This is getting muddy…

Sloppy

When you are from a small state like Kentucky, you pay particular attention to things that are part of your cultural fabric. College basketball comes to mind, although my primary team is the University of Louisville, not the better-known program down the road in Lexington. UofL is not my alma mater but Columbia University isn’t a frequent participant in high level hoops competition and, you gotta go with your home town. Similarly, the Kentucky Derby is a big deal for any Kentuckian. I always watch the Derby, stand when the horses are brought on the track and the band plays “My Old Kentucky Home”, and enjoy the most exciting 2 minutes in sports.

Like many who watched this year’s muddy race with 20 impressive horses barreling down the stretch, I was surprised and confused by the objection concerning an alleged foul around the last turn. I’ve seen objections before, but never in a race of the Derby’s stature. At first, I didn’t agree, but after listening to the explanation of the stewards, I came around to the logic of their decision.

The next day there was the expected sports talk – blah, blah, blah – by commenters who watch horse racing at most once a year. Unexpectantly, the debate spilled onto social media suggesting that the Derby decision has broader societal and political ramifications. The commentary could be characterized as breaking down along political fault lines. “Good grief”, I thought. When a Kentucky Derby result is blamed on a societal or political agenda, we really are in a bad place. Have a mint julep and calm down!

Speaking of Competition

But what has the Derby to do with power markets? Nothing except to point out that competition sometimes can be controversial. For several years, many parts of the West have struggled with the concept of competition as it applies to power. As a full-throated champion of the virtues of competitive markets, even I would have to admit that the recent interest in a regional power market in areas outside of California are motivated by the need to effectively integrate renewable generation sensibly rather than out of fealty to competitive outcomes.

So, it was refreshing when Gary Ackerman – the former (shall we say Emeritus) jefe of WPTF sent me a copy of a letter for the Department of Justice Anti-Trust Division to the Texas House of Representatives. It seems that Texas asked DOJ to comment on some proposed legislation concerning competition for building electric transmission. In the first page, DOJ made a statement that was startling in its simplicity and clarity:

“Competition is a core organizing principle of the American economy.”

In the footnote that was attached to this clarion statement was a quotation from a 1951 Federal Trade Commission case involving the Standard Oil Company:

“The heart of our national economic policy long has been faith in the value of competition.”

The thrill for me in quoting these sentences is just below that of “We hold these truths to be self-evident, that all men (persons) are created equal….” Fundamentals are a good thing to study from time to time.

But how do we apply this to building a market in the West, with its varied political and regulatory profiles? Think of the coastal states of California, Oregon and Washington in comparison with Arizona, Utah and Wyoming. My head hurts! The one unifying feature of Western sentiments often seems to be antipathy toward Federal regulatory assistance. But what of the current crop of Feds that inhabit the halls of 888 First Street – the FERC?

The Humble Regulator

While attending an Energy Seminar at a well-known law firm in its DC offices, I was able to listen to the considered thoughts of the FERC General Counsel – James Danly. The GC (some call the FERC GC the “6th Commissioner”), gave an interesting talk in which he spun a cautionary tale on the proper role for a regulator by drawing parallels to the end of the Roman Republic). The GC asserted that Rome ceased to be a Republic as it gradually ignored its (unwritten) Constitution.

Mr. Danly then went on to outline the lesson this had for the “humble regulator” in exercising its authority. In its essence, the lesson is to adhere to a very strict reading of the Federal Power Act and Natural Gas Act in which FERC gave a “thumbs up” or “thumbs down” on proposed filings without alterations or advice on ways to do things better. While acknowledging the possibility of engaging in generic rulemaking, one got the impression that this should be very rare and aimed at curing obvious problems. The GC made this offering of philosophy given a reading of federalism in which the states are recognized as supreme sovereign entities.

One can appreciate how well this would sit with most state regulators. It is not a bad philosophy, except that power matters are so intrinsically inter-state that it seems hard to rigidly adhere to this philosophy. Indeed, as California makes decisions on procurement that are predicated on significant levels of imports from its various Western neighbors, I thought about writing the GC. I even drafted an email:

“I enjoyed your presentation. Naturally, as a history enthusiast I had a great time with your trip down the classical memory lane. While I appreciate the “guard rails” that you outlined as a FERC roadmap, I would suggest that FERC is needed as a balance against some regulatory hubris in the West. The last several Commissions have been exercising what I will call “extreme” deference regarding all things California. This was a natural reaction to the perception that California blamed FERC for the 2000-01 power crisis, although I believe the fault lies mostly with the California process that conceived the original market design… Enough said about that.  

However, California’s “sense of sovereignty” resides at the same level as Confederate states had in the 1861-1865 timeframe. While the CAISO tariff is a FERC tariff, any attempt by FERC to be at all directive would be seen as a violation of the California borders. This, even though California is reliant on imports to balance much of its large renewables ambitions. As the region begins to contemplate how to manage resources to make the political desires for “green energy” match reliability, an open, competitive network will be essential. Most folks in the West now recognize this and that is why so many are working to achieve a regional market. But it is reasonable to say that California is getting in the way by virtue of its governance.

California has no fear of anyone. They are the population center and will attract the assets of the rest of the West. That is capitalism. Goods go where the demand is… But this is also interstate commerce and it may not evolve in a manner that is consistent with the needs of other states and may not be efficient, without some federal oversight. In the current environment, the CAISO knows that FERC would not back them if they disagreed with the State. The same with regulated entities like the utilities. The CPUC and others would kill them in rate cases and other forums if they did anything that did not conform with the political dynamic in the Golden State. Unlike other RTO areas, where FERC has told the ISO/RTOs where they were wrong (ever notice how many deficiency letters SPP has gotten?), FERC never says “boo” in California. You may call this “humble”; I call this a plan predicated on the hope that all will ultimately go well.”

In the end, I didn’t send it for fear that someone would assert that it dealt in matters that were ex parte (something contested before the Commission) or, that in this day of “gotcha” politics, someone could assert that it was an improper communication. But the point is important. Westerners need to understand to what lengths FERC will go to avoid upsetting California or seem an “arrogant regulator”. Will the rest of the West be able to negotiate with the new Rome (California) without some help? We must hope so, but the way forward is as muddy as the Tiber… or the track last week at the Derby. E pluribus unum?

Biases are a waste of time…

This past week, I got to spend quality time with western state regulators and industry folks at the CREPC-WIRAB meeting in Salt Lake City. Meetings of NARUC are good, but most state regulatory bodies have a variety of industries to regulate from natural gas and electricity to taxis and other things of public interest. Consequently, it was great to have folks from all over the West discuss how the grid is going to manage so many challenges; from carbon policies in the coastal areas of the West to the changes in the generation mix all over the interconnection. This focus is the real benefit of CREPC-WIRAB – plus visiting beautiful Salt Lake isn’t bad either.

Naturally, one of the main focal points of discussion was how to incrementally obtain the benefits of a regional market that will help the West do the best job possible of using the evolving generation fleet as efficiently as possible. The potential of a truly regional market that links the population centers of California, western Oregon and western Washington, with the renewable and thermal generation of the rest of the West, is tantalizing.

The challenge to this future is getting everyone to talk to each other while recognizing everyone’s varied perspectives and history. This point was made clear to me when Kenna Hagan of Black Hills Energy explained the varied business models that exist in the West to the WPTF DC Roundtable last year. This situation is different in numbers and needs than in the East. Investor-owned utilities, public utilities, federal power authorities, municipal utilities are almost equal parts of the Western fabric. Add in the evolving Community Choice Aggregation (CCA) of California and the existence of merchant ownership of generation of all kinds and the result is a “United Nations” of interests.

“We need to talk…”

I’ve been very aware of this diversity since I took over the day-to-day management of WPTF. In fact, WPTF has evolved into an organization that has all these organizations as members. It’s why I like to think of WPTF as an “information clearinghouse” on market related issues rather than a traditional trade group. So, it was a surprise to me when a friend pulled me aside and said; “we need to talk”. Whenever you hear this introduction, you know that you’ve done something that somebody doesn’t like.

This friend, and I do view this person as a friend, said I was getting a reputation for being “anti-IOU” (Investor-Owned Utility). I was taken aback. I admit that 20 years ago I had that bias, but the days of distinct IOU versus IPP (independent power producers) fights have long since passed. Indeed, ownership of non-rate base generation is often part of a “blended” utility. But the accusation bothered me. I pondered my public appearances, business conversations and even my blog to see where I had exhibited “anti-IOU” behavior. I didn’t think I had, but something I had been saying must have appeared to be annoying to this community. My intent is never to offend but engage. Where had I gone wrong?

Was it possible that my stated concerns about the “day-ahead” product as part of the EIM market development with CAISO was being viewed as “anti-IOU? The point I had made was that it would be hard for any day-ahead product which left transmission under the control of the utilities rather than the independent network administrator to be approved at FERC. This point seemed straight forward to me. FERC has more than 20 years of precedent in which it has noted the difficulties of having transmission controlled by incumbents who also own generation. This problematic situation is why the Commission has pushed the idea of independent grid operation, both to eliminate the incentives and the perception of possible discrimination.

Incrementalism: Time & Risk

The reason that I have focused on the difficulties of a “day-ahead” product where transmission is not controlled by the network administrator – CAISO, SPP or a similar body – is to avoid wasting time on something that is very likely to get shot down at FERC. Many EIM entities have noted the many “false starts” in getting a market going in the region. This point was made to me most eloquently by Sarah Edmonds of Portland General, someone I consider a thought leader in the region. As someone who has worked for over 20 years on market development around the country, I empathize with their situation. But I fear proposals that might result in more frustration.

It is understandable why the EIM entities don’t want to hand over control of their transmission to CAISO, given that the ISO Governing Board is comprised of appointees of the Governor of California. They would be ignoring their fiduciary obligations to shareholders and their own state regulators if they did that. But any “work around” to get the benefits of a day ahead market that doesn’t place transmission into the hands of an independent market administrator seems to invite more disappointment when such a possible construct is considered by FERC. I hope that pointing this out and advocating for other solutions is not viewed as “anti-IOU”.

Many (not all) of the EIM entities have emphasized the belief that an “incremental” approach is the best way to reach the goal of building a regional market. My response to that view is that the EIM entities and CAISO have already done splendid work in incrementally building consensus for a market. Proving the benefits of the EIM has been a great success as is evidenced by the interest of state regulators. If we did not have the rapid onset of renewable generation penetration, accompanied by increasing interest of state legislatures in pushing more renewables, along with the retirement of significant amounts of legacy thermal generation, we might have all the time we need to continue to move incrementally. But time is not on our side.

To my friends in the IOU community – and this includes many WPTF members – my concerns for market formation in the West are not rooted in a bias. I am biased only in the belief that transparent markets benefit all interests; reliability, environmental and economic. But having worked as regulatory staff and as a market participant for over 20 years suggests to me that some approaches to markets will work and find regulatory approval and others won’t. I know the EIM entities are trying hard. Perhaps, just perhaps, a solution to the dilemma before them is available. I have an idea, but I’ve stated it already. We can debate that later. For now, let’s all agree that “biases” are a waste of time. But so are market constructs that are problematic. Let’s not waste time.

What goes on there? Sacramento and… FERC?

It was a strange week. A lot of travel, but it was all in the Eastern time zone – evident by the humidity in the air as Spring begins to arrive in the East. It began with a trip to Columbus, Ohio to present before the State Commissions in the PJM region on FTRs and then to Miami, FL to the WSPP meeting where I moderated a panel on the PG&E bankruptcy. Strange, but interesting.

The FTR discussion was a refreshing example of reasoned discussion. I was there as an independent consultant at the request of the Organization of PJM States (OPSI). It was a good group of the very diverse state commissions in the PJM footprint.  They had a lot to discuss regarding RTO Governance and Financial Transmission Rights (FTRs, we call them CRRs in California) and the recent default of a firm known as Green Hat in that market.

I was struck by the very serious, levelheaded attention paid by Commissioners and staff to a contentious issue. This was a hard subject with a lot of money at stake. But the tone was respectful but probing with PJM staff and industry representatives invited to speak.

Regulation, in my mind, is a task that requires a relationship between the industry and the regulators that is arms-length, which should neither be overly antagonistic, nor should it be overly “chummy”. Most states in the RTO markets seem to get this about right. Contrast that with some states in the Southeast where the relationship with regulated utilities seems overly accommodative while the relationship in California is poisonously confrontational and seemingly distrustful.

The California Hall of Mirrors

The distinction between how issues surrounding regulated utilities is handled in California and elsewhere was highlighted by the panel I moderated at WSPP. The participants were great; Katie Bellezza of Novatus Energy, David Perlman from the Bracewell law firm and Karol Denniston from Squire Patton Boggs.  Katie provided the perspective of renewable generators who face challenges to maintaining contracts with a utility in bankruptcy and navigating the changing credit environment going forward. Both David and Karol detailed how unique this bankruptcy is. PG&E has abundant cash on hand but is in bankruptcy because of the unknown risk of wildfire liability in a state with “inverse condemnation” (more on that later and why it is a crazy liability structure). Furthermore, the bankruptcy is less about satisfying creditors and more about coming up with a political solution to the liability problem going forward.

The bottom line: The solution lies with politicians rather than equity or creditors’ needs. Sure, whatever is decided regarding future liability may affect contracts that need approval of creditors, but the solution of whatever emerges from bankruptcy must change the liability standard from “inverse condemnation” to something more in line with the rest of the country – like a “negligence” standard. If the politicians in Sacramento can’t decide to do this, then it is hard to imagine anything emerging from bankruptcy. What entity could possibly bear the risk of getting stuck with all the resulting damages from a wildfire even its system was operated properly and yet some electrical equipment is involved in causing the fire?

So, while the Governor and others in California go around setting up task forces about how to deal with wildfires in the future, one hears nothing of any appetite to legislate a reasonable liability standard. Without this, there is no solution. No CCA, no municipality, no shareholder owned company, not even the State of California would want to shoulder that risk going forward. The bankruptcy judge and a creditor’s committee are unlikely to have anything to act upon until this issue is wrested to the ground. Yet it is evident that nobody wants to take on this politically unpopular issue.  It is unlikely we will see any inserts into Profiles in Courage for the political class in Sacramento.

Talent Drain at FERC

Anyone who knows me professionally will agree that I have high regard for the FERC as an institution and great respect for the staff there. While we all have been dismayed by the bickering between Commissioners (even “tweeting” at each other) most of us took comfort that the staff was there to maintain the standards of carefully reviewing the record of all contested proceedings and using their experience and deep knowledge to help the Commission adjudicate the matters before them.

The loss of quorum was difficult for FERC staff. The subsequent illness and death of Chairman McIntyre further set back the Commission and made life for the staff uncertain. During this time, some senior staff began to leave. These were people with deep experience. Then staff that comprises the “bench strength” of the future staff began to leave as well. I have been made aware of so many “going away” parties in the last few months that I am now genuinely concerned. The solid, honest broker that we have all come to rely upon suddenly seems less than it was. This is bad for everyone in the Power and Natural Gas industries but especially so for us in the West.

Many states in the West are changing the generation mix aggressively to renewables based upon state legislation. This transition needs a federal referee so that state policies don’t collide to hurt the regional grid. The West needs a regional market to help with the transition and to allocate resources as efficiently as possible. FERC assistance in this matter is likely to be needed. Is FERC going to be willing and capable to help us? I wonder.

Ch, ch, change…

“You’ve changed.”

I was having lunch with a former colleague at FERC and took a moment to appreciate the changes in the Commission’s Northeast DC neighborhood. I can recall working there in the early 2000s and it was quite sketchy just a block or two away from FERC. This sprint, walking to lunch in the crisp Atlantic air, I took in the sight of all the new apartments and other buildings. When I passed a Gelato place across the street from a Whole Foods, I figured it was safe to say that part of DC had changed.

Paul Bunyan Sized Changes

Speaking of changes, I was reading about an E3 study on how much the generation mix is going to change in the Pacific Northwest. In turn, these changes many will alter many assumptions that folks throughout the West have about power, prices and what capacity can be relied upon. The implications are being considered in many venues. Attendees at the WPTF Winter meeting last month in Del Mar may remember the “round robin” we had at the end of the program. Randy Hardy, former head of BPA, gave an impassioned overview of the likely changes in generation in the Pacific Northwest and indeed the rest of the West surrounding California. Given Randy’s experience, he is well qualified to comment, and his testimonial lends credence to the E3 study.

The gist of the E3 study is that, with several legacy coal plants in the region retiring and load growth increasing, the Pacific Northwest faces a possible 8-gigawatt (GW) deficit by 2030 unless new “dispatchable” capacity is constructed. Randy, along with former BPA executive Larry Kitchen, further note that this situation would be exacerbated by looming state policy goals. Specifically, the proposed Washington State legislation requiring 100% carbon-free electricity procurement, and a bourgeoning “no new gas” sentiment in the region are likely to make getting the needed flexible capacity challenging. Randy and Larry correctly observe that the logical outcome of these trends suggests massive amounts of batteries and possibly pumped storage as the only “dispatchable” capacity that reconciles these narratives.

Randy and Larry further point out the logical implications for California in its drive for 100% carbon-free electricity: there may not be as much export potential from the Pacific Northwest as California policy makers are planning on to meet the Golden State’s needs. This scenario was amply demonstrated around March 1 of this year.  Cold temperatures combined with an unusual number of unit outages led to Mid-C prices at nearly $1,000/MWh and natural gas selling at over $150 MMBtu. This situation should give policy makers some pause as aspirations of carbon-free electricity production spread from California to Oregon and Washington State. Even states like Nevada and Arizona are moving toward greater requirements for renewable resource procurement and the phasing out of units like Navajo and others in the Desert Southwest.

So many changes with so many moving parts – as is the case in any regional electric system – calls for some contemplation. Who better to facilitate this contemplation than WPTF? Consequently, expect to hear about a roundtable on Pacific Northwest generation resource mix soon. Currently, the thought is to have it in Portland in early June. Panelists could be E3, environmental advocates, some regional utility folks, some regulators and interested WPTF members. Sounds like a party! Uh, I mean “thoughtful roundtable.” Stay tuned.

States & FERC: A time to work together?

Regulators throughout the Pacific Northwest – and California – need to consider how to manage the evolution of the generation mix considering their environmental goals while maintaining reliability. Naturally, state legislatures consider these matters for their own states.  As part of an interconnected grid, however, state regulators would do well to inform development of goals and implementation strategies based on the situation of surrounding states. There may be an opportunity for FERC to facilitate a discussion even while allowing the states in the Pacific Northwest and California to take the lead. While respecting the prerogatives of the states, the reliability of a multi-state grid certainly seems an ideal place for a Federal role.

In any event, a real regional RTO is necessary

It is certainly right to contemplate the future regional generation resource mix and how it fits together. It is even more urgent, however, to get a regional market in place that will greatly assist in the efficient allocation of resources over a broad area. As I argued in my last blog post, the effort to grow something like an RTO from EIM with a day-ahead product from CAISO seems fraught with so many difficulties that the region and the EIM entities are better off considering alternatives.

Trying to make a silk purse of out of a sow’s ear seems an apt analogy to EIM trying a day-ahead market where the incumbent utilities still control the transmission. We know the EIM utilities will not – and should not – turn over their transmission to an entity whose governance is controlled by the Governor of California. It is hard to imagine a legitimate market growing out of a day-ahead appendage to CAISO in which the utilities control the transmission.  Such a structure would be rife with problems for non-transmission owning utilities and generation.

The footprint of the EIM entities is already quite robust. It contains a great deal of transmission, generation resources and geographic scope that could allow for very efficient market allocation of resources and help focus transmission planning. It has a governance structure at a Board level. Certainly, it would need a stakeholder governance structure to inform the Board on its decisions. But in the meantime, why not issue an RFP for all market administrators – SPP, MISO, PJM, ERCOT, even CAISO – for bids on performing the role of administrator for an RTO with a real-time and day-ahead market and an allocation of transmission rights. It’s all there. It just needs an experienced market administrator. There are a few from which to choose.

E3, Randy Hardy and Larry Kitchen are doing a great service by pointing out the possible outcomes of various political and industry trends in the Pacific Northwest. As we discuss the changing resource mix, let’s also consider how to best use what we have. One thing is for sure, the way the system is currently dispatched needs to change.

Power Market Choices for the West

calvin-hobbes-the-world-is-a-stage

When I began my tenure with WPTF last year, the outlook for market development in the West was bright. The CAISO had grown the Energy Imbalance Market (EIM) and looked like it could even change its governance to evolve from this incremental step into a true regional market. The folks in the Mountain West were set to join SPP. The PEAK Reliability Coordinator (RC) had joined PJM to offer a credible platform for the economical implementation of a regional market. That was soooo January 2018.

How things have changed! The Energy Imbalance Market (EIM) has been up and running for a few years now. CAISO and the members of the EIM have done a great job at enhancing that platform to provide some additional benefits in terms of efficiencies. But while the number of EIM participants continue to grow, the concept itself seems to have stalled.

The legislation needed to change the governance of the CAISO to be independent enough to allow utilities outside California to turn over their transmission for CAISO to operate did not pass last year. Given the wildfire issues, PG&E bankruptcy, and a new Governor in Sacramento, it appears “regionalization” will once again fall by the wayside. Certainly, the idea of a day-ahead component as an extension to the EIM has been discussed but this idea – without hard to imagine changes – suggests the EIM growing into a real regional market improbable (for reasons discussed below).

Mountain West died an unexpected death when Public Service Colorado (PSCo) pulled the plug weeks before that market was to go live. We hear that Western Area Power Administration (WAPA) wants to find a way forward and that Black Hills and others are interested but that is about as far as the information goes. Do they have rekindled interest in SPP? Do parties want to look at other providers like PJM? Perhaps there is there a desire to proceed, but no consensus on the direction.

In the Desert Southwest, Nevada and Arizona are marching ahead with the addition of renewable resources at levels that cry out for a network market to manage the flows, resource sharing and optimization that can only occur in an independently dispatched market. Does this group want to join the CAISO, even with its problematic governance structure that makes a full RTO almost impossible? Or do these entities hope to convince their regulators to build investment costs into rates in order to create the redundancy required to ensure reliability on a grid with high renewable penetration but without a market?

These thoughts were upper-most in my mind when I attended the Winter Policy Meeting of NARUC in Washington D.C. a few weeks ago. Among the attendees, there seems to be universal acceptance that the EIM is as close to an RTO as the West can get for now.  Even so, some companies seemed to hold out hope that the CAISO’s day-ahead market (DAM) enhancements would enable the evolution to an RTO-like entity. Though I hate to rain on the parade, this begs the question of how the EIM can function competitively when participating entities control transmission capacity in the day-ahead and real-time. The problem of unilateral market power is immediately clear; a utility controlling its own generation and transmission could bid in the day ahead in such a way that the only solution in the real-time market would be its own resources!

I know from personal experience that FERC and its staff want to be flexible in getting a Western regional market going, but such a construct would be too problematic even for FERC’s permissive urges.

But wait – there are alternatives to the depressing status quo. The alternatives are within reach because they would be building on the incrementalism forged over the last few years. Consider these alternatives:

  • The Git ‘er Dun Option: The EIM entities publish a request for proposals (RFP) for a market administrator. Consider the breadth of the companies to date and the work they have done to be ready for a network market. This would be a substantial market that already has its own outline of governance. (Consider the independent EIM Board.) FERC would require a joint operating agreement (JOA) to ensure the ability to transact with California with few impediments. CAISO, SPP, PJM and others could bid on it and given the work that has been done, a full RTO with a real-time market, day-ahead market and FTR assignment could be done and in place within two years. The benefits are speed, the ability to command one’s own governance, and the elimination of any California legacy policies that might be unpopular outside the Golden State.
  • The Mountain West Redux Option: WAPA has selected SPP to be its RC following the move to close PEAK RC. One of the problems with the previous SPP was that Mountain West was essentially adopting SPP’s governance. In this scenario, the remaining Mountain West participants could see if SPP is willing to form a separate entity based on the members’ own design. This would be akin to what PJM was offering others in the West – namely, a complete RTO separate from any other and with a governance and design set by the member parties. If SPP is unwilling, try an RFP for a market provider such as CAISO or PJM that would work with SPP or any other designated RC. The telemetry and other information necessary for the RC would be the same as that for a market platform. Again, the benefit would be speed, governance by design of the owners, and an opportunity for state regulators to participate.
  • The Better Yet Option: How about both options? The EIM entities have gotten to know each other and work together. They have worked out systems and procedures that could make a network dispatch work nearly seamlessly. Let the EIM entities establish their market to facilitate sharing of resources with the rest of the West now. The Mountain West entities seem to want their own incremental start. Let them have an RFP for their own EIM from any of the current RTOs with an eye to moving toward a full RTO as experience allows. This would give their state regulators some comfort and some input that does not exist with joining SPP as it currently exits.

The work has been done. It’s time to move on. The needs of the Western grid with the introduction of renewables and the retirement of legacy units requires the next step to be taken.

Confession is good for the Soul… but not Social Media.

Scales of Justice

I was raised in Louisville, Kentucky. My father and mother were socially progressive for their time. One was never allowed to use a racial epithet. My father, a state Senator, sponsored or co-sponsored legislation to advance civil rights and the environment. When I went to Columbia University as an undergraduate, I had no problem adapting to the liberal social environment.  New York City in the early 1980s was an exciting brew of cultures.

However, like many an undergraduate, I sought ways to distinguish myself. Surrounded by so many Northeasterners, I leaned into my Southern roots.. Aside from professing a love of Bourbon, the Allman Brothers and Lynyrd Skynyrd, I had a Confederate flag in my dorm room. Stupid, in retrospect? Sure. But it was 1982 and I was young and, even though I was a history major, I did not appreciate what that flag symbolized to other people. I was wrong, of course, but how long-lived are the consequences for that mistake? If I were now an elected official of a high enough level, and this came out, could my explanation and apology for youthful insensitivity be accepted? Could my record as an adult be judged rather than my college years?

Missed price signals – short-run mistakes with long-run consequences

I thought about the perils of rushing to judgement and the risk of mistakes with long-lasting consequences when I got a call from a reporter on a case before the CPUC on Natural Gas that occurred last summer. You may recall that in late July, SoCal gas spiked and penalties put in place to ensure reliability were invoked. These “OFOs” (Operational Flow Orders) and associated penalties provide incentives to keep a pipeline reliable. So, when the reporter asked if Southern California Edison’s request to reduce OFO penalties was justified simply because the penalties “raise prices,” I was surprised. Of course it would raise prices – that is the point! The penalty serves as a price signal indicating that natural gas is scarce. Those high prices provide incentive to conserve.

Dampening the price signal in this instance would lead to second-order problems. Many market participants make hedging arrangements that would be undermined if penalties are cancelled or altered. Participants will cease to make those hedging arrangements in the future since the basis of making contract determinations is not to be trusted. If that happens, prices over time rise as the market for supply shrinks because there is no way to trust the market signals – the “fundamentals.”

Advanced economies long-ago determined that prices will lead to a disciplined behavior that would not exist without them. Prices – in the short run – indicate that the market participants or operator must take action. In the long run, prices indicate the need for system upgrades, investment, or accessing new supplies. But the drumbeat in many regulatory quarters against “high prices” and suspicion of “the market” has become so pervasive that a trade reporter asks if a proposal to suspend OFO penalties is justified to avoid high prices? Rather the reporter should ask whether the price signal offered by the penalty helps ensure reliability and economic efficiency? But the underlying predicate – that prices honestly derived in a competitive market – achieve the best solution both in the short-term and over time, seems lost.

Carbon pricing – case in point

The lesson of price signals has not escaped those who wish to promote carbon reduction. We know that a carbon cost – whether an outright tax or a more subtle cap-and-trade program – will cause those that emit offending carbon to increase prices. This, in turn, makes production of less noxious resources more economical. As my favorite publication, The Economist would say, this is the “non-hairshirted” approach to environmentalism. Nevertheless, even this approach normally leads to higher prices, at least in the short run.

The question has been this: can we allow high prices in the name of driving behavior? Do we need to hide the high prices so that the result is not too transparent as to become unpopular? This may have been one of the attractions of “renewable portfolio standards.” Regulators push the procurement of resources through requirements on the utility and, voila! You get renewable energy to order. No muss, no fuss.

The problem is that to meet the requirements, utilities have entered into contracts that span for multiple years, even as prices have fallen. Unlike generation built to compete in a market that moves and is “marked to market,” the contracts can get more and more expensive in relation to the marginal price in a market like CAISO. That is because CAISO is reflecting the cost as the market develops, not at the cost that was “anticipated” over the course of years and baked into the contract. If the utility runs into financial trouble, the regulator must find a way to stand by the utility.  Otherwise, debt holders can call contracts that are “out of market” into question, even if the utility does not reach the point of bankruptcy.

PG&E is an example of this scenario, but so are bets made by big utilities in the East on nuclear power or Clean Coal in the last decade. In fact, the entire effort of moving to power markets in the 1990s was driven by bad utility investments of the 1970s and 1980s abetted by well-meaning regulators without the discipline of a market. As we wish to move to cleaner power, we risk making the same mistakes because sometimes markets “raise prices.”  Failing to respect price signals now can lead to inefficient and untenable outcomes for decades. We can move to clean energy, but competitive markets should be allowed to work. Building economic incentives rather than hiding the costs in an “order” to procure renewable resources will make the transition as inexpensive as possible.

Capitalism Administers a Harsh Lesson: How to Finance Green Projects

My wife and I attended a party Saturday night in Washington, DC. So, we used some credit card points to stay at a plush hotel near the White House. Over a leisurely breakfast, I read the weekend edition of The Financial Times – yes, I am that much of a geek. An article on the PG&E financial crisis and possible implications for financing “green” energy projects caught my attention. It suggests possible lessons, not just for California, but all states that wish to promote renewable power.

The premise of the article is that leveraged long-term green power contracts signed with investment grade utilities became very popular for investment by pension funds starved for yield. Since regulators in many states would approve these things that did not have to compete in a market, the price became somewhat immaterial. This lack of competition allowed for these projects to deliver what often seemed “absurdly high” rate of return targets which made them magnets for those offering finance.

As I said in my last blog post, I am not a climate denier. I believe that carbon reduction is important across the economy, including the power sector. However, I have long been troubled by the “command and control” (Soviet) approach to green energy procurement. While most Americans want more renewable energy to help address climate change, economically efficient procurement decisions are key.

Fundamentally, efficient procurement decisions hinge on establishing the cost of emissions, and then requiring the producer to pay to offset the cost of any emissions they do not mitigate. The cost of emissions can be assessed as an outright tax or by trading credits for emissions up to an agreed-upon cap. In this latter approach, those who do not emit have credits to trade to those that do – a stream of revenue for the clean producer and a stream of costs to the emitting producer. This serves as an economic incentive for the emitting producer to reduce costs by investing in cleaner production.

As I noted in my last blog, there was broad consensus in the US political sphere prior to the 2008 financial crisis about the favorability of a national cap-and-trade program for the power industry. The concept had worked wonderfully in reducing acid rain in the 1990s but there were technological solutions (“scrubbing”) that could be attached to a plant to deal with NOx and SO2. The technological solutions to cutting carbon from thermal generation are – to this point – quite expensive (see Southern Company’s travails with the Kemper IGCC plant in Mississippi). This makes carbon cap-and-trade a bit harder.

When the consensus on developing a cap-and-trade program to deal with carbon broke down after the financial crisis – and whatever else poisoned our collective political environment – states began a “feel good” frenzy of renewable portfolio standards for their regulated utilities. The motivations behind the standards were doubtless varied, but for most regulators and legislators this must have seemed an expedient way of driving renewable procurement without the messiness of explicit cost increases to customers. This “command” from the gods of state policies (images of Mount Olympus come to mind) came even in areas where a cap-and-trade policy was being implemented, such as in California and in the states in the Northeast (see https://www.rggi.org/).

Why take this duplicative approach? Well, it may have “felt good” and besides cap-and-trade market mechanisms require tinkering to make sure the cap is low enough to cause the proper economic response without causing too much disruption. This can be a very transparent process that can be politically uncomfortable. Practically speaking, the media and most voters have an easier time understanding and accepting a simple “order” to procure clean energy.

So now we are back to the article sited at the top of this blog. The ordering of green projects through regulated utilities which then either build or contract for them is dependent on financial viability of the utility. This means that if anything threatens that economic viability – like a large liability – then the regulator or state must step in to keep the utility whole to creditors.

What happens if regulators or the state government refuse to make the contracting utility whole? This increases the risks that the green projects would hold in a bankruptcy proceeding as “out of market” in terms of costs and open to being eliminated in a workout. If this happens, the costs for financing the next round of renewable resources then goes up because the perception that the utility contract is ironclad is in doubt. If that perception is allowed, then capital can go elsewhere or be attracted back to the utility contracts by higher returns on the capital. Higher returns on the capital mean higher costs to customers.

Let’s be clear: Any attempt to achieve meaningful reductions of carbon in the power sector will cost money. That is why I wish my friends in the environmental community would stop with the Messianic messaging on carbon reduction which seeks to vilify and enrage skeptics (did I mention our poisoned political environment?) but rather embrace carbon reduction as a “risk management” tool. “Risk management” is a market term that implies hedging or things that might involve a “cost”, but that help insure against the possibility of a worse outcome. Thus, we have insurance or agree to participate in a market that has costs for collateral, etc. to provide collective security against a bad event like a big default.

Those who say an efficient way to manage climate risk is infeasible and expensive need to pay attention to the hidden costs and problems associated with the way we are pursuing our environmental goals now. Capitalism has administered a stern lesson on the “feel good” approach. Time to try something different.

“Hey, stop. What’s that sound? Everybody look what’s goin’ down!”

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I frequently am reminded by my kids – and my CAISO Committee Chair, come to think of it – that I often “date” myself with my cultural references. Oops, I did it again with the above referenced lyrics from “Buffalo Springfield.” But these words come to mind as I contemplate the relentless evolution of carbon issues in states across the country and how they are dealt with in an economically efficient manner – or not.

The assaults on allowing markets to clear at the competitive marginal price has been underway for some time. At one time, markets were under assault by regulatory fiat in states where the concern was not enough capacity. Then they were attacked by those who believed that prices were too high regardless of market results. Last year markets were under siege because of the desire to keep some older technologies and fuel types around. Now, the natural process of efficient market clearing is being subverted because of the urgent desire to address carbon. Each time, the onslaught has been because of the false notion that markets cannot deliver. It is a pernicious sentiment held by many, especially when faced with an existential threat such as climate change.

By contrast, my faith in market solutions is nearly absolute. I believe that competitive markets yield the best outcomes for society generally, and particularly for customers. No market disruption – including the so-called “energy crisis” in California (it was a “regulatory crisis”) – has shaken that belief. This is true even in the face of our daunting environmental goals. Beginning in the 1980s, competition drove efficiencies that resulted in lower emissions that would not have been possible under traditional regulation. Now, however, we may be entering a policy epoch in which we embrace command-and-control solutions put forth by state policy makers in a fit of panic to curb carbon. This is different than the other market assaults. This really is something “going down” that – left unchecked – can seriously erode competition.

Let me say that I am not a climate change skeptic. I believe the science that anthropomorphic activity is changing the climate. To my friends who remain skeptical, I have always preached embracing solutions like “cap-and-trade” as a reasonable risk management solution in the event their skepticism proved wrong. Any sensible market participant understands the fundamental importance of hedging. The resistance to sensible hedging when it comes to climate change probably has to do with the religious rhetoric of the climate debate. We have somehow come to a point where rather than debating policy we are impugning the morals of the people on the other side of the debate.

This was not always the case. There were significant points of agreement that we could use market methods to curb carbon the way we had successfully cut acid rain from atmospheric nitrogen oxide (NOx) and sulfur oxide (SO2). There was significant Republican support of the basic cap-and-trade concept in the run-up to the 2008 election. I can recall when it seemed a given that a national cap-and-trade program would be adopted by Congress after the 2008 election and signed by whomever became President. But then came the 2008 financial crisis and, as with so many other things, seismic faults seemed to erupt within the body politic that have refused to close.

The result of this chasm is denial of increasing ferocity on one side, and messianic assertion of doom and repentance that would make Martin Luther blush on the other. Even so, the answers, my friend, seem to be blowing in the wind. The Congress has agreed to tax breaks and investment credits for clean technologies. Meanwhile, many states have imposed portfolio standards that start slowly but often result in “doubling down” on greater and greater requirements vis-a-vis specific renewable technologies. These are scatter-shot efforts that allow politicians to do window dressing that neither addresses real emission reductions or market efficiencies that might help.

I could rail against what is an essentially anti-competitive and likely economically inefficient demand by legislators and regulators for this kind of discrimination. I could offer history lessons on how the increasing tendency to procure these resources may prove to be a mistake as there are no “philosopher kings” among our policy makers – never have been.

I was willing to continue these points of debate, but I am now thinking it is necessary to consider that things have changed. Looking out beyond the typical progressive bell-weathers like California, New York, Massachusetts, I see states with moderate political profiles like Michigan and Virginia that are charging ahead with policies that may be discriminatory but are billed as necessary in the face of Federal inaction. I look at mainstream media that embraces zero-carbon resources like nuclear power plants that heretofore would never have opined in favor of such expensive resources.

This new zeitgeist shows no signs of slowing and, in fact, is picking up speed. Perhaps those of us who believe in market efficiencies risk marginalizing ourselves in this environment without a change of tactics. The alternative may be surrendering the policy battlefield to the parts of the environmental movement that do not care much for arguments of reliability and wasted resources. Now may be the time to jump in and help form the debate of how to meet climate goals without sacrificing reliability or ignoring economic efficiency by engaging some parts of the informed and responsible environmental movement.

If we, the “Knights of Competition” or the “Warriors of Efficiency” emerge from our castles and defensive positions and engage the “Prophets of Green” and “Apostles of Renewables” to form a new basis of discussion. If we do not, the reasonable people in the environmental community – and there are many – will be left to debate with the less responsible members of their movement. If we don’t, I fear we risk the destruction of the market and all the benefits that provides. Besides, it could be as fun as the video below suggests. Here’s to an environmental “Peace of Westphalia” (click on the link).

My Faith is Shaken

DISCLAIMER: Let me reiterate that my blog reflects my opinions only and not necessarily those of the Western Power Trading Forum (WPTF) or its members.

“What the Hell?” … That was what I muttered after I was finished reading FERC’s Order in answer to the La Paloma complaint (EL18 177-000) about the California market for “Resource Adequacy” (RA). The reaction was not to the decision itself, but rather to the very sloppy and dismissive way the text of the Order treated the record on file. I’m used to not always agreeing with the decisions of the Commission – even when I was on staff there. What is so disappointing are the omissions and the cursory treatment of the record. If one had the money, I contend that this could lead to a challenge in Federal Court on purely procedural grounds. Or is the Commission counting on the fact that parties will just accept their writ?

First, let’s review the outcome of the Order. FERC rejected the complaint that the market for RA procurement in California was producing “unjust and unreasonable” outcomes. This is the standard for a complaint under Section 206 of the Federal Power Act. I disagree, but that is not the root of my dismay. In rejecting the complaint, FERC dealt only with the issues and facts raised by the initial complaining party – La Paloma. Others, including WPTF and Powerex, raised issues and facts which were not answered by FERC other than to say they “were not convinced” with no analysis or discussion as to why. That is not acceptable under any administrative or procedural rules to which FERC has traditionally adhered.

I will admit that part of the La Paloma complaint that FERC knocked down – that low prices are not (by themselves) evidence of a failed market – is well taken. The obverse – that high prices are not in and of themselves evidence of a failed market – is also true, though it is a fact that some regulators opt to forget. It is possible that La Paloma erred in making that argument central to its complaint.

Who will rid me of this bothersome filing?

While I am not necessarily a fan of markets for RA or “capacity,” they have always been supported in the industry as a necessity for “reliability.” How can the Commission ignore issues of reliability raised in the record if that responsibility is under its jurisdiction? In addition to failing to deal with matters concerning state subsidies as it had in a similar case involving the Eastern market in PJM, it ignored many other issues. How can the Commission ignore large portions of the record with a regulatory wave of the hand? The “we are not convinced” moniker felt like Queen Victoria’s dismissive “We are not amused.”

Also, of note are some justifications by the Commission that frankly border on flights of fancy. Specifically, the Commission seems to have concluded that “all is well” based on the mere fact that the CPUC has “a process” underway. This ignores a major complaint that promises have been made repeatedly over the past 15 years to “fix” RA. Each time, the effort to fix RA either dies or is morphed into another procedure. The image of “Lucy with the Football” looms in my mind when I read this part of the complaint. But perhaps the most troubling justification made by the Commission was that the current market is the subject of several filings under Section 205 of the FPA. In other words, if the CAISO files under 205, then the Commission takes the ISO’s word for it. No need to explain.

This wreaks of abrogation of FERC’s authority and certainly won’t get the Commission a chapter in “Profiles in Courage.” No, the Commission just seemed to want to avoid annoying California.

Something has changed… Something has been lost

Here is the deal: this is a strange time at the Commission. In times past, one could always count on staff to help the Commission fulfill its obligations to consider the record before it. We hear rumors of staff morale being low. Could it be that staff is not as central to the crafting of orders as has been in the past or that process has so changed that this is the kind of order that gets produced? Is it possible that all of this has turned the Commission from a bastion of collegiality and thoughtful review into a partisan battlefield? The increasing reality of contemporary Washington seems to suggest that the “circus” may have come to FERC.

So, what now? Will there be a filing requesting rehearing based on the procedural errors and administrative mistakes? That would be the normal course of events – even given tight budgets for regulatory filings. However, the sheer dismissiveness of the FERC Order, combined with the CPUC’s determination to ignore the realities created by load migration and its own resource discrimination, makes one hesitate as to what is the natural response. Could it be “normal” no longer applies to interactions with the Commission?

I hold out hope that some parties file for rehearing. FERC rarely grants rehearing, but if it rejects a well-crafted request based on the procedural omissions in this Order there would be, in my view, a case for taking FERC to Federal Court. I suggest this knowing full well that FERC would be granted great deference in any Federal judiciary venue. Nonetheless, the process by which the Commission justified this Order needs to be reviewed. Parties lose their right to complain if they don’t ask for rehearing. This order demands complaint. The solution could be found by FERC having a technical conference to build the record and allow them to answer the issues raised.

FERC is an institution I hold dear. I have great admiration for the staff’s integrity and dedication. I have had respect for every Commission I have served, or with which I have interacted as a party. I hope my recent disappointment will be short-lived. Have the times and circumstances changed such a beloved institution that much? Where is Jimmy Stewart when you need him?

California “exceptionalism” and other tragedies.

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I began to write last week about what the California Public Utilities Commission (CPUC) needs to do to ensure that the market is procuring sufficient “resource adequacy” (RA) capacity to ensure system reliability. However, the unfolding wild fire disaster made such commentary seem trivial at this point. There will be time to deal with the importance of RA and a recent FERC decision of dubious logic about the RA market, but not this week.

It is hard to fathom all the suffering and anguish caused by the most recent wild fires in California. Every day seems to bring some new stunning news item about the blazes. The number of confirmed deaths; the number of “unaccounted for,” the Beijing-like air quality in places like San Francisco and Sacramento; the incredible economic toll.

I can offer no wisdom on the extraordinary human tragedy that has unfolded this past week in California. However, I can speak to some of the economic toll. I offer my perspective on the way in which California legally assesses liability – unique in the entire US – and the resulting economic damage done to captive ratepayers and companies that must do business with California utilities.

“Inverse condemnation” stipulates that an entity with assets that may have contributed to a disaster like the wildfires – even if not found to have been operated negligently – is subject to almost limitless liability. This liability doctrine is so unique that it has been the subject of bewilderment in recent news reporting.  It took on-air analysts with news venues such as Bloomberg TV and Radio and CNBC several minutes to convey the concept, and on-air hosts could be heard incredulously asking if this is truly the way California assigns liability.  Indeed.

The legislature, with Governor Brown’s backing, recently tried to modernize these liability laws in California and make them better align with what the rest of the country does. Insurance companies, naturally, have not been in favor of such a commonsense solution as it removes significant risk to their books. No doubt, they contributed to the outrage commentary that the utilities were being let off the hook. This assertion was outrageous (one must use this term in California as it is a common currency of political debate in the Golden State) by virtue of the fact that, absent inverse condemnation, the utilities are still be liable if they are found to have been “negligent.”

Regrettably, the legislature did not have the wherewithal to ignore the cries of outrage and enact change that might help a large-scale utility business. I have developed a theory that the California political milieu loathes any policy supporting big business – unless it’s “tech.” But I digress… Instead, the legislature has allowed the utilities to issue bonds to cover costs related to wildfires under inverse condemnation. In other words, the government has tacitly encouraged utilities to take on more debt, which customers will ultimately pay. Of course, since they are still open to potentially limitless liability, the companies could find themselves in the untenable situation of taking on vast and accruing debt.

The levels of liability that are being discussed in relation to the most recent fires would almost certainly overwhelm any debt or credit vehicle that a California utility might have available. Worse, the perception in the credit markets and among those with whom the utilities do business could lead to onerous demands for cash and collateral.  That would result in an increase in the cost of doing business that would flow throughout the energy sector in the West. All for what?

California is the largest energy sink in the Western US. At peak hours, many companies throughout the West do business with the California utilities. If the perceived risk of doing business with a California utility were seen as high – due to open-ended obligations of liability or debt – then counter-parties would demand more “insurance” against a possible default in the form of cash or other fungible collateral. These costs would be passed on to customers and could even affect perceptions of the creditworthiness of those doing business with the utilities. Such credit ripple effects can create cascading events in stock prices and unrelated money markets. The bottom line is that this is a dangerous place for the utilities and for the energy sector in the West generally.

California often revels in the belief that it is special, unique, an “exception.” It is, as anyone who lives or visits there can attest, a place blessed by unparalleled beauty and often glorious climate. It has many great centers of innovation and entrepreneurship. More recently, however, it has been “exceptional” for reasons that are not so enviable: high taxes, high cost of living, and a political environment that has become “anti-business.”

Like many of us, my optimism has given way to cynical disbelief that our legislative bodies can work collaboratively and make tough choices. And in California, my optimism that the legislature can deal with any difficult situation such as the wildfires is beyond low. The departure of Governor Brown – not exactly my political soulmate but certainly the “adult in the room” of California politics – does not bode well for solutions that require tough choices. Here’s to hoping the new legislative session kicks off the New Year by surprising me and changing the liability rules so that a company in California can be assessed in a manner similar to the rest of the country. It would be good for California in the long-run as well as California’s neighbors.