Study Depicts Bleak Future for Merchant Generation

Merchant generators are increasingly unable to recover fixed costs in electric power plants, an economic reality eroding their financial viability and grid reliability , according to a study released by the Wilkinson Barker Knauer LLP law firm and the Power Research Group. 

“Flat demand growth, increasing renewable generation with zero variable cost, and historically low gas prices create headwinds that have the merchant generation sector once again in crisis,” the study said. Given this difficult economic environment, “investments in new merchant generation are tolerable for only the highest-risk investment capital,” the study found.

“While electricity markets may seem flush with capacity and low prices at the moment, similar to the housing boom in the early 2000s, policy makers and regulators ignore fundamental economics at their own peril,” the study warned.

Merchant generators fueled mostly by natural gas supply more than 40 percent of U.S. power demand. During the advent of electricity restructuring in the 1990s, some energy experts hailed merchant generators funded by private risk capital as the future of electric generation. Instead the industry could face its second round of bankruptcies, the study said. NRG unit GenOn Industry, with more than 15 GW of power across 18 states, filed for bankruptcy in mid-June. Meanwhile, Calpine’s 2016 profits nosedived by 60 percent from a year earlier. Dynegy reported a $1.24 billion loss in 2016.

The study, The Breakdown of the Merchant Generation Business Model, questioned the underlying finances of the industry.  In an atmosphere with flat demand for electricity, low gas prices and high penetrations of zero marginal cost renewables, the study breaks down the economics of the merchant model and explains how the dispatch or supply curve drives markets to the marginal cost of operation where merchants cannot recover fixed cost.

“The key weakness of the merchant generation business model is that generators’ revenues generally do not cover the all-in cost of supply, which includes the cost of capital recovery as well as the variable cost of operation,” the study said. Also, legislation and regulation have imposed new costs on merchant generators at the same time energy mandates and tax credits have suppressed prices by subsidizing renewable resources producing electricity at zero variable cost, the study added. 

The study also examined the difficult market dynamics for competitive merchant generators.  From 2017 through 2019, the increase in low cost generation just from renewables and combined gas cycle turbines (CCGT) is expected to outpace anticipated growth in demand. “As a result, we expect the highest variable cost generators (the marginal, price setting units) in each of the five RTOs to experience significant declines in power output and capacity factors through 2019,” the study said. 

Generation from the existing CCGT fleet will plummet in regional transmission organizations, including a 28 percent drop from 2016-2019 in the California ISO, the study found. “These expected declines in the power output of existing generation fleets are unlikely to be offset by increases in power prices and spark spreads, at least through 2019,” the study stated.  

The development of new generation is also problematic. Construction of merchant CCGT plants “does not pencil out” to cover the fixed cost of the new generators, the study said, noting the expected shortfalls range from 13 percent in part of the New York ISO to 59 percent in ERCOT.

“The losers in this scenario are not just the merchant plants with suffering bottom lines,” the study cautioned. “Customers lose in the form of higher and more volatile prices, decreased reliability, or both, and policy makers and regulators lose because they are left with the mess and no clear remedy,” the study concluded.

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The Clarion Energy Content Team is made up of editors from various publications, including POWERGRID International, Power Engineering, Renewable Energy World, Hydro Review, Smart Energy International, and Power Engineering International. Contact the content lead for this publication at

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