The winter of 2013-14 offered up a perfect storm of natural gas price spikes and threats to electric reliability. Expect more of the same.
Trusting Capacity Markets
Does the lack of long-term pricing undermine the financing of new power plants?
reason for Constellation’s purchase of generating plants in Texas as well as its recent acquisition of 2,950 MW of generating plants in New England, which “improved [Constellation’s] net load to generation ratio to approximately 55 percent.” 6
Direct Energy, another retail service provider, appears to have started pursuing a similar strategy through long-term contracting power from generation suppliers, buying physical generation assets, and even acquiring natural gas production, storage and transportation. 7 Similarly, NRG’s recently announced acquisition of Energy Plus Holdings was explained as an effort to “expand its retail marketing presence in the Northeast and Mid-Atlantic” to give the company “more of a retail presence to offset its generation assets in periods when wholesale power prices are depressed.” 8 NRG’s announcement also marked another retail acquisition following Constellation Energy Group’s purchase of StarTex Power and its planned acquisition of MXenergy, and Direct Energy Services’ purchase of Gateway Energy Services.
It’s unclear what fraction of total retail load should be supplied through long-term contracts or physical plant ownership. Such decisions will depend upon a company’s tolerance for risk and expectations regarding future market conditions. While long-term contracts and physical plant ownership will stabilize procurement costs, they also create the risk that costs will be above market. However, it’s possible that the most efficient amount and duration of long-term contracting may exceed the amount realized for load under current default service procurement. This potential concern over whether the short- and medium-term nature of default service procurement creates a barrier to efficient contracting should primarily be a matter for state commissions and state legislatures, which should examine it in the context of improving retail choice and default service regulations. The best way to realize an efficient level of long-term contracting and asset ownership among retail providers might be for the states to reform or reduce their reliance on default service. That would foster increased interaction between retail service providers and customers—would allow market participants to determine the most efficient retail supply portfolio. Reduced reliance on default service, for example, exists in Texas where most retail customers are served by competitive suppliers after default service was eliminated in 2007—although a provider of last resort service is still available to customers who lose their competitive service providers. 9 A second option that states could pursue would be to review default service procurement practices to determine the extent to which longer-term contracts, procured on a non-discriminatory basis from existing or new resources, should be part of default service procurement.
Only if states fail to pursue these options and generation investment lags, even as market prices reach or exceed net CONE [cost of new entry], might it be necessary to add mandatory long-term procurement to the current capacity market designs. However, this is a far less desirable option and worth pursuing only if it becomes clear that a review and revision of default service procurement is unlikely—and then only if it can be determined with sufficient confidence that longer-term contracts will actually be needed within the RTO capacity market design to assure resource adequacy at reasonable costs.