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Ivory Tower: FERC, Main Street See Polar Vortex Very Differently

May 05,2014

If you want a microcosm of what is not only wrong with the deregulated energy industry, but also America in general, simply take a look at the responses from different stakeholders to this winter's polar vortex, and the punitive electricity prices it imposed on customers.

Customers are, rightfully, fed up, and even though most customers are not well-versed in the intricacies of capacity markets, must-offer obligations, and price caps, the problem is so self-evident that, Robin Schumacher, the organizer of a community event regarding Niagara Mohawk generation rate increases, gave the most succinct summation of the problem we've heard to date:

"Somebody's got to investigate the people that are setting the prices, from these generation places, because they know what it costs to generate power," Schumacher told CBS-6 Albany

See CBS-6 Albany for more on the community event regarding the NiMo rate increases

Schumacher has hit on the truth that federal regulators are apparently unable or unwilling to see, since their short-term solution was to give generators more money -- and their long-term solutions also appear to be to give generators more money.

Generators know well the following:

• Their own costs to produce power;

• That certain input costs (fuel) may be outside of their control, unless they hedge;

• That in exchange for a capacity payment, they have agreed to make their power available to the ISO, under current market rules, and

• Long-standing market rules cap prices at $1,000/MWh (or a higher amount in PJM under certain administrative scarcity pricing mechanisms).

Therefore, if a generator knows that it must offer at $1,000/MWh or less, and that it is being subsidized through mandatory capacity payments to make such offers, you'd think that it would engage in prudent behavior to ensure that its variable costs never exceed $1,000/MWh.

But because many generators wanted to gamble, and because in a few hours of the year gas prices hit over $100, suddenly the bargain struck with customers in exchange for capacity payments is no longer adequate, to the generators. And FERC seems to agree.

Never mind that 40% of the capacity in PJM, which ratepayers paid to be available and prevent scarcity pricing (and prevent the 40¢/kWh electric rates we've seen at retail), was unavailable, essentially making the billions paid in capacity subsidies a wasted investment. No, apparently, FERC, from all the public statements we've heard and read, isn't concerned with this non-performance, and does not see it as a problem.

The problem, in FERC's eyes, is that these generators, which already had a capacity obligation and were receiving capacity payments to ensure reliability, somehow didn't have enough of an incentive to reliably operate, and therefore, FERC's focus should be on providing incremental compensation to certain generators -- not penalizing those who don't live up to their obligations.

To wit, we recently attended the National Energy Marketers Association annual restructuring conference, which featured keynotes from several FERC Commissioners, and the Commissioners' sheer indifference to the plight of customers, and eagerness to pump more revenues to generators, left us disappointed, but not surprised

We stress that due to business obligations we could not attend NEM's roundtable on the polar vortex, but we attended two keynotes from FERC Commissioners (Cheryl LaFleur, Acting Chair, and Philip Moeller), and based on conversations with those who attended the roundtable, plus based on other comments from FERC officials since the winter, we don't think Commissioners offered anything at the NEM roundtable to sway our judgment of their response to the polar vortex.

To begin, none of the Commissioners' keynotes which we attended addressed generator non-performance as a failure of the administrative capacity market to achieve its ostensible value to customers.

Indeed, Moeller, while stressing that he had not come to any conclusion on the question, framed the issue as whether FERC needs to pump more money to generators in exchange for better reliability.

"Do the capacity markets properly reward baseload generation that has on-site fuel," Moeller asked during his NEM keynote.

LaFleur likewise said that FERC must consider how to, "reward the generation sources that either have fuel on-site or have fuel security in an emergency."

Viewing the problem in this context is, quite frankly, outrageous. Customers were promised that in exchange for billions in capacity payments -- mandatory payments that are contrary to customer choice -- they would be assured generation adequacy. Now FERC Commissioners are tacitly acknowledging that the capacity markets cannot be relied upon to produce generation adequacy, because they don't assure fuel availability, and therefore, customers need to pay extra money on top of the current billions in capacity subsidies to be assured of reliability.

The question should be, do customers get the reliability they were forced to pay for under the capacity market? If not, the market should be dismantled as impotent. The question should not be: do we need to pay extra to actually get the reliability customers were promised?

But FERC appears to be full-speed ahead on increasing compensation to generators, not increasing value to customers.

Commissioners also appear eager to raise the long-standing $1,000/MWh price caps, under the guise that the caps are "outdated" because, in less than 1% of the hours of the year, spot -- we stress again, spot -- fuel prices may have led to marginal costs of generation production in excess of the cap.

This ignores that in a world where customers are forced to subsidize capacity, the price cap is not only about recognizing the cost of various variable cost inputs such as fuel. The price cap is an inherent benefit provided to customers which is essential in exchange for the subsidization of capacity. Since customers are covering the fixed costs of capacity through subsidized payments, there is no need for scarcity pricing, particularly scarcity clearing prices, to allow generators to earn a recovery on fixed costs.

Getting back to the observation from Main Street America, generators know their cost to produce power. If they are worried about under-recovery under the current price cap, there are two solutions readily available to them:

1. Hedge variable cost risks prudently, to ensure such costs are less than $1,000/MWh

2. Forego participation in the capacity market. If generators are worried about selling power at $1,000/MWh, they can simply elect not to assume a capacity obligation, thereby relieving themselves of any potential that they may in the future be called to offer power at a price less than their variable cost.

Raising the price cap is not needed to solve any problems arising from the polar vortex. But this past winter is being used as an excuse to simply transfer more wealth from customers to generators.

FERC   Capacity Market  

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