let’s focus on the first item, which has been called by experts a “grenade lobbed into competitive energy markets.”

The NOPR to the Federal Regulatory Energy Commission suggests the adoption of a rule that would require utilities in competitive energy markets to pay each eligible resource its fully allocated costs (their fixed investment costs plus their electricity production) and a fair return on equity if these plants have 90 days of fuel supply on-site. On the surface, requiring 90 days of fuel supply favors nuclear and coal, since natural gas plants receive fuel through pipelines. It’s not clear, however, whether natural gas plants could also store fuel (liquids) on site.

Secretary Perry faced a barrage of questions on this topic when he testified in front of the House Energy Committee on Oct. 12.  Back in April, the Secretary had requested a grid study in order to understand the reasons behind the retirement of certain baseload power plants, basically coal and nuclear, and to check the reliability and resilience of the U.S. electric grid.

A DOE study, which was completed in August, listed the availability of cheap natural gas, flat-lined electricity demand, an increase in variable renewable energy, and regulatory compliance as the four main reasons for retiring coal and nuclear plants. However, even with the changing dynamics, the report emphasized the fact that “the grid was, on average, more diverse in 2016 than in 2002 in terms of both capacity and generation.” Indeed, looking at projections made by the government’s Energy Information Administration, the amount of electricity generation anticipated from nuclear energy is relatively flat among both baseline and sensitivity analyses; coal shows a bit further decline, but most older coal plants that cannot meet current environmental regulations have already closed and a substantial share of electricity continues to come from coal plants.

With these facts in mind, it is not a surprise that reliability does not appear to be an issue either.  It looks like reliability is not an issue either. A previous report by North American Electric Reliability Corporation, 2017 State of Reliability Report, already demonstrated that power markets had an adequate level of reliability in 2016 despite these retirements. The new DOE study also found that the grid is currently reliable.

Recent extreme weather events underscore the importance of a flexible and resilient system that can snap back quickly after a catastrophic hit.

However, it is questionable whether having fuel on site would make much difference. Even though the Secretary used the 2014 Polar Vortex and natural gas shortages in the Northeast in his reasoning, some coal and nuclear plants were also forced offline due to extremely low temperatures. In another instant, during Hurricane Harvey, coal plants had to switch to natural gas due to unusable soaking wet piles of coal. Fuel contracting structures are an important element of reliability (and a lesson learned from the Polar Vortex), which the Secretary’s proposal does not discuss or recognize.

Another analysis also shows the minor role of fuel shortages in power disruptions: Over the past five years, only 0.0007 percent of (or 7 out of 1 million) power outages were due to fuel supply problems. The majority of outages were related to severe weather knocking down power lines. Addressing how to make power lines more resilient to extreme weather could be a much effective policy for increasing the reliability of the grid.

Then there is the perverted logic of fighting subsidies with subsidies. As rightfully noted in the Secretary’s memo “analysts have thoroughly documented the market distorting effects of federal subsidies to boost one form of energy at the expense of others.” But introducing another form of subsidy that favors coal and nuclear and further distorting market incentives would do more harm than good. Simply put, imperfectness of markets is not a reason to give up on pursuing market structures, which will provide better long-term outcomes than the increasing regulation proposed by the Secretary.

Reliable power generation is vital for a healthy and growing economy. It is important to have a diverse source of power and a reliable grid. However, this cannot be achieved by introducing more distortions through regulations or subsidies for certain fuel sources at the expense of others.

Dr. Pinar Çebi Wilber is Chief Economist at the American Council for Capital Formation

Dr. Pinar Cebi Wilber

Pınar Cebi Wilber’s research interests are diversified and include energy policy, tax policy, international trade and finance, and general government policy. Recently, Pınar has researched issues related to climate change legislation including the impact of such legislation on the U.S. economy. She has also done extensive research on the effect of government policies on retirement saving as well as the use of annuities in retirement.

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