The Coal Bailout Nobody is Talking About

September 24, 2018 | 10:27 am
Photo: Mike Poresky/CC BY Flickr)
Joseph Daniel
Former Contributor

If you are reading this blog, chances are you are either an energy economist, grid geek, or maybe my mother. Regardless, this administration seems intent on trying various coal bailout attempts. Hopefully, you’ve already read up on the high costs and low benefits to such bailouts, how the first attempt failed, and how they’re at it again. My latest research has uncovered that every month, millions of consumers are unwittingly bailing out coal-fired power plants to the tune of over a billion dollars a year.

Merchant vs monopoly

Before we dig into the numbers, let’s talk about the two types of utilities that own coal power plants.

Merchant utilities primarily rely on revenues from the competitive power markets to make money. Monopoly utilities, on the other hand, own power plants and directly serve retail customers. They are household names in the areas they operate, probably because they send those households a monthly bill; those bills are how those utilities make money.

The first part of this new research looked at how these two types of utilities operated in four large competitive power markets. These markets were designed such that power plants that are cheap to operate should run more often than plants that are expensive to operate.

My analysis looked at market prices for energy where every coal plant is located and calculated how often a plant would operate based on market prices alone. I then compared that “expected” value with the power plant’s actual operational data.

For the most part, the merchant power plants operated at or below the expected value. Power plants that were owned by monopolies, however, typically operated more than would be expected.

The actual vs expected value of several large utilities. You would expect the dots to fall along the diagonal line, but monopoly owned plants tend to overgenerate.

The stark difference begged for additional investigation, so I used hourly data to conduct a detailed analysis of each power plant to discover if power plants were operating at times when cheaper energy was available.

Billion-dollar bailout

Some utilities appear to be finding a way to undermine the competitive market structure that would have lower cost resource operate more and higher cost resources operate less. Expensive coal plants—which are objectively not competitive—are being operated in such a way that costs consumers money, reduces flexibility, and exacerbates existing pollution problems.

Based on my analysis, monopoly utilities appear to be running more expensive plants while depriving their customers of access to cheaper (and likely cleaner) sources of energy.

This new analysis builds on earlier work of mine that investigated this issue in the Southwest Power Pool, SPP, the market that covers several great plains states. My original analysis calculated that ratepayers were incurring a burden of $150 million a year from just a few power plants. The new analysis (which includes all coal units in SPP) indicates that the number is closer to $300 million a year, just for SPP.

I looked at four large electricity markets, SPP, ERCOT, MISO, and PJM. Together, these four markets span from New Jersey to North Dakota; from Texas to Virginia.

The latest results suggest that, across the four coal-heavy energy markets, coal-fired power plants incurred $4.6 billion in market losses over the past 3 years or $1.5 billion dollars in market losses each year. Most of these “losses” were incurred by power plants owned by monopoly utilities and are not absorbed by the investors or owners. Rather, those costs were likely covered by customers. Consequently, I estimate this practice places a least a $1 billion burden on utility ratepayers each year.

New spin on old news

The fact that so much coal-fired power is uneconomic is not new news. The financial woes of coal have been well documented by UCSRhodium Group and Columbia University, Bloomberg New Energy FinanceMoody’sBank of America Merrill LynchMJ BradlyRocky Mountain InstituteUBS, Synapse Energy Economics, IEEFA, and others.

My new research differs in two ways. First, it quantifies the financial impact on consumers when utilities opt for dirty and expensive fuel over cleaner and cheaper alternatives. And two, this work focuses on a very specific aspect of how these coal plants operate and draws a somewhat unintuitive conclusion:

Some coal-fired power plants might make more (or lose less) money by operating less. 

My analysis further suggests that, for at least some of the owners of these power plants, the current economic woes are self-inflicted.

Throwing good money after bad

If it costs $25 to produce a unit of energy and the market price is $30 per unit then it makes sense to operate that power plant and take that $5 margin and use it to pay down debt or other fixed costs.

If market prices stay at $30 the power plant keeps operating as much as it can and begins to pay down the fixed costs and eventually the revenues go to building up a profit. If the market price drops down to $20 and the unit keeps operating, then the owner’s profits begin to erode. The longer the owner does this the more the profits erode.

“Stop throwing away money,” is not something you’d expect to have to tell a corporation.

Some plants generate at a loss so often that they make it impossible for the power plant to make money.

If utilities allowed the market price to determine when to run, this wouldn’t happen. However, in the competitive markets I analyzed, power plant operators can choose to ignore price signals, and the owner can “self-commit” or “self-schedule,” effectively bypassing the market’s role as the independent system operator.

If a merchant-owned power plant does this, it does so at its own risk. But when monopoly utilities do this, customers bear the burden. Below is the list of the 15 power plants that each incurred a $100 million market loss over the 3-year study period.

Power plants that imposed at least $100 million on rate payers. Note that many of the merchant-owned plants (highlighted in purple) burn waste coal and/or are “cogen” facilities.

The common excuses I hear

I’ve talked about this issue with advocates, economists, lawyers, engineers, market monitors, utility operators, and reporters. I like to take a moment to share some of the things I’ve heard in response to my analysis, and my response to them.

The most common: Aren’t these plants needed for reliability? 

Markets are designed to provide low-cost, reliable power. The idea that a power plant needs to bypass the market’s decision-making process and self-select (as opposed to market-select) is to presume that the markets are incapable of doing its job. Arguably, if the clearing price in a market is constantly below a power plant’s production costs, then, there were other resources available to reliably provide lower cost power. In some cases, the plants might be needed in some months but not others, like the municipal coal plant owner in Texas that realized it only made sense to operate in the summer months and decided to sit idle 8 months of the year. The municipality still provides electricity to their customers year-round, they just decided it didn’t make sense to burn $25/MWh coal in a $20/WMh market.

At the end of the day, this research was not designed to indicate or evaluate reliability and makes no judgment about the “need” for any of these plants for reliability purposes.

The most insulting: You just don’t understand how this works.

After the SPP report came out, SPP and utility officials challenged my conclusions (oddly, they did not contest my results). According to E&E news, that pushback included the specious argument that “[w]holesale electric rates do not directly correlate with retail electricity rates…” And, “[w]holesale electric rates also do not reflect other costs, like the price of ensuring the grid’s reliability, or utilities’ long-term fuel supply contracts”

Really? Retail and wholesale are different? Please, tell me more.

Of course retail rates are different, they include additional costs (for example, distribution system costs). Yes, regulated monopolies are allowed to recover prudent capital costs from the past, but we are only talking about operating costs.

None of these arguments changes the fact when wholesale prices are low, there is an opportunity for utilities to buy lower cost energy off the market and pass along savings to customers.

The silliest: I have the right to “self-supply.”  

When monopoly utilities joined competitive markets, they did so voluntarily. In fact, some had to jump through hoops to do it. These utilities often have a “least cost” obligation, meaning they are supposed to provide electricity to retail customers at the lowest reasonable cost. Now that there are resources available that are lower cost, utilities are desperate to retain their monopoly rights to supply their customers with resources they own. That’s just silly from any point of view other than the plant owner.

The most technical: Fuel contracts turn fuel costs into fixed costs.

This being the most technical excuse it is also the most complex; not easily handled in a few-hundred-word response. Maybe I’ll come back to this one in a future blog, but in the meantime…

Many coal-fired power plants enter into contracts for fuel which have “take-or-pay” provisions. Utilities claim this means there is effectively no cost to burning the fuel. First, most contracts can be re-negotiated. Fuel contracts I have reviewed are akin to a rental agreement: Yes, technically, you are locked in for a number of years, but typically there are ways to negotiate your way out. Second, the accounting logic they use to justify discounting the coal costs can produce sub-optimal results when companies fail to appropriately account for opportunity costs.

What’s next?

This research raises interesting questions, including:

  • Does this impact how we value energy efficiency and renewable energy?
  • Are power plants owned by monopoly utilities receiving de-facto ‘out of market’ subsidies?
  • When do fuel contracts and fuel cost accounting become imprudent?
  • Are inflexible coal units crowding out renewables on the transmission system?
  • Is coal partially to blame for negative energy market prices?

UCS wants allies, utilities, and decision makers to look at this question of operating uncompetitive coal plants without regard for the availability of lower priced energy. Utilities have the ability to stop engaging in this practice; if they don’t, regulators have agency to create (dis)incentives to help end it. If neither of those groups acts, consumer and environmental groups would seem well aligned to work together to stop it.