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Missed Opportunity: What's Right and Wrong in the FERC Staff Report on the Midwest Price Spikes

Fortnightly Magazine - November 15 1998

to obtain more explicit interruptible contracts and remote control of loads. Contrary to the popular view that retail wheeling should go slow to avoid mistakes, true competition is needed to create incentives to pursue potentially controllable or interruptible load.

This failure to complete the transition to complete deregulation (em to have ISOs in place, to have state and federal governments commit to a market with adequate information and known rules (em is inhibiting construction of new plants. Investors, already befuddled by the lack of basic information, are understandably hesitant to invest when the rules of the game are not clear. For example, will states suddenly insist on over-construction of new rate-based peaking units (em thus killing merchant investments in peaking units (em or will they rely on the market? Will there be transition arrangements like enforceable planning reserves (e.g., structures like NEPOOL and PJM) or complete reliance on the wholesale market? In other words, can politicians credibly claim that they know who is in charge of generation reliability, or that deregulation is so organized and coherent as to warrant reliance on market forces?

The failure to identify the unique circumstances in the Midwest blocks actions to resolve them. This failing is especially glaring in a report on the Midwest. Specifically, in the Midwest, combustion turbines are urgently required. These plants are suitable only for meeting power demand at the super peak. Their economic viability depends on super high prices, which are highly uncertain. Further, there is little experience building and financing peaking plants in a deregulated market. Turning to Wall Street for debt financing or new capitalization initiatives for what amounts to a new sector will be possible but will take time (em all the more if deregulation remains incomplete and inefficient.

The uniqueness of the Midwest capacity situation is only fully seen by contrast. In New England, a huge construction boom is under way. Thus, one might expect a smooth transition to market-based construction in the Midwest. In New England, the revenue of the new plants appears more certain and more familiar to investors. These new plants do not depend on the exact balance between supply and demand at the extreme summer peak, but on the fact that their fuel costs are lower than old-style steam units now on line. These new plants employ new technology. They are thermally more efficient, for a given input in fuel cost. Their power production costs run about 30- to 40-percent lower. Thus, these plants are almost guaranteed to generate at least some income to cover debt obligation. These plants are also hedged. As fuel costs of new gas-fired combined cycles go up, so do power prices as they reflect the marginal costs of inefficient, old gas steam units. By contrast, Midwest peaking units could flip from feast to famine and have little or no income for debt.

Going Forward: At Least Identify the Risks

It is important that the market work as efficiently as possible. The market can ultimately handle the need for reliable supply (em even for peaking plants in the Midwest. However,