POWER July 2012 - 28

When Successful
Procurement Policies Fail
Steven F. Greenwald
C
Jeffrey P. Gray
By Steven F. Greenwald and Jeffrey P. Gray
alifornia is approaching a tipping point with respect to the
near-term economic viability of existing non-utility generation.
The procurement policies and practices implemented
in response to the statewide energy crisis over a decade ago have
evolved into market conditions that do not offer " uncontracted "
existing resources with sufficient and stable enough revenue
streams to recover going-forward costs. Continued adherence to
these policies will subject such resources to an increasing risk of
economic retirement, threatening long-term reliability and potentially
costing electric consumers billions of dollars.
How We Got Here
In the wake of the rolling blackouts, price spikes, bankruptcies,
and bailouts that marked the California energy crisis, state policy
placed the highest priority on ensuring the availability of sufficient
capacity to meet local and system reliability needs. As a
result, debt and equity investors would no longer financially support
the development of new resources as " merchant " plants and
financing became available only to non-utility generation projects
with a power purchase agreement (PPA) already in place.
The regulatory response was the creation of a so-called hybrid market
in which utility and non-utility generation filled an administratively
determined long-term " need. " Resulting procurement policies and
practices achieved the primary objective-significant new generation
resources-but resulted in a flawed long-term market structure.
These policies limited the availability of long-term PPAs to
new resources. As a consequence, relatively new, efficient generation
resources developed in the late 1990s are deprived of
a realistic opportunity to obtain long-term contracts. They are
relegated to short-term bilateral markets for resource adequacy
capacity, and energy and ancillary services markets.
The Math No Longer Works
The " success " of these policies is the current oversupply of resource
adequacy capacity at both system and local levels and downward pressure
on the compensation available in the short-term bilateral market.
Prices in the daily and other short-term energy markets are uncertain
and will likely decline as additional renewable resources come online
to meet the state's Renewables Portfolio Standard (RPS).
In a 2010 report addressing the operational requirements necessary
to reliably integrate a 20% RPS requirement, the California
Independent System Operator (CAISO) concluded that " The combination
of increased production of wind and solar energy will lead
to displacement of energy from thermal (gas-fired) generation in
both the daily off-peak and on-peak hours. Due to this displacement
and to simultaneous reduction in market clearing prices,
there may be significant reductions in energy market revenues to
thermal generation across the operating day in all seasons. "
The expansion of the RPS requirement to 33% by 2020 will exacerbate
the challenges confronting uncontracted existing resources
to cover going-forward costs. Economic reality dictates that if the
28
compensation from available markets is insufficient to ensure the
recovery of going-forward costs, resources will shut down.
Market Flaws Exposed
The addition of increasing amounts of intermittent renewable
resources on the system has necessitated a rethinking of traditional
resource adequacy requirements. Previously, resource adequacy
focused on the procurement of generic capacity; the focus
today needs to be on resource flexibility.
CAISO projects that existing gas-fired plants will experience
a significant increase in " cycling " and a double-digit percentage
reduction in revenues. These projections assume that most uncontracted
existing resources will remain available to help meet
renewable integration needs. Thus, while market compensation
is dropping, the CAISO projections show increasing reliance on
these resources for integrating renewable resources.
Given the current oversupply of generic capacity, some resources
may not be " needed " for three to five years. If existing resources
assumed to be available shut down in the near term, substantial
amounts of new replacement resources costing billions of dollars will
likely be necessary to maintain reliability within the next five years.
The specter that relatively new, efficient generation resources
might retire for economic reasons demonstrates a fundamental flaw
in the market: On the one hand, inadequate revenue streams subject
uncontracted existing resources to an increasing risk of economic
retirement, while on the other hand, the continuing availability of
these resources is critical to future system reliability.
Crafting a Solution
In California, a diverse cross section of stakeholders recognize
fundamental problems permeate the state's energy markets and
need to be fixed. Policies that restrict new resource procurement
to meet planning reserve margins undervalue existing resources
to provide renewable integration services. The market structure
must evolve to ensure the ongoing availability of the existing
gas-fired generation fleet to help integrate renewables.
Under consideration is the creation of multiyear forward procurement
obligations. Such obligations would be designed to provide stable
revenue flow for existing resources over a five- to seven-year period
and reduce the likelihood that resources needed for future renewable
integration would prematurely shut down for economic reasons.
Paying a resource now because it will be needed some time in
the future is a foreign concept to an industry built on 20th-century
concepts of ratebase and " used and useful. " However, in light of the
nation's commitment to intermittent renewable resources, and given
the alternative-increased reliability risk and high resource replacement
costs-it is a concept deserving full attention. ■
-Steven F. Greenwald (stevegreenwald@dwt.com) and Jeffrey P.
Gray (jeffgray@dwt.com) are partners in Davis Wright Tremaine's
Energy Practices Group. Davis Wright Tremaine represents independent
power producers participating in California's energy markets.
www.powermag.com
POWER | July 2012
http://www.powermag.com
POWER July 2012

Table of Contents for the Digital Edition of POWER July 2012
