Policy Memo: How We Pay For Free Electricity

In Brief

What rationale sustains competition in a wholesale electricity market where some bidders have no marginal costs? 

As state governments enact net-zero laws, this becomes a strategic question. 

The author, a participant in 2022's Financing and Deploying Clean Energy cohort, sets out an approach that can stoke efficiencies beyond New England. 

Don't let the sun go down on price reliability, our author urges

(Photo by Don and Suzan Weller, via Flickr Creative Commons.) As the sun sets over Waterford, CT, an expert proposes a price floor in wholesale electricity markets. 

To: NEPOOL Participants and Stakeholders

Subject: Generating resources while sustaining supply, or: How to pay for something free

Summary

As New England states make progress towards their decarbonization goals, the electricity spot market will see offers from solar and wind generators that incur no marginal cost for one more unit of power. That can harm reliability and put some operators hastily out of business.  To retain existing resources and the stability they bring, we need to set a floor price for carbon-free generation.

Background

As a developer of grid-scale energy resources and asset manager for Record Hill Wind, I have an intimate knowledge of the cost pressures that operators of aging resources face. I am also well versed in the risks these facilities face as they age, and in the ways that many of them generate low-carbon or no-carbon power. Maintaining the economic viability of valuable carbon-free generation is the primary concern of this proposal.

States representing the bulk of load in ISO-NE (the region covered by New England's independent system operator) have mandates to decarbonize the electricity sector, ultimately reaching net zero carbon emissions. These include Senate Bill 9 An Act Creating a Next Generation Roadmap for Massachusetts Climate Policy in Massachusetts, Governor Ned Lamont's Executive Order 3 in Connecticut, and the Act on Climate bill in Rhode Island.  While new resources will certainly be needed to meet these ambitions, so too must existing resources remain online lest new developments serve only to replace existing clean resources.

Market forces can efficiently deliver maximum benefit at the lowest cost.  That maxim becomes less reliable in a regulated market like the one for electricity. There, market design matters. An improperly designed market serves only to efficiently deliver suboptimal results.   The complexity of the myriad markets and policies within New England – all geared towards a valid purpose – prevents a suitably efficient market that would incentivize and maintain existing renewable energy resources.  A virtual price floor, administered through ISO-NE, is the best mechanism to retain our renewable energy fleet.

Solution

NEPOOL, the organization that stakeholders lead to guide ISO-NE’s electricity markets, has recognized the need to plan for the transition to a net-zero generation fleet, and the Pathways to the Future Grid process is an excellent step towards bringing in all relevant stakeholders.  In particular, the “hybrid proposal” from the New England States Council On Energy (NESCOE) takes a big step towards recognizing the need to retain existing resources by proposing a carbon price adder to ensure that existing generators draw adequate revenue for the value they provide.

NESCOE’s carbon price adder, however, only considers conservation of the Millstone Power Station in Waterford, CT.   The same mechanism that has been proposed to support Millstone should be used to develop price floors for the existing carbon-free generation fleet.  As NESCOE laid out, the price discovery and floor pricing should explicitly prohibit any resource using the Forward Clean Energy Market (FCEM)/ Integrated Clean Capacity Market (ICCM).

Those new market designs, like others, leave existing renewable plants in peril. We have capacity, real time, day ahead, RGGI, and REC markets (among others), but no market adequately ensures that existing renewable energy facilities can cover ongoing costs.  The new market mechanism needs several key characteristics:

  • Definition of what resources qualify – resources that qualify for Class I RECs in both Massachusetts or Connecticut would be a meaningful starting point.
  • How old the resource needs to be – A project’s vintage is necessary to prevent speculators from attempting to game the system.  10 years seems a logical start.
  • Mechanism of compensation – A guaranteed minimum real time electricity price. This minimum would be an additional revenue item should real time pricing fall below the set threshold.  Should the generator exceed this threshold, overpayments from prior periods could be collected via reduction in future payments 

Integration Into Existing Markets

The real-time electricity market drives ISO-NE's economics.  Every five minutes a price is published and generators are able to dispatch in real time based upon rational economic decisions about whether to sell electricity.  The market’s focus is to find the lowest cost of electricity by participants making frequent decisions about whether current market pricing will cover a plant’s marginal costs.

There is perhaps no clearer sign this system was designed for a different era than the 10-15 minute disconnect between the pricing used for dispatch and the pricing used to compensate generators.  Combustion-based generation may take hours to significantly ramp up or down, making this difference negligible.  However, a modern wind farm can ramp from full production to zero output in seconds, necessitating the creation of the Lost Opportunity Cost payment to compensate generators for acting faster than the markets were designed for.  As we increase renewable energy penetration, numerous other unintended consequences will undoubtedly surface – the most significant being the zero marginal cost problem.

Fossil fuel-based generation has a high marginal cost, based largely on the cost of the fuel burned to generate electricity.  A typical wind or solar generator has no meaningful cost associated with an additional unit of generation.  If the sun is shining, it costs the solar plant no more to be operating at full output.  So in a world of increasing renewable energy penetration, generators will have a marginal cost of $0, meaning that all generators will get paid nothing to generate.  While this may be an acceptable outcome for the immediate term, at some point the economically rational behavior will leave the plants unable to cover their very real fixed costs (capital, maintenance, taxes, etc).

Because no single facility can set the market price - the Market Monitor exists to prevent such a possibility - each individual generator is incapable of moving the market to cover their fixed costs, and the financial stability of the entire fleet becomes in jeopardy.

According to the President and CEO of ISO-NE, “ISO New England has long advocated for carbon pricing as a solution that allows markets to efficiently price emissions without harming price formation.”  While a national carbon pricing mechanism has appeal for accelerating the reduction in the release of greenhouse gases, it fundamentally cannot solve the problem we are trying to address in a real-time market. Consider: if the real-time electricity market is zero because no fossil fuel generators are on line, carbon pricing would not impact the situation.

Instead, we should modify ISO-NE’s long held preference for carbon markets to create a floor price that makes financial sense for generators whose health looks vital to achieving state policy requirements.  In so doing we shall merge the cost effectiveness of market power with the efficient planning processes necessary to foster the carbon free energy future demanded by the states. 

  

 

 

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