Some rate-regulated coal-fired power plants are running uneconomically, when price signals dictate that they shouldn’t be. This distorts the market for everybody else.
Basic economic logic tells you that a business flooding the market with free goods or services will lower market prices and make it hard for competitors to compete. Ordinarily, offering something for free--whether it’s free cookies or free coal-fired power--would be a questionable business model, or at least not one that would be sustainable in the long run. But when captive electricity customers are forced to pick up the bill for this questionable strategy, there’s little downside for utilities.
Unfortunately, some U.S. electricity markets face this issue. Many coal-burning power plants owned by regulated utilities are self-scheduled, leading them to operate when market prices aren’t even sufficient to cover the cost of running the plant. Ordinarily, selling each unit at a loss would be a recipe for a failing utility business, but as explained in the first installment of this series, losses are passed along to captive electricity customers of those utilities, who have paid an estimated $3.8 billion more than they would have in a functioning marketplace.
Self-scheduled coal plants are depressing wholesale electricity revenues by bidding into the market at a cost much lower than their actual cost of operating, which forces the market to take electricity from a generator that might not be the lowest cost. Sierra Club’s new research estimated the impact of this practice on wholesale market prices, using a model of the Midwest Independent System Operator (MISO) in 2017. If self-scheduled coal plants had been dispatched economically, wholesale electricity prices would have been roughly 30% higher on average, rising from $22/MWh to over $28/MWh.
Why is this happening? In a competitive electricity market, prices are set by the most expensive power plant that has to run to meet demand at a given point in time (this is typically called the “marginal” unit). The diagram below represents the supply curve for electricity. On the right side, all power plants bid their actual cost of producing power. The market price (P’) is set at the cost of the last unit that needs to run to meet demand (d), and the coal plant (gray bar) is too expensive to run. Now on the left side of the graphic, the coal plant is self-scheduled. This pushes the rest of the supply curve out to the right and results in a less-expensive plant setting the price at (P). Since the cost of the coal plant is higher than the resulting market price, captive retail electricity customers of the utility that owns the coal plant are picking up the difference, through rate cases and fuel dockets that are held at state commissions outside the visibility of the electricity markets.
Lower market prices? Sounds great! But not so fast. The coal plant owner may be losing money in the wholesale market by operating when revenues are insufficient to cover operating costs. But it’s the utility’s captive electricity customers who end up paying more to run the plant, even when the market is saying that power isn’t needed. And not only are these customers saddled with the bill, but this market price distortion makes it harder for clean energy, independent power producers, and more efficient power plants to compete for market revenues.
To build a new wind or solar power plant, a project developer (and their investors) need to know that the project will earn enough revenue over its lifetime to maintain the plant and repay investors for what they invested to build the plant (plus interest). If market revenues are artificially low, solar and wind projects may struggle to attract investors. When the levelized cost of energy from wind ranges from $14-47/MWh, lowering average market electricity revenues from $28/MWh to $22/MWh could lead to many potential projects that simply do not get built.
It’s not just large wind and solar power projects that suffer from this price suppression. Market revenues are also used by many regulated utilities as a benchmark for “avoided energy costs.” This is intended by regulators to represent the cost of generating electricity that is avoided by using an alternative resource or by increased energy efficiency, so if the benchmark for market revenues is $28/MWh, every megawatt-hour of energy that you avoid generating is worth $28/MWh. For instance, many utilities are required to purchase power from Qualifying Facilities (QF) under the Public Utility Regulatory Policies Act (PURPA) at their avoided cost of power. When the avoided cost of energy is artificially low, those resources are potentially being undercompensated for the energy they provide to the grid. In another example, when utilities judge the cost effectiveness of energy efficiency programs based on the value of avoided electricity generation, a low benchmark power price risks underestimating the benefits of these programs. In either case, using artificially low market revenues as a benchmark is inappropriate, especially when captive utility customers are paying more to cover the losses of uncompetitive coal plants.
When regulated utilities choose to self-schedule their coal plants, it’s not just their own customers who bear the costs. The practice of self-scheduling depresses electricity market revenues, and this perversely hurts competition and the continued development of lower-cost clean energy. In the next installment in this blog series, we’ll explore ways federal and state regulators can address self-scheduling and create a level playing field for electricity producers.
-Brendan Pierpont, Sierra Club Beyond Coal Campaign Senior Analyst