Our Grid Needs to Go on a Diet to Get Leaner and Greener

Part of NRDC’s 2017 year-end retrospective in hopes of informing changes to come

Many regions of the United States have overbuilt and retained too many power plants, which can be detrimental to their owners, consumers, clean alternatives like wind and solar power, and flexible resources like energy storage and demand response (compensating customers for being flexible with their energy use). Reforming the wholesale electricity market rules and administrative requirements can help trim power plant overbuild for a greener, leaner grid. This blog highlights some of the main points discussed in this paper on wholesale electricity markets.

Trends in wholesale electricity market changes

Looking back at recent controversial wholesale electricity market proposals, a common theme has been to ensure that power plants make enough money given that market prices have been relatively low. Unfortunately for consumers footing the bill to keep power plants online, these proposals ignore the basic economic fact that low prices reflect supply outpacing demand (i.e., cheap natural gas is flooding the market while electricity demand is falling), and that ailing power plants that can’t compete with newer, more efficient resources should get the boot. But instead of retiring aging power plants, their owners have been lobbying for bailout money, in part through wholesale electricity market rule changes designed to increase market prices.

While higher prices could be justified if customers receive additional benefits, inflating prices above market value backfires. Power plants would get a temporary hit of higher prices, but these prices (or the expectation of them) lead to building more power plants, exacerbating the oversupply problem, which ironically brings prices back down.

The bump in generator revenue may be temporary, but market rule changes can have lasting detrimental effects on cleaner energy resources. Further, as explained below, an excessive generation fleet can impede investments in flexible resources like energy storage, demand response, microgrids, and other means of absorbing extra variable renewable generation at times when its sunny or windy to use when it’s a calm night.

Excessive generation

Most regions in the United States have target reserve margins (the excess generating capacity beyond what is needed to satisfy electricity demand), and most have actual reserves exceeding that amount. For example, PJM, the electric grid operator serving 65 million electricity customers in the Midwest and Mid-Atlantic, has an excess of about 50 gigawatts of generation beyond what is needed to serve these customers this winter. (50 gigawatts roughly equals 100 extra coal plants.) According to the North American Electric Reliability Corporation, this oversupply is expected to continue for at least a decade.

PJM planning reserve margins. PJM’s target reserve margin shown here is 16.6%, while the actual reserve is almost double that at 32% to 33%. (“Prospective” includes power plants lacking firm contracts or transmission or approvals.)

Source: North American Electric Reliability Corporation

Oversupply disincentivizes investment in flexible resources

Grid operators, like PJM, make sure there is plenty of electricity available for the customers they serve—which is important—but procuring too much extra must be balanced with the costs. All customers pay to keep these plants around, and like an all-you-can-eat buffet of plentiful generation, customers are less likely to conserve energy when it makes sense, store electricity for later, or separately purchase greener or more local options as compared to ordering a la carte and paying for just what is ordered.

How investment incentives change with varying levels of reserves is apparent from the cost breakdowns in the figure below in a study conducted for the Texas grid. 

Total system costs across reserve margins modeled for Electric Reliability Council of Texas, the grid operator for most of Texas.

Source: Brattle

First, note that the total system costs are the smallest at a certain reserve level—10.2% for the Texas grid (corresponding to a total system cost of $35.7 billion/year)—going to higher or lower reserves would result in higher total costs.

As the reserve increases to the right of that minimum, the cost of building out the generation fleet drives up total system costs (the bottom pink bars show that capital costs grow as the reserve margin increases). At the same time, the costs associated with demand response deployment or costs that would encourage investments in other flexible technologies like storage, onsite generation, or microgrids decrease (as indicated by the top set of colored bars that become vanishingly small on the right). As with the buffet of plentiful generation, customers perceive less of a need to consume less or store it for later, but everyone pays more to maintain a higher reserve level than most of them individually want, and there is no practical way to account for different customer preferences. For example, some customers like hospitals with life support systems would pay a lot to keep electricity on at all times, while more cost-conscious customers would rather save money through demand response than pay for that high level of reliability.

Indeed, with the large reserve margins common across the United States, actual demand response reductions have been anemic. For example, PJM notes that demand response dispatch has been infrequent in its energy market, a far cry from demand response’s envisioned role as being a routine means of smoothing out daily or seasonal variability with high levels of renewable generation.

In contrast, the types of costs that become significant at smaller reserve margins relate to services flexible resources can provide. With lower reserves, customers can choose to save money through demand response if they can be flexible in consuming electricity, or invest in storage, onsite generation (e.g., rooftop solar panels) and/or microgrids if they want to pay more for a higher-than-baseline level of reliability.

What is the optimal baseline level of reserves? Most grid operators don’t determine it based on minimizing total system costs. Instead, they use an arbitrary limit—most commonly, by requiring that an outage cannot occur more than once every 10 years on the high-voltage power system. Unfortunately, this criterion is not well-defined or consistent across systems (e.g., a larger grid is more likely to have more outages than smaller ones). This arbitrary limit can also result in oversupply (for Texas, the once-in-10 years limit would require a reserve of 14.1%, much higher than the 10.2% cost-minimizing reserve).

Reforming market rules driving oversupply can help fix the problem

Requirements to maintain too much excess generation oversupplies the system and overcharges electricity customers by making them pay for more than they need. This can take the form of maintaining too much generation that is online all year versus buying what is needed tailored to the seasons. The figure below shows that electricity demand is seasonal, but certain grid operators procure all capacity to be available all year at a level that meets its highest peak need, plus a generous reserve margin.

Source: Simplified version of PJM’s graphic

Buying only annual resources results in oversupplying the off-peak seasons and favors large, always-on power plants over clean energy resources that can more cost-effectively and reliably meet variable seasonal demand.

Further, procuring capacity without considering desired attributes can also contribute to oversupply. Public policies and customers have indicated preferences for cleaner resources like wind and solar and flexible resources like energy storage. But buying all capacity to meet the entire annual need without regard to these preferences is like stocking up your refrigerator with food just to take care of your caloric needs and then going back to buy food you like or need for nutrition. You end up buying too much food you won’t eat. A more sensible approach would be the reverse: procure resources with desired attributes and then shore up the rest at least cost.

A New Year’s resolution for some of our regional grid operators

Grid operators with oversupply could take a number of steps to trim excess. There are more ways than mentioned here, but revisiting how reserve margins are set and how market rules procure capacity are certainly ways that could help reduce oversupply while making the grid greener and customer bills lower.

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