COVID-19 Highlights the Need to Ensure Reliable Electricity
Insufficient intensive care unit (ICU) beds and ventilators at American hospitals combating the COVID-19 pandemic demonstrates the importance of capacity planning for critical systems. The desire to minimize empty ICU beds and unused ventilators during normal times has led to acute shortages during the pandemic. We should learn from this experience and not let poor capacity planning endanger our electricity supply, especially during a time of crisis. A December 2019 Federal Energy Regulatory Commission “Minimum Offer Price Rule” (MOPR) change achieves this goal and it should be supported.
Sufficient power generation capacity is key to reliability, and in thirteen states along with the District of Columbia the PJM system operator manages this capacity market. PJM ensures sufficient future capacity by levying a fee on ratepayers that is ultimately determined in an auction overseen by FERC. FERC changed the MOPR rule because the capacity auctions are now grossly distorted by state subsidies protecting uneconomic nuclear and coal electricity generators or promoting renewable power sources.
Currently, eleven states in PJM’s territory have renewable energy mandates, three have nuclear subsidies, and at least four have coal subsidies. We are locked in a vicious cycle where multiple states try to out-Green each other, only to be followed by other states acting to protect non-renewables sources with their own subsidies. For example, in the early 2000s, Maryland, like many states, began requiring a certain percentage of electricity come from renewable energy, primarily wind and solar, even if the power is produced in a different state. Since the inception of its program, Maryland taxpayers have sent hundreds of millions of dollars to out-of-state power producers. The fact that these payments undermine its renewable program seems inconsequential; this is just what happens when states start handing out taxpayer money for over ambitious policy goals.
In addition to working at cross purposes and wasting taxpayer money, the subsidies in PJM have grown so large and ubiquitous that they can endanger future electricity reliability. Keeping uneconomic coal and nuclear resources operating and artificially lowering wind and solar production costs force truly competitive natural gas producers out of the market. These subsidies also mask and distort the real future price of electricity, and make it difficult to know what type, and how much, new power generation should be built. Once we emerge from the pandemic induced economic slowdown, valid price signals will be even more important for knowing what type and how much new power generation capacity is needed. Allowing the existing and increasing thicket of subsides to continue muddies our ability to use capital efficiently and makes the best choice for future capacity buildout harder.
In response to this subsidy morass, FERC revised the MOPR by expanding the rule’s applicability from selected natural gas power generators to most all power sources offered into the wholesale, future generation market, be it wind or solar, nuclear or coal, or natural gas. FERC’s action would make it more difficult to use subsidies to win an auction and get its benefits, e.g., the direct PJM payment, and often lower project financing costs and easier facility site approval. With some minor exceptions, the revised FERC rule helps contain runaway subsidies by invalidating all equally.
Yet in light of the ruling, states – including Maryland – are considering leaving PJM’s capacity market and instead creating a Fixed Resource Requirement (FRR). Under the FRR, power companies would be required to meet their capacity requirements by generating or purchasing electricity from companies within and outside of the state. The Independent Market Monitor (IMM) for PJM recently concluded that if Maryland went in the direction of an FRR, costs for consumers would rise by more than $200 million in the next auction. While FERC’s ruling seeks to restore competition and deliver affordable and reliable power, Maryland state leaders are instead considering options that would place an unnecessary financial burden on its residents.
In the midst of an escalating Green subsidy race, CO2 emissions in the power sector have come down but mostly due to private decisions based on the economics of using natural gas, not distorting subsidies. If state legislators wants to take action to deal with climate change, they can take more efficacious measures such as spending the equivalent subsidy amounts on improving climate change resilience and working to back a national carbon tax. Such a tax would save us all a great deal of money and more efficiently reduce our emissions.
The COVID-19 virus has shown that shortsighted measures to limit capacity expansion in critical systems, or efforts to manipulate these systems for non-central policy goals, is dangerous. We should allow the FERC to reform the electricity capacity market and enable this market to serve its real purpose of providing reliable and affordable electricity to consumers.
Jonathan Chanis manages New Tide Asset Management, LLC, a Maryland-company investing in listed equities and commodities. He formerly taught at Columbia University and worked at several financial firms, including Citigroup and Goldman Sachs.