CERAWeek 2014 - Power Supply Cost Recovery: Bridging the Missing Money Gap

After fifteen years of power deregulation, the accumulating evidence is that market-clearing wholesale power prices are chronically too low. As a result, competitive power suppliers are "missing money" in their cash flows. These conditions help to set expectations that cause too few new power plants to be built and too many existing power plants to retire. As a result, some power systems such as Texas are confronting shortages while others are beginning to move toward a less efficient generation mix. Efforts to address the problem are evolving slowly and often addressing some but all of the problem. This session discusses the nature of the problem and the efforts underway to bridge the missing money gap in power generation.

Lawrence Makovich, IHS Chief Power Strategist, chaired one of seven concurrent Strategic Dialogues. The panel on "Power Supply Cost Recovery: Bridging the Missing Money Gap" focused on how low wholesale power prices are leading to "missing money" in the cash flows of power producers, which results in too few new plants, too many retirements, and thus more electricity reliability issues. The panel concluded that capacity markets are needed to help solve this problem. However, the panel also discussed other factors at play including distortionary tax policies, environmental regulations, transmission and gas supply constraints, and investment lead times. Overall, there was some optimism that the "missing money" problem will improve.

Bill Mohl, President, Entergy Wholesale Commodities, agreed that the problem is real. He stated that a capacity market is necessary for Entergy to invest. He said that subsidies, such as the Production Tax Credit for wind, distort the market and bring online uneconomic resources, and create additional problems. Mr. Mohl said he believes that the power demand as a result of this winter's cold weather may force the issue for more reliability, but he is not optimistic about all markets adequately responding, in particular New York, which has a single market operator and regulator for the state. Overall, the problem will need leadership and long-term planning that focuses on the objectives of reliability and economic and environmental sustainability.

Thad Hill, President and Chief Operating Officer, Calpine, also agreed that subsidized generation and federal tax policy distort the market and help to create this missing money problem. However, Mr. Hill emphasized that stakeholders must first acknowledge that there is a problem, citing the Electric Reliability Council of Texas which has no capacity market; market players must be given an incentive to hold excess capacity by being paid for it. When asked if perhaps customers did not value reliability enough to pay for it, Mr. Hill doubted that assertion. He expressed concern with the ability of markets to reflect scarcity in time before the issue gets serious enough, possibly pointing to a capacity market with longer terms. He also saw the need for dual-fuel capacity to provide greater flexibility in response to gas supply reliability constraints. Overall, Mr. Hill was optimistic as he said he believes PJM and ISO-New England are making strides on this issue and the Federal Energy Regulatory Commission has been supportive.

Richard Doying, Executive Vice President of Operations, Midcontinent Independent System Operator, Inc. (MISO), also agreed that generators cannot recover all of their costs through the wholesale power market. He spoke of the need for higher reserve margins, which would help during times of extreme weather and fuel availability issues. He considered the power environment "difficult" when rules are trying to be created for different types of stakeholders, regulated and unregulated entities. Mr. Doying also said that capacity markets appear to treat all capacity the same, but in reality that is not the case, since capacity differs, and that has impacts on the ultimate reliability. When asked about MISO's choices on incentivizing more capacity, Mr. Doying commented that there is work to be done. However, he said he does not believe a crisis will be necessary to provide the appropriate incentives and that the process will continue to evolve and rules will be refined.

Terry Boston, President and CEO of PJM Interconnection, said that environmental regulations and low natural gas prices were putting pressure on the profitability of nuclear and coal-fired power plants and agreed that a capacity mechanism is necessary for the market. Mr. Boston stressed the importance of transmission and dual-fuel capability, pointing out that the plants with dual fuel capability fared better during this winter's cold weather. He expressed concern over the retirements expected in 2015 owing to the Mercury and Air Toxics Standards and what role that will play with system reliability. Overall, Mr. Boston said that he expected the situation to worsen in the next few years because of increased environmental regulation but to improve in the long term.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.