Larry F. Eisenstat and Robert C. Fallon, Dickstein Shapiro Morin & Oshinsky LLP
Two fundamental attributes of competitive markets are, first, that capital is deployed to investments that earn the highest return; and, second, new, less costly and more efficient products should replace older, more costly and less efficient products, thereby lowering costs and improving service to consumers. These attributes are no less applicable to generator investments and retirement decisions.
Generation owners should be allowed to retire their units, just as manufacturers may go out of business and deploy their capital to other projects. Were it only this easy. The difference is that if the generator retires, the lights might go out. So, obviously, everyone agrees that procedures need to be in place to ensure continued system reliability before plants are retired. Unfortunately, though, there does not appear to be agreement as to whether federal or state regulators should make this determination and/or approve retirements. In PJM and New York, for example, the issue of generator retirements already has led to some rather contentious disputes.
On Jan. 25, 2005, the Federal Energy Regulatory Commission (FERC) approved a new retirement policy in PJM requiring that a generation owner give 90 days prior notice of its intention to retire a unit, and that compensation be paid to any units that delay their retirement (PJM Interconnection L.L.C., 110 FERC ¶ 61,053, at PP 123-158). PJM has 30 days to inform the generation owner whether the retirement would adversely affect reliability, and estimate how long the unit would be required to continue operating pending completion of whatever is needed to maintain reliability. Generators that operate beyond their noticed retirement date are compensated upon their filing a cost of service rate, or adopting a formula rate that allows for the recovery of costs that otherwise would be avoided were the unit allowed to retire-minus any revenues earned in the market. (The formula includes an adder of between 10 percent and 50 percent depending on how long the unit must operate, and up to $2 million in capital costs. Capital costs above $2 million can be recovered in a rate filing.)
Retirement policy raises many issues of general applicability but we address here only two. The first issue concerns whether the proposed policy will ensure investment comes on line so that generators, otherwise needed for reliability, can, in fact, retire. Specifically, do the policy’s compensation provisions promote the “right” new investments; what kinds of plants should be built; and will it be true that the best plant will win? Our view is that these questions cannot be answered appropriately unless there exists a comprehensive and fair regional planning process open to all potential solutions to identified system needs; and an environment in which load has the incentive to “invest” in such solutions, whether in the form of new construction or otherwise. Nor can one answer the equally important, but considerably more complicated question as to when, if ever, plants should be retired even if their owners have not served notice.
The second issue concerns whether FERC will allow a generator to retire, even if the generator is needed for reliability. Presumably generators should not be required to operate indefinitely. Some tariffs, such as PJM’s, appear to give generators discretion whether to continue operating, and FERC has said, for example, that PJM only has the authority to require generators to provide reasonable notice of their retirement, but not to require that they continue operating. But neither PJM nor any other system operator appears to have addressed the scenario where, although it has been determined that the generation unit is needed for reliability, the generation owner nonetheless wants to retire for legitimate business reasons. As to this question, presently before FERC, state and federal regulators may well line up on different sides given that state regulators likely are much more willing than FERC to require the unit to continue operating.
Similarly, the New York Public Service Commission (NYPSC) recently began to investigate generator retirement issues in New York (see “Order Instituting Proceeding and Notice Soliciting Comments,” State of New York Public Service Commission, Case 05-E-0089 (July 27, 2005). The NYPSC claims to have jurisdiction over wholesale generator retirements because generation retirement is akin to abandonment of service and the transfer of utility property, both of which typically are state jurisdictional. Other parties argue that such matters should be left to the New York Independent System Operator (NYISO), and ultimately to the FERC. It is possible, then, that units operating purely in the wholesale market might be permitted to retire by the NYISO and the Commission, but foreclosed from doing so by the NYPSC. No one will win if this happens, except maybe the lawyers.
Larry Eisenstat is a partner with Dickstein Shapiro Morin & Oshinksky LLP and the head of the firm’s electric power practice. Robert C. Fallon is of counsel in the firm’s Energy Group.