Consumers and policy makers have a rare opportunity to show the wisdom of foresight – and gain access to lower energy prices in the medium and longer term. To take advantage of this tantalizing opportunity however, a crucial policy issue must be dealt with. A position on new supply must be established.
In energy policy terms, Ontario is facing a critical fork in the road. The province, along with many other jurisdictions, will need to decide soon whether to accept and provide for the risk that significant volumes of new embedded supply will appear in the market, a development that would solve several problems while possibly creating others. The alternative to accepting this risk, the other fork, would be to try to suppress the entry of new embedded supply, to avoid excess capacity, in an attempt to ensure that existing infrastructure has time to pay off its debts. (Cue the weary groans of dissent amongst those who have seen this sad movie before, where self-defeating artificial revenue streams are mandated to support stranded assets and discourage new development.)
The reason this question must soon be considered by Ontario’s new government, and by others, is that the chances are good that a potent publicly-visible problem will soon arise as a consequence of unexpected oversupply of some types, if only because consumers and businesses will inevitably try out new technologies coming onto the market. The oversupply could materialize in the form of an apparent decline in some types of power demand, a condition that is already becoming evident, combined with the potential addition of significant volumes of DER (Distributed Energy Resources), which could be in its early stages. Counter-intuitive prices, and wide variations in prices between different groups of consumers, are two examples of the kinds of potential problems that could get consumers riled up.
Jim MacDougall of Compass Consulting and one of the principals behind the DER Advisory Committee notes that DERs can be analyzed from a short-term marginal impact perspective or from a long-term system planning perspective. Short-term thinking will often lead to a conclusion that regulators must protect ratepayers from the dangers of over-supply, he explains. “Long-term thinking will usually lead to a conclusion that DERs can help avoid the next major capital commitment and should therefore be credited for providing capacity to the system. In addition, DERs shift capital risk to their owners and away from the central agencies, reducing costs for all customers. In an era of rapid technological advances and cost trends in favour of small-scale customer-centric energy solutions, it can be particularly valuable to transfer risk from central agencies to DER proponents.”
In other jurisdictions it’s becoming apparent that there is a need to re-assess projections and plans to reflect the growth of DERs. Examples include the following:
• Recent developments in New England and California where DERs have caused daytime demand on the wholesale grid to fall counter-intuitively below nighttime levels.
• The New York ISO predicting long term decline of wholesale demand in its region, at the same time as record levels of new generation capacity are projected to come on line. This kind of double-whammy can only mean downward pressure on prices.
• Australia’s power market, which recently reported that renewables were pushing prices down.
• Western Europe, which has seen new renewables depress retail prices to the point that cost recovery for existing assets has become fraught.
To avoid hasty or cosmetic policy responses to such problems, initiatives that would likely create further problems, government will need to clearly enunciate its position on the key question of whether new supply is welcome, and promptly hand off the management to regulators. The key question on which a clear and definitive public policy position must be staked out can be defined as choosing one of three options:
a) The unfettered entry of new embedded suppliers is accepted as a valid form of contribution to the market, or
b) The total amount of supply must be limited, or
c) A middle path must be defined whereby markets are allowed to function freely, within a stable, limited, clearly defined set of rules designed to ensure new supply meets tests of economic benefit, without otherwise constraining its growth.
Failure to make a clear choice amongst these three options leads to the negative investment conditions associated with uncertainty on how option b will be acted upon, without the positive benefits from new technology that flow from option a.
The management of embedded supply is becoming an issue now primarily because it appears that North America, and much of the world, is entering a period of inexpensive electrical energy and relatively expensive infrastructure. Although one can never be too certain about the future, recent trends suggest that the cost of distributed generation and storage, the services that put electrons on to the grid, is declining to the point where new suppliers can underprice existing suppliers. This kind of “inversion” has happened on several occasions in the past, usually benefitting customers as new technology replaces old. However it often creates problems as consumers flock to the cheap stuff while the existing suppliers make claims, often entirely valid claims, that the old stuff has untapped value and the terms of their investments must be respected. There is little to be gained, and much to be lost, by idling existing capacity that has attractive economic and operational characteristics. Often policy makers have hastened to craft compromises whereby specific revenue streams are dedicated to help bid farewell to the old capacity, while markets are opened to the newer lower cost supply. It’s pretty hard to do otherwise, as who would want to tell customers they have to buy from an old higher cost supplier, or leave good assets to sit idle?
When considering the a, b and c policy alternatives for government as outlined above, the moderately minded will likely choose option c. Almost inevitably that means handing over the details to a regulatory agency, after defining certain key principles about how much to embrace the entry of new supply, and how far to protect stranded assets. If you address this issue squarely, and proactively prepare solutions, you may be able to maximize the value of existing assets while benefitting from most if not all of what new forms of infrastructure have to offer. Fail to decide and you could very well have the worst of both worlds. Ontario has already taken a first principled step in this direction by implementing revenue decoupling for residential consumers. (See “Enabling the future with rate redesign,” IPPSO FACTO May 2016.)
Many problems can be avoided by ensuring that policy makers recognize the difference between the cost of electricity as a commodity and the cost for a delivered kilowatt-hour. For bulk power transmitted across a wholesale grid, the difference can be substantial. For distributed energy resources, the difference can be much less, but still significant.
The current difficulty with managing this issue is one of timing. Unfortunately, the current incentives as to the best time for action are inappropriate if not perverse. In order to maximize effectiveness, the time to put new regulatory rules into place is when the affected amounts are small, and prior to any crisis or acute situation. In contrast, in order to stimulate high level policy attention it is often necessary to have a sense of urgency created by external forces. Unfortunately, by the time circumstances create a sense of urgency, the problem will be much larger, more contentious, and more difficult to fix. Considering that the residual stranded debt in Ontario runs into the billions of dollars, and that current borrowing plans require that significant funds start to be directed to defeasing that debt by 2022, it’s reasonable to project that this is the right time. The urgency may not be palpable, but it’s wiser to act now, before there is a crisis and it’s too late to implement a comprehensive solution.
Procrastination on supply policy does not pay. In fact it carries a double-whammy: If you wait too long to establish your position on new supply, then not only have you exposed your entire customer base to unnecessary risk and the risk premiums that go with it, but you have missed opportunities to install improved lower cost technology at the natural points for capital replacement.
This is the time to priorize the establishment of a clear policy framework on the entry of new supply. Positive action now, to set the policy stance and construct a framework for managing new and existing supply, could save a world of headaches in a few years from now. At the same time it could open one of the few channels available for actually enabling access to lower cost electricity in the near term.
— Jake Brooks
References:
“New England sets a record: more demand at night than at noon” elsewhere in this issue of IPPSO FACTO.
"New York ISO Predicts Electric Use Will Decline Through 2028" and "EIA: 2018 Capacity Additions Predicted at 10-Year High"
“Renewables bring prices down, reliability up in Australia,” IPPSO FACTO, April 2018.
“A world turned upside down” in the Economist, February 2017:
https://www.economist.com/briefing/2017/02/25/a-world-turned-upside-down
“General Electric's power unit fights for growth as wind, solar gain” May 24 2018