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Better to Bite the Bullet Than Take it Elsewhere

Issue 6 and Volume 89.

by Larry F. Eisenstat, Dickstein Shapiro LLP

State-level requests for proposal (RFPs) within organized markets stems from the failure of these markets to elicit new, clean and efficient baseload or intermediate peaking facilities mainly because the maximum commitment period is insufficient to underpin the financing of such resources. Because of this design flaw, nearly no new baseload capacity of the type most sought after is being added where many state regulators most desire. Most additions are uprates and reactivations to existing units, many of which are old, inefficient, far from clean or scheduled for retirement. To secure the long-term revenue streams and certainty to attract the private capital to address their needs, they feel forced to go outside the auction mechanism and to issue RFPs for long-term power purchase agreements (PPAs).

Most criticism of state-mandated RFPs appears to be predicated on two incorrect assertions. First, capacity is fungible—a commodity with but a single value and one that should have but a single market price regardless of its fuel source, age, emission profile, heat rate or long-term impact on retail ratepayers. Second, long-term contracts are an overexpansive, inefficient and uncompetitive solution to short-term problems and potentially saddling ratepayers with unnecessary costs. As for fungibility, it is inaccurate and at odds with many states’ energy and environmental policies, for example, in states that (a) have a renewable portfolio standard; (b) are members of organizations such as the Regional Greenhouse Gas Initiative; or (c) have enacted clean air or other environmental legislation. Such initiatives demonstrate that the capacity it wants to serve ratepayers’ load is not fungible.

Critics argue that long-term PPAs are unnecessary for new clean capacity to be built because the markets are awash in excess capacity. But some states want to secure new in-state capacity resources or a specific fuel to facilitate their policy objectives. Characterization of capacity as a fungible commodity must be re-examined. Consumers are signaling that new capacity is needed because those responsible for protecting consumers have so indicated.

It is incorrect that RFPs are economically inefficient, anti-competitive, or market distorting. Critics contend that it is because the capacity auction results do not reflect the load’s alleged desire for new, clean energy generation that one should conclude they are working and these resources aren’t needed; and, any state’s attempts to develop these resources through a competitive RFP is anti-competitive. To the contrary, because the organized markets fail to incorporate negative externalities into their price signals, the RFPs will establish the long-term price signals for the new, clean generation being demanded. Clearing prices never have represented the true market price for all capacity resources. The clearing price only for such resources that could be available and paid for over a short term, such as existing generation, reactivated generation and demand response. By contrast, the state RFPs reflect the value of the new capacity resources that require long-term price certainty. Much of the operating unregulated capacity in organized markets originally was financed and constructed as rate-based facilities. Although those assets, most of which are decades-old, can compete without long-term contracts or regulatory pass-through mechanisms, they could not have been constructed had their owners not been assured of receiving the long-term retail revenue streams to justify their investment. Critics also say that long-term PPAs will remove successful bidders from the wholesale competitive market. False. The contract term secures a revenue stream for a long enough period for a winning project to attract the debt and equity necessary for it to be financed—what the capacity auctions do not do. Even a lengthy tenure represents only a fraction of a new plant’s useful life. That a commodity such as corn can be secured through long-term contracts or spot purchases does not mean that the former means is extra-market.

Long-term PPAs secured through a competitive procurement process are as much a component of a competitive wholesale market as are the real-time market and short-term standard offer service contracts in states; the difference is time. The stability provided by long-term PPAs hedges against short-term price volatility and can provide the opportunity for securing electric service at below-market rates. Any long-term commitment lessens volatility by fixing price. The price of that commitment may be above- or below-market, and this might fluctuate over the PPA’s term. Nothing about long-term PPAs makes them more expensive than short-term commitments or real-time or day-ahead purchases. The content and design of the long-term PPA determines its effectiveness at providing specific resources at a reasonable cost, and state commissions have authority to protect ratepayers. Much criticism of long-term contracts is touted as an effort to protect wholesale competition, particularly in the face of such stark evidence that it is not, and that the current capacity markets have failed to generate the resources being sought. The outcry for and my agreement regarding the need for long-term PPAs stems from a necessity, not a preference, under current market conditions if baseload facilities are to be built in time to meet state energy policy objectives.

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