Questioning Competitive Power Markets

On September 7, the U.S. House Energy and Commerce Committee’s Energy and Power Subcommittee hosted the first in a series of hearings examining the effectiveness of the Federal Power Act (FPA).

This first hearing focused on historical perspectives on the FPA, posing specific questions to understand the history and performance of the law, to gain insight into contemporary challenges facing competitive power markets and regulated distribution utilities.

For competitive wholesale markets, the challenge of the day is low natural gas prices and flat demand that is driving down market revenues, prompting coal and nuclear plant retirements. States are worried about losing these resources and are raising concerns ranging from lost jobs, decreased reliability, and diminished fuel diversity. States like New York, Illinois, Ohio, and others are promoting state-level policy interventions (potentially including reregulation of generation) into the markets to address these concerns.

For monopoly distribution utilities, the proliferation of distributed energy resources and advanced technologies is challenging the traditional cost of service model of regulation. For example, utilities across the country are attempting to increase fixed customer charges or institute new fees on solar customers in response to net metering policies that promote distributed resources.  States like New York and California are leading the way to explore the future of the electric distribution utility.

With respect to the FPA and markets, state-based policies impacting competitive electricity markets often raise questions about federal jurisdiction, and the boundaries of these state-level interventions, see Hughes v Talen.

Scott Hempling wrote an insightful piece on the FPA and another essay framing state actions that can viably avoid tripping on federal toes, for example by enacting policies that impact demand (e.g. energy efficiency and conservation) or supply (e.g. clean energy standards), but avoiding policies that impact pricing. Hempling also promotes greater state-federal cooperation, dubbed “cooperative federalism”.

But are these interventions into competitive wholesale electricity markets needed?

A report from PJM Interconnection concluded that its competitive wholesale market is efficiently managing the retirement and entry of resources and is evolving and adapting to changing needs. PJM found that resource entry is happening in a cost effective manner, characterizes concerns about fuel diversity as solutions in search of a problem that doesn’t (currently) exist. Most importantly, PJM clarifies that the goal of competitive markets is to deliver cost effective resources needed to reliably serve customers, noting this goal doesn’t include broader environmental, social, and political policy goals. PJM concludes that imposition of policy goals can interfere with achieving the goals of competitive power markets.

A report from Raymond Gifford and Matthew Larson found: 1) coal and nuclear exits from competitive markets are happening and raising questions about reliability in these markets, 2) claims that these exits are a natural part of market competition are too simplistic and ignore local realities that prompt state policy interventions, 3) fuel or generator specific bailouts are not the right response to the problem, rather institutional market structures that value and compensate capacity, reliability, and fuel diversity are needed, and finally 4) in the absence of implementing these institutional market reforms, the only option remaining will be reregulation of generation.

Free market think tank, R-Street, recently published a study finding that competitive wholesale electricity markets are in fact working well, but certain shortcomings can be addressed through market reforms.  R-Street recommends the following market reforms: 1) enhance price formation to reduce non-market uplift payments (e.g. increase transparency on cause and location of uplift payments), 2) reduce artificial barriers to entry and exit (e.g. 24/7 performance requirements for capacity resources), remedy incomplete markets (e.g. improve competitive transmission planning processes). R-street also gives a shout out to the notion of “cooperative federalism” as enabling the multi-jurisdictional coordination needed to move markets forward.  

So what can be learned by this super-brief overview of a super-complicated issue?

  • Pay attention to the past. The history of the development of the FPA and its implementing agency, FERC, reveals an effort by Congress to promote natural gas and electricity competition to address shortcomings of an uncompetitive system.
  • The only constant is change. Twenty years ago when the relevant amendments to the FPA were passed, few knew carbon could change the climate, natural gas from shale rocks would be plentiful and cheap, and new technologies would enable widespread customer sited generation. All systems must evolve and evolution doesn’t have to mean devolution (i.e. returning to an uncompetitive environment)
  • Remember why we are here. Regulated generation receives compensation based on average costs, whereas competitive generation receives revenues based on marginal units in the market.  Natural gas units are typically on the margin. Gas prices are low, so market prices are being driven down below the average costs of some generators.  Of course, a return to regulation looks attractive to generators in this scenario (but not great for consumers).  However, natural gas prices won’t stay this low forever…and if they do, then we shouldn’t be worried about nuclear and coal retirements (i.e. fuel diversity).
  • Markets and policy must coexist. State policymakers are rightly concerned about their jurisdictions and have the ability to exercise energy priorities as long as they don’t tread on federal jurisdiction. There are also clear opportunities, and perhaps even needs, for competitive market reforms.  Market reforms must create pathways for states to exercise their rights without obliterating market efficiency.
  • But who will lead? Cross jurisdictional dialogue is needed – across states, markets, stakeholders, and with the feds – to develop optimal strategies that enable exercise of individual states’ rights while insulating other affected states in the market from negative outcomes by preserving market efficiency. Someone must lead this dialogue, and soon, but who? Market leaders – like PJM – have also been trying to promote various reforms (e.g. capacity performance requirement), within their authority and stakeholder governance structures. Congress is holding hearings, and that is useful especially if changes to law are eventually required. FERC would be an ideal choice to go beyond its current case-by-case approach and launch a broader investigation.

Future energy needs will be more demanding than the past.  Reliability and cost effectiveness are baselines.  Lack of imagination is leading to the reregulation solution. Innovation will be needed to create frameworks to enable environmental, social, political, technical, and market goals to thrive together.

Christina Simeone

Kleinman Center Senior Fellow
Christina Simeone is a senior fellow at the Kleinman Center for Energy Policy and a doctoral student in advanced energy systems at the Colorado School of Mines and the National Renewable Energy Laboratory, a joint program.