Department of Energy Walks Into a Fight About Subsidies

September 7, 2018 | 1:52 pm
Mike Jacobs
Mike Jacobs
Senior Energy Analyst

There is a fight over power plant costs that could threaten grid reliability, and it’s not as simple as the fight you have been hearing.  This wraps together three issues, each of which could cost billions of dollars. By throwing them together, policymakers are jeopardizing the electric grid reliability they say they are trying to protect. The three subjects in this fight are:

  1. Long-standing state policies for utility-owned generation in Kentucky, Ohio, Virginia, and West Virginia have been challenged as uneconomic;
  2. Renewable energy supports enacted by states are under attack;
  3. The federal government is pushing contradictory treatment for old coal plants.

A mess this big takes time

Presently, new political appointees in key agencies have tossed their respective agencies into a manufactured crisis that casts doubt on the basic means for paying power plants to keep the lights on. This uncertainty is a train-wreck of unacknowledged and uncoordinated policies verging on playing chicken with grid investments. In a hasty decision that invalidated the existing rules for reliability payments, a three-person majority at the Federal Energy Regulatory Commission, all appointed by President Trump, has made the continued operation of coal and nuclear plants less certain and new investment riskier. Meanwhile, DOE proposals to override the market, and over-pay coal plant owners threaten market investments.

Taxes on CO2 are a good idea for sorting out subsidies.

The owners of coal and nuclear plants opened this battle in 2013-2014 by arguing that the markets were paying too little, and despite all evidence that cheap natural gas had lowered prices across all U.S. energy markets, the fault lay in state policies that supported the gradual use of renewable energy. Soon, states began to rescue nuclear plants with additional payments and the fighting widened. Economists predicted that subsidies would lead to more subsidies, though this is already what we call U.S. energy policy. The Trump administration soon proposed subsidies for coal plants, and a national debate broke out.

No one expects markets to function when subsidies keep uneconomic plants online and force the supply to be greater than demand.  While the arguments to straighten this out will continue at the federal agencies and courts, here’s an explanation that should get you up to speed on how the economics and regulation are meant to provide grid reliability are complicated by old policies colliding with market prices driven down by innovation.

The focus is on FERC. What is FERC?

The Federal Energy Regulatory Commission (FERC) is center stage for this drama. For over 20 years, FERC has championed competition between power plants as the best way to determine how much should be paid to plant owners. The fundamental role for FERC is to ensure that rates for buyers and sellers of energy are just and reasonable. FERC was created in the 1930’s after financial manipulation by an interstate electric company demonstrated the need for a federal system to regulate in conjunction with the long-standing state authority over power plant construction and electric company service to consumers.

FERC’s role in electricity markets addresses the interstate commerce of power plants once they are built. With considerable reliance on competition to sort out winners and losers, as well as set prices, FERC looks to ensure open access to the transmission system and the administration of fair markets. This assignment has been accepted in much of the U.S. by independent system operators, with names like ISO-New England, Southwest Power Pool, California ISO and PJM. In addition to markets, these organizations are key to maintaining the reliability of the power system.

Role of grid operators getting into politics

PJM and the other grid operators are utilities and regulated by FERC. Unlike most utilities, the grid operators own no power plants or wires. Instead, they have rule-making and stakeholder processes where policies are made that shape competition. These stakeholder and governance processes are not perfect. Where a grid operator covers multiple states, grid operators in New England and PJM have entered a dramatic policy battle between state policies and the grid operators’ perception of economic subsidies for certain power plants. PJM accepted the idea that state policies are subsidies in these rule-making and stakeholder processes.

PJM functions for reliability and adequacy of the power supply involve consumers and utilities in 13 states and the District of Columbia. All grid operators create a demand forecast and projection of needed future electricity supply. This is key to signaling the need for new investment in power plants or alternatives, which would help ensure reliability. PJM’s approach to ensuring adequate supply also addresses the challenges related to power plant utilization and revenues from energy sales that vary by hour and season.  PJM calls this the Reliability Pricing Model or RPM. This operates through a series of auctions that are expected to determine what existing plants remain operating in future years or close, and what new plants will be built.

Take a deep breath- we are diving in deep

There is so much investment in our electricity supply, it is unrealistic to think there are some fuels and power plants that have no subsidies. PJM got into trouble by trying to pick sides and pretend that it wasn’t doing so. In practice, the folks with subsidies from “the old days” are unhappy that there are new subsidies. What might have been a principled stand by PJM about the new subsidies and their impacts on a market has to address many layers of subsidies and protections. We debated specific fuel subsidies and tax breaks, only to discover the very basics of old utility monopolies would be put on the table by FERC.

Since RPM pays for capacity that can produce energy (or reduce demand) separate from how many days or hours it actually runs, the debate over retiring coal plants, maintaining nuclear plants and how to recognize subsidies all focus on the RPM market. (In the midst of these debates, many observers say all the tweaking and adjustments PJM makes prove the RPM is not actually a market…but that is another debate.) PJM started the debate over state actions in 2016 when legislatures in Illinois and New Jersey took steps to provide nuclear plants with additional revenues. This, along with earlier action by the Ohio Public Utilities Commission and the West Virginia Public Service Commission to protect coal plant owners from losing money in the energy market led PJM to the position that state policies supporting existing plants could be suppressing the RPM auction prices. At this stage, PJM is saying it has a problem with every state it serves (except Kentucky, but that may not last), as each has either a renewable portfolio standard in its laws, a nuclear support in its laws, or a recent regulatory decision bailing out a coal plant.

The auction clearing prices are applied to all generators in the auction, so PJM says it is keenly interested in preventing available out-of-market revenues supplementing the auction prices bid by generators, thus hiding the true costs of the generators and suppressing auction prices. However, there is a spectacular hidden exception to this pursuit of accuracy and fairness of auction bids and results. (Sorry Kentucky.)

“Guaranteed revenues” sounds like a subsidy

PJM has long accepted the presence in its markets a category of old plants (mostly coal) that receive state support through consumer bills and are protected from competition. These old plants are a legacy of monopoly utilities that have their costs repaid through state-approved rates that are paid in consumer electric bills. This remnant allows old generation that is owned by utilities and still paid through cost-recovery rules to automatically succeed in the capacity auction (i.e. PJM rules say this is “a mechanism to guarantee that the resource will clear in the Base Residual Auction”).  The effect of this provision in PJM’s rules is it allows state-supported generation to bid low in the auction while receiving out-of-market revenues from state-sponsored payments made by consumers.

A rough estimate of the old plants protected in Kentucky, Ohio, Virginia and West Virginia is approximately 40,000 MW. Another measure is that over 100 power plants in PJM bid zero in the most recent capacity auction.

In its stakeholder process, PJM pushed to decide what kinds of subsidies it would tolerate, and which it needed to “correct” or “adjust” so that the RPM auction would have correct prices. This all got out of hand when PJM requested permission from FERC to adjust bid prices for nuclear and renewable generation that receive out of market payments. The industry was not prepared for what happened next.  The proposed “minimum offer price rules” were rejected by a split decision that declared PJM did not go far enough to root out all out-of-market payments to generators of all kinds. The three Trump-appointed commissioners voting to reject PJM proposal also found PJM could not rely on existing rules, as those would result in rates that are not just and reasonable.

FERC makes a big splash

FERC instructed PJM to make several changes not proposed by any party to the case, and to do so quickly. In effect, FERC ordered PJM to reshape the market that distributes $6-10 B a year, maintains reliability and determines coal plant closing.  Acknowledging this would be difficult, FERC nonetheless ordered this be done in 90 days. (FERC has since granted an extension of 6 weeks.)

Does anyone know what happens next?

As of late August, PJM discussion with stakeholders have not been promising. No clarity on what counts as a subsidy. Is a municipal- or cooperative-owned electric plant “subsidized”? Consumer-owned utilities see no overlap between their business model and the issues in this debate.  If the U.S. Department of Energy orders payments to uneconomic old coal plants to keep them open, is that a subsidy that should be “corrected”? PJM has said yes, and they intend to include any DOE-directed support to coal or nuclear plants with the bid price re-setting to protect the PJM auction from interference by subsidized bids. PJM has said things like “if the reason is national defense, then the payments should be made from a nation-wide fund.” Also, PJM showed stakeholders on August 15 “Out-of-market payments from any federal program adopted [after 3/21/16] will be subject to [adjustment through] Minimum Offer Price Rules, unless there is a clear statement of congressional intent indicating otherwise in the law creating the subsidy.”

In other words, PJM still believes that as the regulated utility responsible for the process, they should decide which subsidies are OK and which are not. PJM wants to stick with their plan:

  • State payments from state laws establishing renewable portfolio standards are bad,
  • State payments for old coal plants that are paid for in rates are OK, because that’s the way we have always done it, and
  • New federal subsidies are bad, but old federal subsidies are OK.

FERC, the regulator, has said all the subsidies are bad. And of course DOE has said once and will soon say again, a new subsidy is good.

Now you are up to speed.