Markets best way to attract new investment, adapt to change

By Vincent Duane, senior vice president and general counsel

Major changes in our industry, such as growth of the use of low-priced natural gas, lower growth in demand for electricity, stricter environmental rules and the emergence of new technologies, are placing unaccustomed pressures on electric power providers. Reacting to those pressures, some have asked if organized markets are doing a good job in attracting new generation investment and – conversely – whether markets are causing some generators to retire prematurely – while they are still valuable to the grid.

PJM explored these and related questions to analyze how competitive markets stack up against traditionally-regulated structures. The data show that, while markets are about as efficient at attracting cost-effective new generation resources, they are far better at minimizing risk to consumers. Appropriately placing risk on generators reduces costs for consumers and tips the balance in favor of a market structure.

In addition, markets are no more aggressive in retiring resources than regulated structures. Our analysis shows that generators in regulated areas are closing at the same rate as those in market areas.

Our findings may be found in a recent PJM study, “Resource Investment in Competitive Markets.”

Arguments suggesting that markets do not fairly sustain legacy generating units have prompted some states to propose subsidies or special arrangements to protect generation sources from market volatility. In fact, in these cases the market is doing what it was designed to do: ensure efficient and reliable electricity supply by enabling the responsive entry and exit of resources based on the value they provide. The market provides transparent price signals, which help owners of generators to make rational economic decisions.

The study looked at how generators complied with the EPA’s Mercury and Air Toxics Standards regulation and responded to competition from lower-priced natural gas generators. If their costs become higher than the competition, the market may be signaling them to retire.

In terms of new entry, our paper shows that merchant generators in organized markets are being reasonably compensated when risk is taken into consideration. At the same time, on a risk-adjusted basis, new generation in regulated environments may be over compensated for the lower risk it faces. In market areas, the investment risk appropriately lies with merchant generators because they are in a much better position than consumers to manage this risk. In regulated areas, consumers bear this risk.

Market competition naturally filters out uneconomic generation projects. In a competitive market, everything flourishes or fails based on its merit.

Wholesale electricity markets are doing the job they were asked to do, the study shows. Markets have made well-recognized contributions to cost-effective, reliable electricity – such as operational efficiency, transparent price signals and accommodating innovations.

However, when governments seek to accomplish other public policy objectives through means outside of market structures, they threaten the ability of organized markets to continue to efficiently deliver the benefits of economic, reliable electricity.

For more background on the paper, please see the recent article about it in Inside Lines.