DOES THE US NEED TO CONSIDER A NEW ELECTRICITY MARKET?

 Bryan Leyland, MSc, DistFEngNZ, FIMechE, FIEE(rtd)

Power systems engineer.   

       Introduction

Many US states have an electricity market based on short-term trading of units of electricity (a so-called kWh market). Recently, most of these have seen high prices because increases in gas prices have increased the cost of generation at gas-fired power stations. The way the market works, the higher price of gas fired electricity is also paid to lower-cost generators: coal, nuclear, hydro, wind and solar who then make windfall profits.

There is a risk of even higher prices, and possibly blackouts, in the Northern hemisphere winter this year. Given that the market is already delivering high prices, a comprehensive review of the market structure is urgently needed.

       The existing market

The kWh market is based on an underlying assumption that electricity is ‘a commodity like any other’. This ignores the fact that it does not have the key characteristics of a market commodity: namely price elasticity and the availability of an alternative good. Demand is largely insensitive to price in the short term, but a long period of high prices reduces demand because electricity becomes unaffordable to industry, commerce and, in particular, poor people. The reality is that electricity is the lifeblood of the economy: if the price goes up, the economy suffers and if the supply fails, it is a disaster.

The current kWh market pays all generators the price bid by the most expensive generator selected to generate. Markets like this do work with mass market commodities where there are a lot of factories producing similar products, and new factories have the lowest production costs. Paying all of them the price bid in by the most inefficient factory ensures the profitability of newer factories and encourages investors to build more of them. If the price is still too high, people can always switch to an alternative product. It doesn’t work with electricity because price has only a small effect on demand for the simple reason that, for most users, its value to the consumer is much greater than the price. With electricity the generators have a captive market because there is no alternative product. Generators quickly learn that the way to make money is to keep the system on the edge of a shortage. Which they can engineer.

In most states, there are several methods of generating electricity, with markedly different technologies and cost structures. Nuclear has a long life, a high capital cost and a low operating cost. Gas-fired generation has a low capital cost and a high fuel cost. Wind and solar are heavily subsidized and so have a low cost if it is measured at the the turbine or solar cell itself but they impose high costs on the power system because of the expense of providing backup when the wind is not blowing or the sun is not shining. The taxpayer contributes to the subsidies and the consumer, not the generator, pays for the backup.

Having intermittent wind and solar compete by bidding in at their low generating cost produces farcical results.

·       If there is a surplus of wind or solar power, subsidized renewable generators can bid into the market at very low prices, causing market prices to collapse and pushing reliable low-emissions baseload generators such as nuclear off the system. This deprives these generators of the income they need to continue operating profitably, and often puts them out of business. If they close down, there will not be sufficient generation available on the system to keep the lights on when the wind is not blowing and the sun is not shining.

·       The nature of the power plant must also be considered. Open-cycle gas turbines are needed to respond to rapid fluctuations of wind and solar power. Combined-cycle plants are much more fuel-efficient, but because they need to operate at a fairly steady load they cannot respond as needed when lots of renewables have been deployed on the system.

·       When, for example, gas is in short supply, the cost of gas-fired generation soars, pushing up market prices, and the market pays this high price to all the other lower cost generators who make windfall profits. These prices are passed on to consumers, so households suffer and industry shuts down, wreaking huge economic damage.

The result is that electricity costs much more than it would have cost if the system was operated to minimise the overall costs of generation.

A carbon tax makes the situation even worse. If the cost of gas is setting the market price, then all the generators get the carbon-tax-boosted price and the unfortunate consumer ends up effectively paying carbon tax on clean hydro, wind, solar and nuclear power. It is hard to get crazier than that!

The current market often results in the construction of more wind and solar than the system can economically manage, (ERCOT being a prime example) and essential baseload power generation becoming uneconomic and retiring from the grid. The result is that the price of electricity and the frequency of shortages both increase. System stability is also at risk: with a large penetration of renewables on the grid, system frequency is more difficult to manage and it is harder to keep the voltage stable.

A single-buyer market

The first country to adopt an electricity market was New Zealand. The recommendation to the decision makers was to stick with the corporatized and very successful Electricity Corporation of New Zealand but they were also offered the option of a ‘single buyer market’ or a kWh market which was identified as the risky option. They chose the risky option. Many power systems in the world adopted the same market structure because, initially at least, it appeared to be operating successfully in New Zealand.

A single buyer market preserves the advantages of the centrally coordinated and optimised generation and transmission that is a characteristic of vertically integrated electricity systems. The big advantage of the single buyer is that that new power stations are provided on a competitive basis, instead of by a centralised and usually inflexible monopoly or by market players centred on short-term profits.

A single-buyer market recognises that electricity is the lifeblood of the economy, and that it has little price elasticity and no alternative good. Ideally the single buyer is a non-profit organization, independent of the government (as far as is possible).

The single buyer coordinates the whole system, managing the generation mix, ensuring that there are adequate fuel supplies in reserve to cover contingencies and high demand periods, and managing system inertia, voltage support and short circuit current as needed to keep the system stable. The aim is to optimize the system as a whole so as to minimise the cost to the consumer while providing a sufficiently reliable supply.

The single buyer operates a competitive market for building and operating power stations. It treats power stations as process plants, inviting bids from the industry for long-term contracts to build and operate the power stations required. These will cover the fixed and variable costs of turning fuel – wind, water, sunshine, uranium, gas or coal – into electricity. They are recompensed at cost for any fuel they consume and for variable operation and maintenance costs, so the amount they generate does not affect its profits. This means that if system costs can be lowered by requiring them to increase or decrease generation it will not cause any problems. There would also be a bonus/penalty regime for efficiency and availability. Power plants that are operated efficiently and exceed availability guarantees would make extra profits.

When assessing tenders for new generation, the single buyer would take into account the cost of providing any transmission lines needed and would also assess future fuel costs. The cost of backup for stations that cannot guarantee to be available when needed would also be a factor in the assessment.

The single buyer would sell electricity to the distributors and to large consumers using cost reflective tariffs, with higher prices during high-demand periods to encourage demand-side management. The distributors would sell electricity to the consumers, so there would no longer be any need for energy traders competing to sell exactly the same product. This could represent a useful reduction in the cost to the consumer. A single-buyer market could also have direct contracts between generators and large consumers.

If governments wished to subsidise some forms of generation this would complicate matters. Given that subsidies can appear and disappear at the whim of governments, the effect of subsidies and their uncertainty would need to be carefully considered during tender assessment.

In a perfect world, such a market would be expected to deliver in line with its objectives because all it does is add real competition to the previously successful monopoly operations. In the real world, the main danger is that the single buyer would gold plate the system to minimise the risk of being criticised for generation shortfalls. Given that a shortage of generation is much more economically damaging to a country than the extra cost of moderate overbuilding, the risk is not great. But it can be minimised by ensuring that the power plans are independently scrutinised.

How could the transition take place?

Transitioning from the existing market to a single-buyer market would be a complex exercise. The first step would be to switch generators onto the market and the second step would be to rationalise transmission and distribution.

For stations not yet built, it would be a matter of persuading developers to bid into a market that promised a steady income and much less risk far into the future. They and their bankers should be delighted!

Switching existing generation into the new market could be difficult. The main problem is that, in many countries around the world, generators have been making windfall profits as result of high gas prices and would be reluctant to lose this bonanza. On the other hand, they could easily see the benefits of joining a market with long-term stability combined with reasonable profits. For those that held out, the government could step in and offer to buy them out.

The transition would create more interest in building power stations with long lives, reliable output and low and stable operating costs.

·       Nuclear power would be attractive because its reliability, long life and predictable costs lead to a steady income for many years.

·       Wind and solar generation would be less favoured, because of their short operating lives and the high cost of providing backup.

·       Open-cycle gas turbines would be less popular because of their poor efficiency.

·       Pumped storage would be favoured, because it has a long life and is much cheaper than batteries.^[1]

A single buyer would also be responsible for managing the transmission system and building new lines. The single buyer could decide that all consumers must share the cost of the core grid, with transmission lines and switchgear dedicated to individual consumers or groups of consumers being charged extra. The cost of transmission lines needed for new generators would be factored into the generator tender evaluation. The lines could then be funded by the single buyer and incorporated into the core grid which would be owned and operated by an independent organization.

How would it benefit the consumers?

Operating the power system to minimise the overall cost, eliminating windfall profits and abolishing the rort of consumers effectively paying a carbon tax on power generated by low emissions stations such as nuclear, and an end to the nonsense of paying for energy traders would bring enormous benefits. Transmission costs would almost certainly fall too, because expensive lines to remote and often intermittent generators would no longer be built.

Consumers would enjoy substantial reductions in prices and see stable prices into the future.

Conclusions

The existing market is fundamentally flawed because it treats electricity as ‘a commodity like any other’, which it most certainly is not. As we are seeing right now, it leads to shortages and unaffordable prices. Some generators reap windfall profits, and many efficient and reliable baseload generators are at risk of being driven out of the market.

In her book Shorting the Grid,^[2] Meredith Angwin provides a comprehensive description of the situation in the US, where consumers in most vertically integrated areas have lower costs than those subject to an electricity ‘market’. She also explains how many rules and regulations are anticompetitive and act against the interests of the consumer.

The evidence supporting the proposition that a single-buyer market would be better seems to be strong. After all, the only substantial difference from the largely successful vertical integration arrangements in the US is that it replaces monopoly generation with real competition. The major risk of a single-buyer market is government interference, but this is a risk that applies just as much to the current market.  

We urgently need a comprehensive review of current markets, identifying its advantages and disadvantages, and comparing it with the single-buyer model (or other alternatives) to see which is the best at providing a reliable and economic supply. Continuing with the present flawed market distorted by subsidies and price caps is not a rational option.

Bryan Leyland is a power systems engineer with 60 years worldwide experience. he lives in New Zealand.

^[1] In the current market, energy storage facilities designed to support intermittent and unpredictable wind and solar are a risky business because no one can predict their long-term future.

^[2] M Angwin, Shorting the Grid, Carnot Communications, 2020.