DOE Opens the Door to Major Energy Market Reforms

The study goes on to make policy recommendations, many of which are directed at FERC, to evaluate and develop price reformation and market rules which compensate power generators for reliability and resilience attributes. The report will no doubt kick off a much more intense debate nationally about the relative role of coal, nuclear, hydropower, natural gas and renewables. The recommendations will cause FERC to take on its market roles in a much more comprehensive way, which will have direct effects on the market shares of each source of generation.

STUDY FINDINGS
The study provides an in-depth, and generally balanced, assessment of the many of the major issues facing the grid today, including:

• How stagnant demand growth, increased renewables penetration, and an influx of new low-cost natural gas generation has resulted in significant decreases in wholesale market prices—which in turn cause baseload resources such as nuclear and coal, to be inadequately compensated despite their inherent resilience and reliability value to the grid.
• That wholesale markets do not accurately represent the “all in” value associated with baseload (i.e., non-variable) power—such as resilience and reliability, impacts on local jobs and the economy, low forced outage and maintenance outage rates, and exposure to fuel supply distribution
• Issues surrounding the integration of increasing renewables on the grid due to large swings in output (i.e., solar providers’ ramp down at dusk when many consumers are returning home), location specificity, and low capacity factors, result in the need for increased flexibility on the rest of the grid and the penetration of renewables increase.
• Natural gas mid-level and peaker power plants have become the marginal generators—and thus the price-setters—for a majority of U.S. electricity load. The short-run marginal cost of these plants are driven by natural gas prices, which have reached historical lows in recent years, averaging less than $3.20/MMBtu between 2012 and 2016. The effect is that power prices for the entire market are being set by cheap natural gas and are entirely vulnerable to price spikes or drops in the volatile natural gas market.
• Vulnerability due to fuel supply and transportation uncertainties as the market share of natural gas increases, particularly during significant weather events like the Polar Vortex and the importance of “maintaining fuel diversity” in order to provide the best assurance for resilience.
• Noting that, while market distortion occurs as a result of state-level Renewable Portfolio Standards (RPS) and federal tax credits, and while demonstrating that renewable penetration has had adverse impacts on baseload generation in some states—most notably in California, New York, and Illinois—the data does not show a “widespread relationship between [renewable] penetration and baseload retirements.” However, as the rates of renewable penetration increase, adverse impacts may become more widespread.

In terms of reliability, the study specifically notes that the grid is not currently suffering from reliability issues, but that could change as penetration of natural gas and renewables increase while baseload resources continue to retire.

RELIABILITY AND RESILIENCE
Throughout its findings, the DOE focuses on the concepts of reliability and resilience—loosely defined as the grid’s ability to reduce the magnitude and/or duration of disruptive events. This emphasis is key, because it moves beyond short-term economic valuation and three-year capacity markets to give weight to the much broader concept of resilience, which may include a whole swath of public policy goals. As former FERC Commissioner Tony Clark summarized, “public policy goals [include…] incenting in-state jobs, promoting ‘green’ energy or other politically favored resources, preserving carbon-free resources, and retaining substantial tax revenues to state and local government.”

This DOE study is the first government study to set out in plain language that markets were not designed to take into account these types of public-policy incentives, but also recognizing the importance of these incentives are paramount. Therefore, a shift to focus on reliability and resilience may provide a comprehensive way for regulators and legislators to include them. Resilience may include anything from energy supply security to mitigating prices spikes, and this switch in focus by the DOE broadens the scope of how power markets are fundamentally regulated.

STUDY RECOMMENDATIONS
The study sets out a variety of recommendations, but the most important point to the need for FERC to weigh in and, subject to their legal authority—move to correct some of the market distortions that are reducing the reliability and resiliency of the current system.

1. Price Formation: The study advocates for price formation reform which mitigates negative offers (i.e. wind generation bidding into the market at negative prices) and refining locational marginal price (LMP) to recognize the contribution of baseload resources in serving overall demand
2. Valuation of Essential Reliability Services (ERS): The recommendation advocates the FERC create “fuel-neutral markets and/or regulatory mechanisms that compensate grid participants for services that are necessary to support reliable grid operations.” While a small portion of the study emphasizes that these solutions be fuel and technology neutral, these elements appear to have been a last minute “add on” and seem out of step with a majority of the study which emphasized the value of conventional baseload plants such as coal and nuclear.
3. Bulk Power System (BPS) Resilience: Emphasizes that RTOs and ISOs should further define criteria for resilience in their market rules, identify how to include resilience in business practices, and examine resilience-related impacts of their resource mix.

Additionally, the report includes recommendations for additional R&D and a reduction in permitting requirements to speed development of advanced generation technologies in nuclear, hydropower, and coal generation.

CONCLUSION AND NEXT STEPS
Overall, the study seems to favor reliable baseload generation such as coal, nuclear, and hydropower, but it is unclear how far the DOE is willing to go in terms of its own reform mechanisms that will make a difference. Rather, the DOE is shifting to a focus on reliability and resilience and then sending the discussion to FERC in order for the Commission to further define specific price reformation and market rules under its broad Federal Power Act jurisdiction. While the DOE is limited in its ability to preempt state policies, the discussion of FERC’s preemption authority is ongoing in both legislatures and courts—an issue which will only increase in importance going forward.

This shift to FERC as the driver of market rules changes comes just as four new FERC Commissioners have been nominated by the Administration—with two just being sworn in last week. While the Commission is currently facing significant backlog, there are indications that FERC could take up the DOE study recommendations sooner rather than later. In particular, last week acting Chairman Neil Chatterjee appeared to foreshadow the conclusions of the DOE report when he mentioned that coal and nuclear “need to be properly compensated to recognize the value they provide to the system.” All this reinforces the necessity for clients to follow the issue closely.

Overall, it would be a mistake to view the study as providing a comprehensive answer to market hurdles faced by certain power providers. Rather, the study provides ammunition for a variety of constituencies to advocate for their interests before FERC. The DOE study sets the stage for broad market reform and it will be critical for clients to take active advocacy roles before the Commission to protect their interests.

The DOE will also take public comment on the study, but did not specify a deadline.