ScottMadden Energy Update 2 – Coal generation and capacity markets in flux
In this blog, I am moving forward into the ScottMadden Energy Industry update from the previous posting on the Executive Summary. As I noted many times, the real meat of the discussion is in the details. ScottMadden brings up much meat to generate insights.
Coal & Capacity Markets
In terms of the coal retirement story, two fascinating things bring to mind that were not discussed in the update. The first one is the PJM capacity auction which is and should be in serious flux, given the required must run (RMR) status put on First Energy Hatfields Ferry Power Station. A moral hazard has been created probably without intention.
In July, after the capacity auctions dropped from the last auction, First Energy announces the retirement of the plant. In theory, the capacity auction should be high enough to keep the necessary units running. Hatsfield Ferry already has SO2 controls and some mercury mitigation which they recently spent $650 million. It is quite peculiar they announce a retirement for such a plant. Nonetheless, with an RMR designation, First Energy is in the driver seat for this plant. They can in effect “guarantee” a return for the plant regardless of the market condition – low load or low gas prices. This may be quite unintentional but perhaps other utilities should follow and announce retirements.
There is no real mandate one has to follow through with an announcement – similar to announcing a new power plant. (Tidbit of fact if you look at new power plant announcement only around 10-20% get built). One could at least see if they can get their plant to be guaranteed for some time. If not decide later to retire or not retire.
Another point worth discussing, coal in areas of significant wind development (e.g. MISO), how can you not mention the interplay with wind. The big debate is how much wind can be attributed to capacity. When you need capacity in times of high load typically wind is not blowing. The most obvious occasions are the very hot days. However, even on very cold days there is a good chance there is too much ice buildup on the blades to obtain any electricity. Therefore, the wind capacity is generally discounted for capacity value. At the same time a trend you can see to the angst of coal units in markets with large wind is the intermittent availability. The coal plants cannot cycle without significant risk of increase maintenance. This has led some coal units to just turn off versus trying to chase the wind.
To capacity market or to not is the question of many market organizers. ScottMadden presents the grand experiment in ERCOT with an energy only market. Discussing capacity markets are as contentious as religion as noted in my Regulation vs. De-regulation blog. In hopes of taking out some of the religious fever on the topic I like to discuss it on a math basis. A market with regulation typically gets a return on investment between 8-12%. If the market is free to compete, the risk is increased. Therefore, the reward needs to increase above the regulated return requirements. This increase leads to boom bust cycles as rewards are large and eventually attract many suppliers.
Not all the suppliers are smart and so herd mentality is likely leading to a market bust when in a boom and market boom when in bust. A boom bust cycle is okay for goods such as beanie babies to cars to cell phones etc… However, power and water have become essentials for society and producing boom and bust cycles will likely lead to very instable society. The spread between the current regulated framework of 8-12% return to now 15+% rate of return, I contend is too great for society. I do agree the potential for a more efficient market is very possible with an open market, but society is not willing to take the means needed to achieve the ends of a more efficient market.
Outside ERCOT, many are trying to rectify the de-regulation imbalance with the security of regulation by offering a capacity value to incentive build before the energy only market induces a build. I believe that there needs to be a more creative way to reduce risk, thereby reduces rewards requirements. As an example, one source of reducing risk is to offer pre-designated projects with permitting and locational issues cleared by the RTO. The RTO can then auction off these locations.
We are now at the half way point of the ScottMadden Energy Update. As you can see the update is more valuable in not just the facts they present, but from those facts the ability to stimulate alternative ideas and potential concerns – insights as like to call it. I will continue on with this in my next blog.
In the meantime, please do consider All Energy Consulting for your consulting needs as I can help you see beyond the facts to find issues impacting your business directly.
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