Who’s the buyer? How better state assignment of procurement roles can improve retail and wholesale markets

Source: By Rob Gramlich and Frank Lacey, Utility Dive • Posted: Thursday, March 19, 2020

Recent controversy over wholesale markets throughout the Mid-Atlantic and Northeast presents an opportunity to fix a problem that has been festering since the beginning of electricity restructuring — no clear assignment of responsibility for buying power.

In the 14 states with retail competition this job was largely ignored, leading to excessive reliance on RTO capacity markets as a crutch. Remedying this retail market flaw is one way out of the capacity market morass in which we find ourselves. In a recently released report, we offer a pathway for states to put responsibility where it belongs — with competitive retail suppliers — to procure power on behalf of the retail customers they serve.

Long term contracting is valuable for all but the most risk-loving customers and investors. A variety of physical and financial contracts allow lenders to offer lower cost financing for new generation and customers to lock in prices as insurance against volatile electricity spot prices. Providing retail customers with price risk protection is the states’ job; it is not a job the Federal Power Act gave to FERC, or by extension, to RTOs. Thus, the actions here are for states to take. If states improve these features of retail markets, they can not only improve the experience of retail customers but also enable wholesale market reforms.

Critical steps to improve retail market performance

While there are several ways to improve retail market performance, two are critical. First, leveling the playing field between default and competitive service across several market design elements would ensure that utilities do not offer subsidized rates and an otherwise advantaged product to consumers, distorting the market. Second, ensuring retail suppliers are sufficiently creditworthy would enable them to execute long-term contracts for the resources favored by their customers, reducing the need for the ever-changing capacity markets. Taken together, these two reforms would greatly improve the performance of retail electricity markets and potentially facilitate beneficial wholesale market reforms.

Currently, 14 states have adopted retail choice for electricity supply, which allows industrial, commercial and residential customers to buy electricity products from competitive suppliers as opposed to limiting their options to the singular product provided by vertically integrated utilities. However, 13 of the 14 states require the incumbent utility to offer a generic default electricity product that is competitively advantaged across a dozen market attributes. Only Texas has removed the incumbent utility from the competitive electricity market. Texas also has much higher creditworthiness standards for retail suppliers compared to the three other states we analyzed: Maryland, New Jersey and Pennsylvania. With these two features in place, retail suppliers have both the ability and incentive to procure power and hedge in wholesale markets on behalf of the customers they serve.

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Retail-based competition offers several advantages, including innovative customer-focused products that access consumers’ ability to respond to wholesale prices and preferences for certain environmental attributes. While it is true that regulated utilities with integrated resource plans can also achieve renewable energy growth, retail competition provides unique opportunities in one-third of the country as laboratories of democracy and should be made to work as well as possible.

Guaranteeing sufficient generation resources

Our report focuses on the ability and incentive of competitive entities to guarantee there are enough generation resources to meet their customers’ electricity demand at all times. When retailers do not have clear responsibility for power procurement, a form of free rider problem results, leading to RTOs stepping in with highly administered capacity constructs. Once capacity constructs are in place, the temptation by RTOs, certain stakeholders and regulators to impose their subjective preferences to capacity market rules becomes irresistible.

The Minimum Offer Price Rule (MOPR) is being imposed by FERC across PJM, NYISO, and ISO New England, causing such a consumer and state revolt that discussions are taking place in Illinois, New York, Connecticut, Massachusetts, Virginia, New Jersey, and Maryland to pull out of capacity markets. We believe the reforms offered here are needed in any state that wishes to depart capacity markets and preserve retail competition.

Placing clear procurement responsibility and accountability on retail suppliers offers states a way out of the capacity market morass and a stepping stone towards working with RTOs to reduce reliance on capacity constructs over time. Accurate wholesale price signals, including prices that reflect value of energy during periods of scarcity, signal to retailers to procure power well in advance of potential peak periods. In turn, retailers are bolstered by the knowledge that their customers will stay in the market without a free option to run back to default service. The retailers are also financially equipped to procure power under state regulations. That is how the retail and wholesale markets work in Texas.

The clean energy transition will require a tremendous amount of investment and these reforms will help to finance those new resources. Voluntary physical and financial contracts provide revenue certainty that supports investment and reduces the cost of capital which ultimately benefits customers. With nearly all of the capital costs of renewable energy projects occurring upfront, pre-arranged long-term contracts provide particularly beneficial certainty for lenders in renewable projects. Pre-arranged contracts also provide revenue certainty in an environment with growing penetration of zero production cost resources that will occasionally set low and zero energy spot prices.

States with retail competition have an opportunity to facilitate better resource procurement and benefit customers by ensuring that the resource procurement job is properly assigned. They can improve retail customers’ experience and enable reforms to vexing wholesale markets while they are at it. With these retail and wholesale reforms, electricity markets can fulfill their promises of innovation and consumer protection, and support the clean energy transition.