This year, utility regulators in Missouri and Minnesota are looking into a practice known as self-committing, which research from UCS shows is costing customers a billion dollars a year in unnecessary costs. Now that this uneconomic and inefficient practice has caught the attention of a few regulators it is time to dive deep into just a few options utility regulators and state policy makers could avail themselves of as potential solutions to uneconomic coal generation.
Disclaimer: This list is meant to illustrate some of the many options regulators and state policy makers have available to them and is not an endorsement of any one course of action as the preferred solution or policy recommendation of this analyst or of UCS.
Disallowance
Monopoly utilities are generally allowed to recover the costs they incur to serve their customers, so long as those costs are prudent. When those costs aren’t prudent, the utility regulator can disallow, or prevent, those costs from being recovered from ratepayers.
Running expensive coal plants when less expensive, less polluting power plants are available doesn’t seem prudent to me.
A disallowance forces a utility’s investors, instead of the ratepayers, to bear the above market costs. Essentially, it would cut into utility profits.
In the world of utility regulation there are few statements stronger than a disallowance. The utility would immediately find a way to protect itself from having future costs disallowed, it would find better ways to run its coal plants, renegotiate coal contracts, and do a better job ensuring that the unit would operate more efficiently. But the ripple effect wouldn’t end there. Other utilities under that regulator’s jurisdiction would hear about the decision and get in line.
Such action is well within the jurisdiction of a state regulator and to the extent it would motivate utilities to operate more in line with rational economic theory, it presents itself as an elegant solution to the problem at hand.
Tracker reform
Another option that I’ve discussed with regulators seems to be the preferred choice for at least one former utility regulator and former president of NARUC, Travis Kavulla. Travis takes exception to the idea of disallowing past costs and argues in a blog that asking, “a regulator to judge whether a utility should have signed a particular fuel contract is a hopeless task in retrospection.”
I would argue that utility regulators need to scrutinize utility decision making more, not less. But I do agree with Travis that there are alternatives to the inevitable game of utility whack-a-mole that can ensue when trying to pin down the prudency of utility decision making.
What is Travis’ preferred solution?
“It involves reforming the “trackers” that cause utilities to be fully indifferent to their power-supply costs. Instead, trackers should incorporate cost-sharing. The basic design is fairly straightforward. First, the regulator sets a rate that reflects anticipated costs over a certain interval. When actual costs deviate (as inevitably they will), both shareholders and consumers share in the added costs or profits of that deviation. This approach motivates the utility toward efficiency in any given fuel supply issue—including its coal contracts. It also allows the regulator to put away the microscope and align the incentives of the utility with its customers’ interests to minimize their power costs. Indeed, this spin on a tracker has already been successfully adopted in several jurisdictions in the Pacific Northwest, though it is regrettably still not commonplace nor is it as amplified an incentive as it should be.”
Travis’ “light touch” regulation, isn’t without its own drawbacks. While serving as a regulator in Montana, it took years to put into place the tracker reform he describes above. Plus, regulators would have to set the target price right (no easy task) all the while avoiding the potential for unintended consequences.
Divestment
For those that prefer a more “free market” approach to solving this issue, there are options. There are several ways to introduce competition into the utility space and at one end of the spectrum is restructuring. Restructuring commonly (but not always) includes the requirement that incumbent monopoly utilities (the utilities that you and I buy electricity from) divest from ownership of any power plants.
After the divestment, the power plants have new owners that no longer have captive customers and become “merchant generators” that rely on the markets for their revenues.
Last year, my analysis showed very clearly that merchant coal plants in restructured states are far more likely run their plants as economically efficient as possible because they no longer have captive customers on the hook to bailout the company after bad business decisions.
Results from my analysis last year. 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 while merchant power plants operate at or below expected values.
Some of those merchant power plants have switched to seasonal operations because they knew they wouldn’t be economic to run for 60-75% of the year. Others have remained available but simply don’t self-commit, they allow the market to give them instructions. At the end of the day, one has to ask: how come some monopoly owned coal plants struggle to operate rationally while merchant coal plants do so with such ease?
After years of frustration with the local utilities, advocates and policymakers in both North Carolina and Florida are considering legislation that seeks to introduce competition to their incumbent utilities. Could frustration over $100’s of millions of dollars of uneconomic behavior precipitate similar courses of action in other states?
Conclusion
Some people are ideologically driven to push for “free-market” solutions. Luckily, UCS isn’t driven by ideology one way or the other. We analyze the pros and cons of all policies and evaluate the merits of proposals on the details of the individual proposals.
So, I am not saying restructuring or divestment is right for every state and I’m certainly not saying that a state should force the divestment of coal assets simply because a few coal plants are operating inefficiently. Restructuring is a policy pathway that should be led by the local community that will be most affected by such decisions. Similarly, I understand that a regulator might balk at the idea of disallowing fuel costs or taking up a long arduous proceeding to reform the tracking of fuel costs.
Whatever your policy preference is, we should be able to agree that something needs to be done.
The three ideas I’ve postulated in this blog are far from the only options to regulators. In fact, this blog focuses on what can happen at the state level, ignoring options for regional and federal interventions. But rest assure, UCS’s analysts aren’t ignoring those options. Stay tuned to this blog and follow me on twitter to stay up to date as we explore all of the ways to stop this uneconomic practice.