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Crux of NRG Op-Ed: Investors Lost Their Shirt on Last Generation Build-Out, So Now They Need Subsidies (NRG Wants Free Bet at the Table) Because investors "lost big" on the last competitive generation build-out, Texas ratepayers must now subsidize generation in order for it to get built -- that's the essence of what John Ragan, President of NRG Energy's Gulf Coast Region, said in a June 11 op-ed in favor of a Texas capacity market appearing in the Houston Chronicle.
Ragan, of course, used more tactful language, but stripped of all the euphemisms and pretense, Ragan's op-ed boils down to what all arguments in favor of compulsory capacity markets amount to: generators want to earn unregulated profits from owning capacity, but don't want to assume any risks of building that capacity.
"NRG is very interested in building new generation, and we are currently permitting two new large units," Ragan assures readers. "But to move forward with new projects, market conditions must support the investment. Generators have learned a lesson from last decade's construction boom: They bet on higher returns to come, and lost big."
"As our reserve margin dwindles, we face two choices: Hope for mild weather or move to a capacity market, which has brought new generation to electric grids in states across the country," Ragan claims.
"Who wants to bet on the Texas weather? We don't. We support the capacity market option," Ragan says.
However, what Ragan and NRG want is essentially a free bet at the table -- the ability to earn inframarginal energy market revenues, while taking no risk of unrecovered going forward fixed costs. That's like putting $1,000 of someone else's money on the roulette table, but if your number comes up, you keep all the winnings.
Matters has no problem with inframarginal revenues earned in the energy market, but ratepayers should not be forced to subsidize a generator's ability to play the market -- especially when probably 90-95% of all capacity which would receive a capacity payment would, due to the plant's in-the-money economics, be available in the energy market without the capacity market -- making the capacity payment nothing but a superfluous wealth transfer which does not "incent" anything.
While NRG may not want to bet on weather, other investors are currently responding to Texas market conditions in adequate amounts to push the 2014 reserve margin above the target. Indeed, the energy-only market has consistently resulted in above-target reserve margins in the prompt year despite prior out-year projections of shortfalls, and this behavior is expected, since the energy market only pays plants when they are needed. So history has shown that investors are willing to take on risks in an energy-only market to sustain an adequate level of capacity, and we disagree with any forecast that says this will suddenly change.
Story Continues Below...
ADVERTISEMENT However, if for argument's sake, Ragan's claim that investors are unwilling to invest without a capacity market is accepted, then policymakers and stakeholders must admit that deregulation has failed. As Matters has previously documented, there is no spinning it any other way.
While it has many moving parts, energy deregulation all boils down to one fundamental principle: who builds and pays for generation. With restructuring, it was agreed that in exchange for the ability of merchant generators to compete and earn unregulated profits on generation, customers would no longer be captive for any costs of such assets, outside of what the customer negotiates in their electric rate.
The capacity market basically stands this fundamental principle on its head, and reintroduces into the industry captive customers. And what do customers get in return? Nothing.
At least under the old monopoly model, flawed as it was (and by no means do we defend it, but rather highlight how a capacity market takes the worse of both models), returns were limited, and customers received average-cost power in exchange for guaranteeing the opportunity to earn the authorized rate of return.
Under the capacity market, it's essentially "Heads I Win, Tails You Lose." for customers. Customers don't get any entitlement to the energy from the plants they are subsidizing with capacity payments -- while such plants may have to offer energy at marginal cost, they are still allowed to be paid the clearing price, meaning customers do not receive any benefit from paying the fixed costs of the asset via a capacity payment. While certain energy and ancillary service offsets are supposedly meant to compensate customers for taking on the risk of fixed costs, the use of a proxy resource and forward look, rather than actual earned profits, make the offsets ineffective and inadequate.
Worse, under a capacity market, customers get whacked with what are excessive capacity payments as well. Again, under the old monopoly model, where ratepayers were captive, customers only had to pay cost plus the authorized return. Now, however, every cleared capacity resource will receive the clearing price, which is above-cost for all but the marginal unit. Again, in the capacity market, private investors enjoy the profits -- profits created only by government-compelled demand for capacity.
The rest of Ragan's op-ed is largely another scare tactic (it is argued no capacity markets means blackouts, which is bad for business). However, actual businesses, who would bear the cost of the capacity market, are largely, and forcefully, opposed to the capacity market.
Additional points raised by Ragan which merit rebuttal are below.
Ragan: "This competitive addition [e.g. a capacity market] builds on the best from the past to reduce risks to businesses and consumers from unpredictable energy pricing and availability."
First, the fact that there is competition in the provision of a service should not be confused with an actual market, with willing buyers and sellers. While a capacity market would have some (limited) competition, this is meaningless when the government is forcing customers to buy capacity. Harping on the "competition" in the capacity market is like being mugged, but taking solace in the fact that your actual mugger competed with four other assailants for the privilege of taking your money.
Second, it is doubtful that a capacity market will significantly reduce risks from "unpredictable energy pricing." First, although Ragan does not address it in the op-ed, NRG previously stated in comments to the PUC that NRG is "confused" by recommendations to reduce the energy market offer cap to $1,000 if a capacity market were implemented. While NRG did not endorse a specific offer cap level, it noted the rationale for a cap as high as $9,000 regardless of market structure, and said that, "effective scarcity pricing is important in any market design, and will help the capacity market work well in ERCOT." Therefore, it's clear that there will be substantial volatility and risk under NRG's preferred energy-market design even if a capacity market is added.
Moreover, most scarcity pricing in ERCOT occurs due to transient events, rather than a resource adequacy shortfall, and therefore having a 15% reserve margin would not reduce risks from "unpredictable energy pricing" compared to the current paradigm.
Finally, even if the energy offer cap were lowered to $1,000, as is the level in the eastern RTOs with capacity markets, volatility, especially from transient events, remains a large risk. In particular, Matters would note the default of a retail supplier in ISO New England this February, due to severe cold weather and the impact on natural gas prices, as showing that the capacity market is not going to insulate the energy market from wild swings, as has been suggested.
Ragan: "But our reserve margin is shrinking each year..." [emphasis added]
Although its unclear what reserve margin Ragan is referencing (forecast or actual), in either case, this would appear to be false. With respect to forecasts, the forecast 2014 margin increased to 13.8% (above target) in the May 2013 CDR, from, 10.9% in the December 2012 CDR and 9.8% in the May 2012 CDR. With respect to actual reserve margins, this could be further split into the literal actual experience (reserve versus peak on peak day that year), or the actual reserve margin meaning the last official margin published by ERCOT prior to that summer. In either case, each of these numbers have increased (not shrinking each year), since 2011 and 2012, respectively.
Ragan: "NRG Energy has brought back to life a large power plant, consisting of four of our oldest units. Put differently, in order to keep the lights on this week and during hot afternoons throughout this summer, we are activating 1950s technology in a 21st century economy. That's like putting your family in a very, very old car with an odometer that has rolled over too many times and then trying to drive across the country."
First, the fact that with a capacity market, all of NRG's competitors, and customers who aren't served by NRG, would be paying for this resource -- whose benefits accrue solely to NRG -- is the largest problem with the capacity market from a retail market perspective, and discussed in-depth by Matters last fall (see prior story)
Second, Ragan relies on more scare tactics about the reliance on old power plants without a capacity market, when, in fact, the history of capacity markets in the East shows that capacity markets actually prolong the life of what were once claimed to be out-dated, past-their-useful-life assets. And, in fact, the presence of these old, largely depreciated assets with low going forward fixed costs actually prevented new generation (with higher fixed costs but lower marginal costs) from clearing the eastern capacity markets and being built.
Indeed, as noted more fully by Matters last year, PJM's capacity market was sold, in large part, on the need for new generation to replace, "units proposed for retirement [that] typically are at or near the end of their original planned useful lives, and cannot be maintained indefinitely."
However, through the end of 2011, more than 93 percent of the total revenue paid by customers under the PJM Reliability Pricing Model had gone to the owners of existing power plants, including those same assets once claimed to be at the end of their useful lives.
Ragan claims that a capacity market, "has brought new generation to electric grids in states across the country," however, the vast majority of that new capacity has been cleared in the last two years, and not because of the capacity market, but because of federal environmental regulations essentially making coal plants uneconomic. Absent these federal regulations, we'd expect to see scant new capacity in PJM, and instead the continued reliance on those "very, very old" power plants that were claimed to be at the end of their useful lives and why a capacity market was needed for new generation.
NRG's pleas for a capacity market in Texas -- an outdated relic of the old-fashioned, monopoly-based way of thinking dominated by central station generation -- also appears at odds with the progressive, forward thinking of its own CEO David Crane, who has been championing distributed generation, even to the point where the customer doesn't even need to be connected to the grid.
According to a recent interview with Bloomberg, Crane said that consumers are realizing that, "they don’t need the power industry at all," yet now NRG is advocating the creation of an artificial, forced demand for capacity?
Calling NRG a "renegade" in the utility sector (supporting a capacity market is hardly a renegade tactic), Bloomberg reported that Crane said in an interview that NRG is installing solar panels on rooftops of homes and businesses and in the future will offer natural gas-fired generators to customers. "The individual homeowner should be able to tie a machine to their natural gas line and tie that with solar on the roof and suddenly they can say to the transmission-distribution company, 'Disconnect that line,'" Bloomberg quoted Crane as saying.
Even if this model will take several years to come to fruition, why should Texas go through the expense of building a central station capacity market, when any resource adequacy needs (again, based on the 2014 forecast, none exist) are transient? Why create a market to subsidize the investment in 20 to 40-year central station assets when disruptive technology may make these assets uneconomic in less than 10 years?
Of course, no one knows what the "best" (lowest cost, best performing, longest-lived, etc.) investment will be when it comes to generation, and changes in various commodity markets and disruptive technologies make any asset at risk of being stranded. That's why governments got out of the power plant building process in the first place. Governments are not experts at managing that risk, so the risk was placed on investors, who in turn were allowed to earn unregulated profits on their investment. Why does Texas want to return to that old model, where the state develops a central plan of how much generation is needed, and dictates the price paid to all generators, as is what happens in a capacity market.
Finally, Ragan says that, "The Texas economy is stronger than any other state's. We don't want to mess this up by creating conditions that lead businesses to believe Texas has an unreliable electric system."
The only thing that would mess up Texas' economy more is an unnecessary tax on businesses and residents. And that's exactly what the capacity market is.
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June 13, 2013
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Copyright 2010-13 EnergyChoiceMatters.com
Reporting by Paul Ring • ring@energychoicematters.com
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