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Coal's Raw Deal

The bias in RTO markets, and how FERC might fix it.

Fortnightly Magazine - September 2005

After years of voicing emotional complaints of little help in forging concrete improvements, ("Electricity is different." "You can't change physics!"), opponents of electric utility restructuring at last have begun to build the kind of logical, coherent and step-by-step arguments that sway regulators and resonate with laymen and politicians.

Recall that the Federal Energy Regulatory Commission (FERC) intends to revisit its decade-old Order 888 , and the pro forma Open Access Transmission Tariff (OATT)—and you begin to see a real counter-revolution.

For the missing link—the driving force, if you will—look no further than right under your nose. Look at coal, the fuel that still forms the hidden backbone of the electric utility industry, but which has remained sadly out of fashion for most of the past decade. Experts now say we need more coal-fired generation, despite the environmental concerns. However, they also believe that the basic regime now in place at the regional transmission organizations (RTOs), with its day-ahead energy markets, financial transmission rights (FTRs), locational marginal pricing (LMP), and a bid-based and security constrained dispatch, exerts a marked bias against coal-fired plants.

The full story can get quite complicated, but it all starts with the planning horizon—the forward time period on which investors are willing to bet their dollars.

Since the industry’s very beginnings, utilities have tended to plan for the “long run”—the time frame in which “we’re all dead,” as the British economist John Maynard Keynes once said, famously. Utilities have done quite well with that. By contrast, the RTOs focus on the short term. 

It’s not that FERC’s RTO markets don’t encourage investment in infrastructure. To the contrary: they do. But it’s the wrong kind—the simple gas turbine, the quick fix, the easy buck.
Under RTO practice, system operators use software to calculate grid conditions in real time, yielding instantaneous marginal prices (the notorious LMPs), plus a set of linked financial derivatives (their partners in crime, the congestion-hedging FTRs). These market signals impose their will on every project, favoring the short-term fix. Yet the base-load coal plant tends to do its best work when bundled up in a 30-year contract.
Simply put, RTO practice creates less risk and uncertainty over the nominal short-term wholesale price of power, but more risk and uncertainty over the long-term cost of transmission. That spells trouble for the coal-fired plant, sited far off at the mine mouth, needing long-haul transmission over a long-enough term to pay back the capital costs.

The Problem Illustrated

Consider this example, outlined in a letter sent to Midwest ISO (MISO) President and CEO Jim Torgerson by a coalition of municipal utilities serving retail load in Illinois, Indiana, Wisconsin, Michigan, Missouri, and Minnesota, dated May 31, 2005:

A 600-MW coal unit costs roughly $1 billion to construct. If we instead constructed 600 MW of gas-fired peaking capacity, it would cost us only about $300 million.
At today’s coal prices, the variable production cost from a base-load coal plant would be less than $20 per MWh. In comparison, variable production cost 
from a gas-fired plant