Consumers win if electricity production capacity remains high
There are many pundits writing about the U.S. electricity markets today who hope that their readers haven’t studied market behavior and competitive price formation.
They want their readers or listeners to accept their narrative and believe that keeping struggling generators in the market will be a costly market intervention resulting in higher customer prices. The opposite is more likely to be true. In competitive commodity markets, production capacity reduction nearly always results in higher prices as supply tightens.
That almost immutable fact is the reason why OPEC establishes production quotas and lowers those quotas if prices fall too low due to an imbalance in the market. It’s why the Department of Agriculture has been funded to buy surplus production during years with bumper crops so that excess supply does not push market prices so low that farmers cannot recover their costs.
I believe it is a major reason why a large coalition that includes numerous competitors in the electricity generation market have joined together in a formal coalition to resist Secretary of Energy Rick Perry’s proposed grid resilience pricing rule.
According to a recently published Axios column by Ben German, the Affordable Energy Coalition includes the following members: Advanced Energy Economy, the American Wind Energy Association, BP, the Electricity Consumers Resource Council, Energy Storage Association, Industrial Energy Consumers of America, and the R Street Institute (formed in 2012 by former employees of the Heartland Institute).
Supply And Demand Effects Amplified In Electricity Markets
Though similar to other commodity markets, electricity has unique qualities that make production capacity reduction particularly rewarding for producers that remain in the market while also being particularly dangerous for customers who prefer reasonably predictable electricity prices.
Since electricity is virtually impossible to stockpile, there isn’t an inventory buffer that moderates price behavior during unplanned outages or spikes in customer demand.
That same just-in-time characteristic of electricity – along with the fact that electrical power is the motive force that enables nearly every aspect of modern living in cities and suburbs – makes many customers insensitive to price variations. Even if prices scream up to a level ten times as high on Tuesday as they were on Saturday, demand does not fall off very much.
Suppliers may apologize and act contrite about the high prices, but there are numerous participants in the market that enjoy putting the extra cash into their banks. They actively seek to cut someone else’s production capacity enough to make those “good times” occur more often. They know they are unlikely to be held accountable for “price gouging” because they can blame The Market as being the perpetrator of high prices.
Customers are sometimes hit with shockingly high power bills weeks to months after a series of events – like slightly more frequent and chillier cold fronts than usual – that caused the high prices. The delay tends to protect the decision makers who caused the price spikes from being held accountable.
Which Generators Need Rule Changes To Remain In the Market?
Most at-risk generators today are characterized by relatively high fixed costs, low marginal costs that approach zero, stable electricity output that eases the challenge of grid management, and enough secure, on-site fuel to withstand disruptive events in fuel supply infrastructure and the resulting market price fluctuations.
The owners of the generators have a limited ability to take action to reduce the fixed costs. For at-risk nuclear plants they are the result of regulatory ratcheting, politically motivated overreactions and industry self-imposed reactions intended to ward off too many new regulations. Nuclear plants built in the 1970s and operated by a staff of 250 people now have payrolls in the range of 700-1000.
They are not producing any more power, but they produce an amazingly voluminous flow of documentation. They employ full time security forces that rival the size of the guard force present at the Kings Bay Naval Submarine Base when I served there in the 1980s.
During my time at KBNSB there were as many as five SLBM carrying submarines in port at any one time.
The nuclear industry spent at least $3 billion in reaction to the events at Fukushima, even though none of the reactors in the U.S. are on sites that are susceptible to station blackouts from tsunamis or any other external event.
What Happens When Large Generators Are Forced To Exit Market?
The generators that are struggling in today’s occasionally oversupplied market are also large enough so that each time one is pushed out of the market, the supply demand balance price point measurably shifts in the direction of higher prices.
In the old days of rate regulated utilities, there was some truth to the assertion that excess capacity causes consumer prices to be higher than they would be without that capacity. Electricity rates for those monopoly utilities were set using the carrying cost of capital equipment plus that “rate base” multiplied by a fixed percentage for allowable return on investment.
Excess, often idle capacity caused the rate base to be higher than needed, raising both consumer prices and the company’s revenue – due to having a larger base number multiplied by the same fixed investment return percentage. Public overseers were tasked with being judicious about the investments they allowed the utility companies to put into the rate base, while also recognizing that some excess capacity was needed to assure reliable service.
Regulators also had a direct line of accountability if the utility experienced a failure to deliver power when it was needed because of avoidable mistakes like failing to maintain reserve generators properly.
That paradigm is invalid for restructured power markets. Excess capacity means more competition in the business of selling kilowatt-hrs. Competition keeps wholesale prices low, but it can produce prices that are so low that total revenue generation is less than what is needed to cover costs. With reasonably functional markets, low market prices will gradually correct themselves by discouraging new market entrants and by causing high marginal cost producers to reduce their output or shut down altogether if they cannot improve their operations.
Why Have Market Prices Been So Low?
Unfortunately, the electricity markets have been disconnected from that kind of capacity restraining feedback. During a period of virtually flat demand, federal, state and local governments have supplied tens of billions of dollars in capacity construction incentives for wind and solar. Those incentives have worked to help those sources move down the price curve associated with repetitive construction and manufacturing.
The significant and growing output from the new, heavily incentivized generation capacity has displaced output from existing generators and has made a big contribution to maintaining the oversupply of natural gas that has kept prices of that commodity so low since the start of the Great Recession.
The large, steady, low marginal cost generators whose stability is a major beneficial feature have difficulty covering their fixed costs of operation in an environment with prices that are often below everyone’s unsubsidized cost of generation. The extreme example proving this seemingly contradictory statement is when prices on the wholesale market fall below zero and generators have to pay to put their power onto the grid.
The explanation for that incredible situation is that some market participants receive $23/MWhr for all the electricity they produce, even at times when it is unwanted.
Generators whose costs are mainly driven by the cost of fuel that is delivered just in time for burning have more options for remaining viable in a market characterized by widely varying prices. They can cut most of their costs by closing their fuel supply valves and sending their small crews home. While shut down, their generators need less maintenance personnel. Since they store little or no valuable fuel on site, they have few, if any, site security personnel requirements.
At the times when electricity demand is high, prices rise into the range where generating and selling electricity is profitable enough to pay all operating costs with a little – or a lot – extra to spare. Flexible units can be quickly started to capitalize on the profitable period. They can shut down and reduce their ongoing costs just as quickly.
Those rapid start, reasonably reliable generators could be considered to be almost as valuable for grid stability as the less flexible large generators in need of assistance if they made a few changes. Even if mechanically sound with high availability numbers, no thermal generator can run without fuel.
The cheapest kind of fuel contract is one that allows delivery interruption if there are constraints in the supply capacity. Any generators supplied by interruptible, just in time fuel is only as reliable as the fuel supply on an almost minute by minute basis.
If operators of this kind of generation want to earn consideration as a reliable power source, they can choose to enter into contracts that put them higher on the fuel delivery priority list.
They can also invest in systems that allow on site fuel storage, either in the form of distillate fuel or LNG. Either choice will come with an incremental increase in cost, which will lead to wholesale price bids that are more reflective of the true cost of providing dependable electricity.
Is The Price Of Electricity As Important As Some Proclaim?
Though I’ve read dozens to hundreds of commentary articles over the years talking about the importance to customers of achieving the lowest possible market prices, I’ve had a number of opportunities to observe the way that suburban customers behave when they are faced with loss of access to sufficient quantities of electricity.
They will often spend thousands of dollars to purchase stand-by generators and they will willingly operate those generators if the power goes out. They won’t think too hard about the fact that each kilowatt-hour of power supplied by running a small gasoline engine starts at about $0.50 – including generator capital and maintenance – and goes up from there if retail gasoline prices rise above $2.50 per gallon.
Even those lucky few who have access to natural gas distribution lines with adequate capacity to support a customer base with a substantial number of running generators will find that the prices for delivered gas in most locations translate to rather expensive kilowatt hours.
Admittedly, few of the people operating generators to make it through a power outage will even bother to calculated the cost of keeping their refrigerators and television sets running while their neighbors figure out how to get a generator of their own.
Bottom line of this rather rambling commentary is that reasonable incentives to retain reliable generators can lower market price averages by serving as a buffer to restrain frequent spikes. That’s why there is such a loud outcry from competitors with tenuous, variable price fuel supplies and from weather-dependent market participants that have no control over whether or not they can supply electricity when demanded.
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Additional Reading
Dick Munson, the Environmental Defense Fund’s Director, Midwest Clean Energy, offers a contrasting point of view that leans heavily on work published by the R Street Institute, a 2012 spinoff from the Heartland Institute. His commentary illustrates some of the convoluted arguments being offered by those opposed to support for continued nuclear generation and coal plant retention.
I think what you are describing is a well understood market failure where investment or asset write off decisions are made on the short term market situation and the consequence only filters through into a market price signal in the medium to long term, producing price bubbles followed by price crashes.
Classic example is housing, when prices are high property developers can raise large amount of capital and sign off investment decisions on building more housing based on the current market status and its current rising price trend. However at the point at which the new houses are finished the time lag between the investment decision and completion of the building results in a significant oversupply of property, and the prices collapse houses are sold of cheap or left derelict and many developers and home owners go bust. The cycle continues to repeat and is inefficient in its use of capital and costly to the economy as a whole.
The electricity market is exactly the same, there is a large lag in the price signal and new capacity coming online. The inevitable result is overshoot in supply followed by market collapse and bankruptcy then undersupply creating large price spikes repeating the cycle. The other side of it is that only the lowest overnight cost and shortest build time generator would survive such a market as they can come online sooner to take advantage of the high prices and have lower write down costs when the market switches.
The background intent by the companies is almost irrelevant as the economies result in a single technology winner and boom bust cycling which benefits neither the ratepayer or society at large. Like in the housing market some companies will make obscene amounts of money during the boom times further exacerbating the situation.
The only solution is a regulated electricity market, however that isn’t in vogue these days where market liberalisation is panacea for all ills.
As someone who’s employer takes a “belt and suspenders” approach to electrical power reliability, the point of a backup system is dependent on what happens when the power goes out. In the case of my headends it means loss of cable, phone and Internet for our customers. To a lesser extent, it also sometimes causes equipment failure because the hardware is designed for continuous operation, in many cases the uptime measured in years.
Our primary backup for about 80% (and growing) of the devices is a DC battery plant, the other 20% by a large UPS. Then the secondary backup is a very large diesel generator. The DC plant and UPS usually only need to supply power long enough for the generator to get up to speed and the transfer switch to engage, usually less than a minute, but are built to supply about 6-8 hours of runtime in case the generator fails to start.
Every month I perform cursory inspections of these systems, and every quarter contracted technicians perform more thorough inspections and maintenance, and annual testing.
Having all this backup is extremely expensive, but necessary if we want to achieve our uptime goals. I’m sure if there were an alternative offered by the power coop that was guaranteed at the same level as our battery plant it might attract interest. But that would likely mean supplying diverse redundant paths to the headend, which immediately doubles the cost of the distribution network. And to really do it right you’d need 100% redundancy, including “worst case” manual switching and multiple transfer points at the delivery point. I’m sure there are customers who are willing to pay for this sort of system, in fact my father once worked for a steel manufacturer who had this sort of redundancy for the electric furnace. But there’s also something to be said for knowing you have options and supply diversity if the power goes out.
I know of a piece of UK critical national infrastructure where they run continuously from the UPS backed by generators with the grid as topping off the UPS if available as the risk of the UPS not working or the generators not starting is seen to be too high.
That’s called an “on-line UPS”. It’s actually rather common.
I understand that many data centers have switched from AC power supplies to switchers fed by 48 VDC… which is conveniently the same voltage used by telephone exchanges since forever. This both allows full battery backup and gets the AC transformer/rectifier out of the air-conditioned machine room, adding in a big savings in A/C costs.
“The nuclear industry spent at least $3 billion in reaction to the events at Fukushima, even though none of the reactors in the U.S. are on sites that are susceptible to station blackouts from tsunamis or any other external event.”
Yeah, everyone knows that southern, central and northern california doesn’t ever experience large earthquakes. And that Diablo is miraculously sitting in a no quake zone.
People with subject-matter knowledge know that Diablo Canyon is sited roughly 3x as high over sea level as the 2011 Tohoku tsunami.
@Jon Hall
No nuclear power plant has ever experienced significant damage to its safety related systems as the result of an earthquake. In fact, there are very few examples of any steam plant built to reasonably modern standards suffering much damage from seismic events. Believe it or not, but engineers understand how to strengthen systems, structures and vital components in contained systems like factories & power plants to ensure they are able to resist serious damage from earthquakes. (Roadways, tall buildings and bridges are much more challenging from a seismic safety point of view.)
Diablo is sitting on a relatively stable part of your relatively unstable state. Sure, there have been heavily promoted discoveries of “faults” in areas close to the facility, but geologists can engage in unlimited debate about what constitutes a fault and whether or not that fault indicates instability.
It’s also worth noting that the NRC believes the design and location provide adequate protection and that the initial “fault” that caused so much angst when the plant was under construction was discovered and reported by a pair of Shell Oil Company geologists.
It’s even named after them – Hosgri. According to characterization published by the Southern California Earthquake Data Center, it doesn’t sound like it’s much of a risk, especially if you know anything about the current state of the Diablo Canyon Nuclear Power Plant.
Well, gee, glad to know if there is a quake of magnitude 6.5 or better, that Diablo will just keep humming along, without even shutting down to assess any possible damages. Yep, a severe quake won’t affect operations at all, and all the customers relying on Diablo’s power might not have chimneys, but, by golly, they’re gonna have power!
BS.
@Jon Hall
Your reading skills still need improvement. How did you read operate without interruption into my comment?
I can guarantee that if the facility is forced to close, it will not be supplying any power any more.
If it is kept in service AND a major earthquake hits AND inspections reveal damage needing repair, the facility MIGHT need to be shutdown for a significant period of time.
Perhaps your writing skills are what needs improvement, Rod. “Station blackouts” aren’t “interruptions”?
“….even though none of the reactors in the U.S. are on sites that are susceptible to station blackouts from tsunamis or any other external event.”
@Jon Hall
“Station blackout” is a term of art.
https://www.nrc.gov/docs/ML1310/ML13108A133.pdf
You are correct in noting that I wasn’t quite as clear as I though I was.
I should have written “susceptible to damage to safety functions from a station blackout caused by…”
Jon Hall
It would take more than an earthquake to cause a station blackout and god forbid….if there is an earthquake (earthquake….not tsunami) large enough to take out a Nuke Plant you can bet that would be the last thing people will be worrying about. Unfortunately, Japan was more worried about the Nukes (that have directly killed zero people) than the 20,000 people who were killed DIRECTLY by the earthquake and resulting tsunami.
You have no idea how robust Nuclear Power Plants are. They are quite amazing actually…….WAY overdone, but still amazing.
Yeah….power is never needed during a major natural disaster. See hurricane Harvey and South Texas Project.
It occurs to me that none of you, (blathering on about man made machinery, buildings, or structures being able to withstand major geologic movement), have ever been through a major quake. In Woodland Hills, California, I had a house I lived in broken in half by the Northridge earthquake of 1994. No man made structure, subjected to the ground movement that broke that house in half, would have withstood the forces at play. The ridiculous notion, that a NPP is capable of withstanding any and all earthquakes that may occur is a disingenuos assertion. There is simply NO WAY you can make that assertion with complete confidence. In the past, I have made the argument here that the NE industry has stepped in it, by making such assertions. Such assertions, that plants are completely safe, no matter what, are doomed to be proven wrong, as they have been in the past, repeatedly. Which opens the door for all the “yeah buts” offered by those opposed to NE. Yet, Rod has repeatedly rebutted by saying “the industry makes no such assertions”. And then, threads like this come along. Go figure.
@Jon Hall
You continue to either misunderstand or misrepresent what you are reading here. We have not said that nuclear power plant structures will not be damaged by a significant earthquake. We have said that the systems, structures and components of the plant will be able to continue to serve their safety functions and protect the public from harm.
Think of the engineering case of NASCAR automobiles that can be involved in horrific accidents involving flying metal, debris and even flames. In nearly every case, the fragile human driver somehow manages to walk away.
Someone with reasonable understanding of the design and situation can confidently state that no one outside of the track is ever splattered with blood from that driver. Some people with little or no understanding or with impressively creative imaginations might be able to come up with an unprovable exception to the statement.
The 2011 Tohoku quake was magnitude 9.1. All the nuclear plants along the coast, from Fukushima Dai’ini to the south to Onagawa to the north, came through without any major damage.
Your Northridge quake was magnitude 6.7. That’s 1/250 the energy of Tohoku. Your house got ripped in half because it was (a) built like crap, (b) set on fill which magnified the ground movement, or (c) both.
Jon Hall
Your house compared to a Nuke Plant as far as being robust goes…..hahahahaha
You seriously need to tour a Nuclear Power Plant…or AT LEAST do some research on the subject matter.
Regarding the PTC, Production Tax Credit, of $23/MWh: BPA, the Bonneville Power Administration, is now required to put as much water as possible through the turbines of those dams which have smolt drifting downstream during spring runoff. So there is lots of electricity generated from those dams in the spring.
The smolt survive the trip through the turbines but when forced to go over the spillways develop the bends, nitrogen decompression sickness.
But the wind is blowing best in the spring and the wind farms are willing to pay customers to wheel away the power; they collect the PTC and make some money in any case. The result is a supply of more electricity than can readily be consumed, despite interties to three cardinal points of the compass.
In the spring of 2010 or 2011 the result was BPA ordering the wind farms to shut down while at the same time giving power away on all interties. The wind farmers complained to the FERC.
The FERC ruled that BPA could so order but was then required to pay the wind farmers the foregone PTC.
This happened again this past spring of 2017. Partly because of these payments BPA has upped its standard rate from $32.50/MWh to just above $35/MWh, a hefty increase.
Good article Rod. In addition to loss of TV, Lights ,range and oven there is the problem of keeping warm when there is an outage. Recently we had a 12 hour outage from 5 PM to 5 AM. We lit candles, got out flash lights, lit a fire in our wood burning fireplace, warmed up down comforters with a hot water bottle. We used a wind up emergency radio and found out that `150,000 had lost power.. Our neighbor checked on us old folks. Also our son telephoned us. His cell phone did not work because the wind toppled over a tower. One week after the storm we heard that our electricity rates are going up 5 per cent per year…
Perhaps you’d be interested in hearing the latest in the South Australian saga. I read in the ‘Australian’, generally regarded as a rabid, right-wing rag, (I naturally feel it’s far, far to the left), that the SA government has spent several hundred million on diesels to make sure there aren’t any blackouts before the SA election in March next year.
Entertainingly, they have also just blown up the last remnants of the Port Augusta power station. It ran on cheap junk coal, not expensive imported oil. There’s enough coal at Leigh Creek for at least another couple of centuries, but our oil imports can be cut off at any time.
We have a Queensland state election on 25 Nov 17. The ruling Labor government advocates 50% renewables. I think I’ll put them second last on the ballot. The Greens always go last, of course.