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Reality: Merchant Generators Don't Care If Retail Choice Dies
If you're an independent retail supplier, and particularly one which started after the 2005-07 bloodbath in the retail market, you need to understand one thing, if it's not already apparent: the leading advocates of "competitive" markets -- meaning non-price-regulated generators, most of whom own formerly incumbent assets -- don't care if retail choice dies, and, in fact, many "competitive" generators have argued for de facto re-regulation of retail generation supply to advance their own profits.
This is why merchant generators don't care that they've thrown at least three retail electric markets into political chaos, with serious retail market-harming policies likely resulting, due to their actions during the polar vortex -- New York, Connecticut, and, most shockingly, Pennsylvania.
Retail suppliers bear virtually no responsibility for the 20¢/kWh, 30¢/kWh, and 40¢/kWh rates that their customers are being billed (even suppliers which hedged their exposure are being exposed to extreme wholesale costs from make-whole payments and/or non-hedgeable uplift). Rather, the rates, on which retail suppliers are still losing money, result from asinine federal policy -- primarily the requirement that end use customers pay billions in capacity subsidies in advance, but with no collar (not even the long-standing $1,000/MWh energy market price cap) on the energy prices to be charged by such subsidized capacity. No rational person would ever enter such a one-sided contract.
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But generators are laughing all the way to the bank. In fact, according to a PJM letter to stakeholders released Friday, the polar vortex windfalls weren't enough for some generators. They're now trying to get cost recovery for gas procured but not used, allegedly due to changes in dispatch. An excerpt: "PJM has learned that several members may have incurred significant gas balancing losses in the course of operations during these unprecedented cold conditions ... PJM is aware that some members incurred losses for which they cannot be compensated under the current terms of PJM's governing documents. As a result, PJM expects that some of these members may elect to make filings with the FERC in order to seek compensation for losses they incurred."
So what's going to happen in the retail market? Well, any of the following:
• Elimination or severe restriction of variable rates (one of the only ways to beat utility-hedged SOS under certain conditions)
• Increased hedging of default service, through long-term and less market-reflective contracts
• Elimination of retail choice for vulnerable (low-income) customers, or even all small volume customers
Do generators care? No.
In fact, for those new to the retail industry, longer-term, less market-reflective default service -- a default service which impedes the retail market -- is exactly what many generators prefer.
Witness the statements from multiple "competitive" generators in multiple state proceedings:
Entergy Nuclear Power Marketing, LLC "As discussed more fully in Section II.C below, utilities should be required to cover some known, predefined percentage of their load through long term contracts."
"Long term contracts also are needed to limit consumers' exposure to excessive price volatility. Thus, the Commission should adopt a guideline that calls for long term contracts to be included as a component of utility supply portfolios."
Reply Comments to New York PSC Regarding Policies, Practices and Procedures for Utility Commodity Supply Service, Dec. 11, 2006 (Case 06-M-1017)
"[L]ong term contracts are a critical component of any balanced hedging program because they most effectively reduce price sensitivity to any particular period. The proposals advanced by a number of energy services companies ('ESCOs') in their respective initial comments to proscribe the utilities from entering into contracts for anything other than very short terms (e.g., one month) simply cannot and will not satisfy the Commission's stated goal of protecting residential and small commercial and industrial customers from market price volatility. Therefore, they must not be adopted."
"Moreover, as most parties except the ESCOs agree, the mechanisms that the utilities are allowed to use to solicit, and the structure of, utility long term contracts must not be inflexible or overly prescriptive. A one-size-fits-all approach must not be mandated. Rather, as ENPM demonstrated in its Initial Comments and as echoed by a number of other parties, the utilities must be permitted to procure electricity from the wholesale market through competitive solicitations for short, medium and long term contracts that allow bidders to provide a wide array of options and pricing proposals to the utilities. Providing the utilities with the flexibility to address the specific needs of the customers in their respective service territories will lead to the most competitive and efficient result."
AES Eastern Energy, L.P., Dynegy Power Corporation, Inc., Entergy Nuclear Power Marketing, LLC, The Mirant Parties and US Power Generating Company, LLC
"Based on the foregoing, the New York Suppliers believe that investor-owned utilities should be permitted to engage in hedging practices to meet their projected loads of their existing customers which include a mixture of short, medium and long term contracts."
"Turning first to the hedging considerations, the New York Suppliers believe that the investor-owned utilities should be free to issue requests for proposals to new and existing generation on a non-discriminatory basis to provide a hedge for them to meet the projected load requirements of their existing customers. To best achieve hedging results, the utilities should have flexibility to utilize a mix of short-term, medium-tem and long-term contracts"
Independent Power Producers of New York, Inc.
"Hedging guidelines should be flexible enough to encompass a wide range of wholesale electricity products, such as agreements providing for firm liquidated damages, unit-contingent physical arrangements, financial swaps and load following requirements products. Longer term contracts between suppliers and utilities are important to facilitate investment in new and needed existing generation, to assure reliable service to consumers, and to reduce consumer exposure to price volatility."
"Electric utilities should be granted flexibility to adjust the mix of short, medium and long-term supply contracts to manage their supply portfolios. The Commission should encourage electric utilities to ladder short, medium and long-term contracts to reduce the risk that the portfolio price will vary significantly from average spot market prices."
Reply Comments to New York PSC Regarding Policies, Practices and Procedures for Utility Commodity Supply Service, Dec. 11, 2006 (Case 06-M-1017)
"As IPPNY recommended in its initial comments, electric utilities should be granted flexibility to ladder a mix of short, medium and long-term supply contracts to manage their supply portfolios to reduce the risk that the portfolio price will vary significantly from average spot market prices. This blending process should fill the valleys and shave the peaks of consumer prices."
[In response to Direct Energy's proposal for utilities to replace their expiring long-term power purchase agreements entirely with power purchased under one-month forward agreements]:
"The Commission should reject Direct Energy's proposal to restrict the forward power procurements to one-month agreements, however, because it is based on faulty assumptions, ignores the critical price stability, fuel diversity and system reliability benefits longer-term contracts provide to the market and is directly contrary to the initiatives already put in place and under consideration in the wholesale markets to support the ongoing viability and continued development of competitive markets."
"Long-term hedging should not be construed as a once-a-year, static process. As IPPNY recommended in its initial comments, electric utilities should be granted flexibility to ladder a mix of short, medium and long-term supply contracts to manage their supply portfolios to reduce the risk that the portfolio price will vary significantly from average spot market prices. This blending process should fill the valleys and shave the peaks of consumer prices."
"In addition, Direct Energy's proposal to limit forward procurements to one-month agreements completely ignores the critical benefits longer term contracts bring to the competitive markets. Longer term contracts between suppliers and utilities are important to facilitate investment in new and needed existing generation, to assure reliable service to consumers, and to reduce consumer exposure to price volatility. Long-term hedging not only provides for price stability, it provides for supply reliability."
"Finally, proscribing utilities from entering into longer term contracts directly conflicts with the initiatives undertaken in the wholesale markets. Recognizing the benefits of longer term markets, the NYISO successfully implemented ICAP Demand Curves, in part, to allow for necessary longer term price signals to support bilateral contracts and investment in needed existing and new generation. The NYISO has initiated discussions to consider additional forward capacity market mechanisms to further augment such signals. Retail markets do not operate in a vacuum; they must be well-aligned with the structure of New York's wholesale markets. Direct Energy's proposal, if implemented, would substantially undercut such efforts at the very time that it is recognized that New York State will shortly be facing capacity shortfalls. Thus, it must be rejected."
PJM Power Providers Group
"P3 similarly supports the recommendation to move from the current 2 year [SOS] contracts to 3 years [sic] contracts procured twice annually. The electricity market is sufficiently liquid to support contracts of this length and there are benefits associated with a greater procurement mix.
PSEG Energy Resources & Trade LLC
"Based on the experience in New Jersey under Basic Generation Service, the annual procurement of one third of the load for a three year term appears to be a reasonable compromise between price responsiveness and price stability. Price averaging over a three year term will soften the impact of rising prices and, with unfettered migration rights, customers should be able to benefit from falling prices.
Exelon Generation Company, LLC
"Pepco should continue to act as the SOS provider. The Commission has successfully been able to promote a competitive market through use of the competitive request for proposals (RFP) process for full-requirements wholesale electric supply."
"The SOS RFPs have resulted in prices that are generally reflective of the market, but insulate customers from the volatility of any given procurement period through a structure which bids out only a portion of Pepco's load for three-year periods (and one-year periods for large C&I supply) at each procurement cycle"
"The Commission should refrain from making changes to the terms of the SOS supply contracts awarded to winning SOS suppliers. As explained above, robust participation in the RFP process each year is related directly to the well-designed, stable and non-discriminatory process that the Commission has established. Potential bidders are comfortable with the well-defined three-year and one-year SOS supply products and are able to efficiently and competitively price these products through the RFP process."
These statements are hardly surprising, in that generators see their business as serving load, not customers. While many have been forced into the retail market over the past five years from cratering wholesale margins, they'd prefer to sit back and simply manage slices of utility (default service) load, with comparatively minimal acquisition costs, higher margins and premiums (for load following and migration "risk"), and less churn (due to customer inertia). Hence, all the support from the competitive generator community for long-term and/or multi-year laddered default service -- this is the product they want to serve. That means making sure the retail market is not viable enough that this default service product is endangered.
Moreover, while the retail market is seriously threatened from the unconscionable actions of generators during the polar vortex, generators see little threat to their preferred business model of serving utility load from any resulting political volatility. That's because they know states can't effectively re-regulate generation; the toothpaste can't be put back in the tube. And for those minimal actions states have done to control wholesale costs (long-term capacity contracts which have no negative impact on the retail market), the generators have successfully defeated them (thus far) at the courts.
So who among generation owners cares if state legislators spend the next six months railing against "deregulation" and adopt longer-term default supply contracts (or even utility portfolio management); utilities are still going to have to ultimately get their customer power supplies from the same sources -- the now-merchant owners of formerly incumbent assets.
What does this mean for retail suppliers? First, it means don't expect any help from the competitive generation community.
But more importantly, it means that if independent retail suppliers want to have their businesses survive, they need to place the blame for the extreme wholesale pricing where it belongs -- on the so-called competitive wholesale market.
And so far, they are not doing that.
Two retail supplier trade associations recently put out what were billed as education materials related to the polar vortex pricing. While one of them did note that retail suppliers were not making any more margin from the higher pricing, both utterly failed to accurately assign blame for the higher prices. Such failure means that the retail market is left to shoulder all of the blame.
When it comes to explaining the reason for excessive polar vortex rates, retail suppliers are not doing the following:
• Explaining that generators had forced outage rates of 40%, which pushed the market into scarcity pricing much earlier than need be, as higher-cost units were forced to turn on due to the unavailability of lower-cost units
• Explaining that generators face no penalties for such forced outages, even as they committed to provide capacity under the capacity market
• Explaining that for as much rent as is extracted from load under wholesale market rules, generators have little incentive to actually produce power in times of scarcity, and in some cases can make more money when some of their generation is offline
• Explaining that generators, with approval from a hands-off FERC, broke their covenant to supply capacity into the day-ahead market at or below the current market rule of $1,000/MWh
• Explaining that despite purported economic theory to the contrary, the existing wholesale market design does not incent generators to lower their costs (as witnessed by generators' willingness to pay $100 spot gas prices, since they knew: 1) they could pass such costs on, and 2) such excessive costs would only further inflate margins for any of their lower-cost units, due to single-clearing price LMPs)
In short, retail suppliers are not telling regulators, legislators, and the public that the indefensible polar vortex prices have nothing to do with giving customers a choice in their electric supplier, and everything to do with a broken, poorly designed, and incompetently executed wholesale market -- one which was not created with consumers in mind.
If retail suppliers don't do this, who will? If retail suppliers stand by silently as politicians blame retail choice for 40¢/kWh rates, what will be the result?
Simply "explaining" that 40¢/kWh rates were the result of higher natural gas prices and colder weather, as retail suppliers have done to date, is not going to fly.
Retail suppliers need to show that there was a dereliction in the generator community in managing their risks. And instead of generators simply eating these losses, as would happen in a real market, FERC has allowed generators to pass these extraordinary costs -- which result from generator incompetence (or worse, strategic behavior to raise marginal prices) -- onto load. State legislators should therefore be directed to bring their pitchforks and torches to bear on FERC and its industry- and investor-driven wholesale market policy, rather than blaming retail suppliers for the actions of "competitive" generators.
If not, retail suppliers just might find a "Closed" sign on the retail market, which won't affect competitive generators one bit.
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March 17, 2014
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Copyright 2010-13 EnergyChoiceMatters.com
Reporting by Paul Ring • ring@energychoicematters.com
Comment on this story at RetailEnergyX.com
Comments to New York PSC Regarding Policies, Practices and Procedures for Utility Commodity Supply Service, Nov. 17, 2006 (Case 06-M-1017)
Comments to New York PSC, Regarding Policies, Practices and Procedures for Utility Commodity Supply Service, June 5, 2007 (Case 06-M-1017)
Comments to New York PSC, Regarding Policies, Practices and Procedures for Utility Commodity Supply Service, Nov. 17, 2006 (Case 06-M-1017)
Reply Comments to Maryland PSC Regarding Investigation Into Standard Offer Service, Nov. 21, 2008 (Case 9117)
Initial Testimony to Maryland PSC Regarding Investigation Into Standard Offer Service, Sept. 14, 2007 (Case 9117)
Comments to District of Columbia PSC Regarding Development And Designation Of Standard Offer Service, March 4, 2013
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