Blog Post

Federal Interventions in Wholesale Power Markets: Examining the Implications for Market Performance and National Security

May 9, 2018 | Susan F. Tierney, Karen L. Palmer

This is the second of two posts summarizing recent efforts by members of government and industry aimed at encouraging the Trump administration to save existing coal and nuclear power plants in the Mid-Atlantic and Midwestern wholesale markets operated by PJM. The first blog post describes the recent proposals, including the latest that rests on authorities set forth under the Defense Production Act of 1950. In this post, we focus on the implications of relying on the act for efficient performance of wholesale electricity markets, with some thoughts on how those markets do or do not reflect national security issues and carbon impacts. We also comment on the potential adverse consequences of exerting this authority.

Grid Resilience and Reliability, National Security, and Wholesale Power Market Interventions

The principal arguments offered by proponents of turning to little-used federal authorities to save certain existing coal and nuclear plants assert that they are essential for the nation’s security because the economy depends on a reliable and resilient supply of electricity and because an emergency will exist if these plants retire.

Where reliability is concerned, the electric industry has long recognized two aspects of system reliability: resource adequacy and operating security. PJM has recently stated that there is no immediate threat to system reliability from the proposal by FirstEnergy Solutions to retire many coal and nuclear plants in two or three years from now, and thus there is no emergency warranting relief. PJM says that there is currently sufficient lead time to take action at a later date should the situation change.

A reliable electric system is not exactly the same as a resilient one. According to the recent report of the National Academy of Sciences, Engineering and Medicines’ committee on “Enhancing the Resilience of the Nation’s Electric Power Transmission and Distribution System” (of which one of us was a member), resilience is not just about “lessening the likelihood that outages will occur. It is also about limiting the scope and impact of outages when they do occur, restoring power rapidly afterwards, and learning from these experiences to better deal with events in the future.”

In considering resilience, many observers, including the Department of Energy’s own Grid Modernization Lab Consortium, have encouraged electric system planners and operators to take more action to assure that the electricity system is resilient. (For examples of such comments, see here, here, here, here, here, here, and here.)

Most of those observers suggest that a resilient system is one that has a portfolio of assets as well as systems and practices that endow the system with needed capabilities. This outcome might arise from a regulated utility construct or an industry structure with a combination of markets (e.g., wholesale markets administered by Regional Transmission Organizations, RTOs) and regulation (e.g., policy actions to ensure that the system reflects all appropriate and necessary services that the electric system needs to supply).

This concept of system resilience does not necessarily equate to having mechanisms to support particular power plants located in particular places. There may be—and likely will be—multiple ways to assure a resilient system outcome.

The recent requests also run counter to the tradition of using markets to identify efficient ways to meet electricity needs. The requests put the federal government in the position of picking winners and losers on the basis of fuel use without the use of market based mechanisms in a market that is already regulated by a duly authorized independent federal regulatory agency (FERC). This is something the federal policy makers on both sides of the aisle have been hesitant to do for many years.

By contrast, PJM is now proposing to address one aspect of a resilient system—fuel security—through a market-based, technology- and fuel-neutral approach. PJM will study the system’s exposure to potential “fuel-supply risks in an environment trending towards greater reliance on natural gas supply and delivery.” PJM defines fuel security as “the ability of the system’s supply portfolio, given its fuel supply dependencies, to continue serving electricity demand through credible disturbance events, such as coordinated physical or cyber attacks or extreme weather that could lead to disruptions in fuel delivery systems, which would impact the availability of generation over extended periods of time.” PJM will conduct analyses to indicate locations on the system where additional fuel security assurance is needed and then, if deemed necessary, to incorporate such locational needs as criteria to be satisfied in its forward capacity market. According to PJM, this would enable the market to value fuel security in an economically efficient manner, with all resources able to compete to meet the criteria.

National Security, Power-Plants Retirements, and Wholesale Power Markets

Given the recent requests for President Trump to take actions that would disrupt markets (discussed in our first post), is it in the interests of US national security for the president to do so? Would the loss of these particular coal plants and nuclear plants in the PJM region be a threat to national security?

These are complicated questions. Although we are not lawyers, our answer is informed by a plain reading of the purposes and provisions of the Defense Production Act of 1950—a statute enacted in a post-war situation more than a half century ago—as well as by our own expertise on the design and performance of wholesale electricity markets and on market-based environmental policies.

The power plants that are now financially distressed in the PJM market are merchant generating units without the protection of cost-of-service regulation. An important question, therefore, is whether those markets fully compensate providers of electricity resources for the services and values they provide—and conversely, whether market failures exist that impede such compensation.

On the one hand, the wholesale electricity market in the PJM region is designed to provide prices and payments that reward suppliers of the electric energy, capacity, and ancillary services that deliver value to the electric system and its consumers. PJM and the Federal Energy Regulatory Commission (FERC), in turn, have attempted to assure that asset owners vie for the opportunity to produce and sell power (and be paid for these services) for the benefit of consumers in a system that does not favor particular fuels or technologies.

If, on the other hand, there are essential services needed by the electric system that are being provided by certain assets and that are not covered by products and prices in the market design, then there are market failures. This could lead to inefficient market outcomes that warrant attention by policymakers.

Perhaps the most significant power market failure in the PJM region is that in the Midwest (as in many parts of the United States and elsewhere), power-system prices do not incorporate the costs of carbon dioxide (CO2) emissions from power production. There are significant costs to society (and America’s national security interests) associated with the impacts of such emissions. Further, the contributions of such emissions to climate change more broadly and the effects on US society, civilian, and military infrastructure and on the nation’s security interests internationally are also significant.

Power plants, such as existing coal-fired generating units, that produce electricity with CO2 emissions have a relative competitive advantage in PJM markets because these power plants can impose public-health and many other costs on others without their offer prices reflecting those costs. Because the PJM wholesale power market does not internalize this cost of carbon emissions (except to a certain extent in Maryland and Delaware, which are part of the Regional Greenhouse Gas Initiative, RGGI), there is a market failure that means that resources, like existing nuclear plants and other resources that generate electricity without carbon emissions, are not compensated for this service that they provide. This market failure affects the profitability of different generating units, based on the carbon intensity of their power production.

For this reason, an out-of-market federal intervention to save relatively inefficient and highly emitting coal plants would run counter to this aspect of US national security interests. By contrast, some sort of intervention—and preferably one that would be market-based—might be warranted for existing nuclear plants because of the carbon-emissions externalities and costs avoided by their output, and because their retirement would lead immediately to an increase in emissions of CO2. This outcome would hurt US national security interests.

There are also market failures associated with the role of electric assets in supporting public-good aspects related to national security that are not now reflected in the prices in wholesale markets. To the extent, for example, that there are aspects of the ability of the electricity supply system to support the provision of critical public services in the event of threats that are not reflected in PJM’s products, then this might warrant changes to PJM’s market design so that any supplier of such a service would receive compensation. Indeed, PJM’s recent proposal to determine whether and how to incorporate fuel-security criteria into its forward capacity market suggests a potential missing element in the current capacity product that PJM seeks to better understand and fix.

In yet one more example, to the extent that certain types of electricity assets contribute to critical supply chain issues that are important to the nation’s national security interest—something traditionally considered to be a public good in economic terms—market interventions might be warranted to protect critical assets whose services are not fully compensated in markets. In an August 2017 report, former Energy Secretary Ernie Moniz pointed to the national security benefits of US participation in the nuclear supply chain as being something that markets fail to value. In light of the financial stress on existing plants (and the prospects for a new modern nuclear enterprise), Secretary Moniz and others have advocated for federal policies—actions or interventions that would internalize the national security benefits of a robust nuclear enterprise, including existing and new nuclear power plants and the associated and extensive supply chain.

Thus, there are both market fundamentals (e.g., low natural gas prices) as well as market failures that are contributing to the financial pressure on existing coal and nuclear generating units. Actions that the federal government might take to address the market failures should focus on the services that are needed for national security and then satisfy those services in a market-based and technology-neutral way. Taking such an approach would likely not end up saving old, inefficient, and carbon-emitting coal plants, unless they provide specific critical services to the system. Taking such an approach could have a positive effect on the outlook for financially struggling nuclear plants, as long as there is timely federal action. Unlike coal plants, which are technically capable of being mothballed and then restarted later if they were to become economic, it is not realistic to assume the same for an existing nuclear plant.

Actions the Federal Government could Entertain in the Interests of National Security

In the end, we do not have visibility into what the White House is considering, in terms of how it might apply the authorities of the Defense Production Act, or of what Secretary Perry might do in response to the Section 202(c) request from FirstEnergy Solutions.

Might President Trump attempt to nationalize the power plants and bring them under federal ownership? Might he order PJM or a federal power entity (such as a “Power Marketing Administration”) or some other unknown entity to contract for power with these resources, and do so in a way that promotes efficiency and competition, as directed by the Defense Production Act? We worry that without the benefit of market-based mechanisms (e.g., to reflect the cost of carbon, or to discipline the cost of operations), such actions might lead to the opposite outcome. This concern could be addressed through a competitive procurement for power from at-risk generators that takes into account the carbon profile or other critical attributes of the resources seeking to obtain a long-term contract. There could even be a fixed pot of federal dollars established under the act, with eligible resources having the opportunity to bid for what they need to stay open, with incentives for bids as low as needed and with benefits to federal taxpayers associated with efficient allocation of that subsidy pot.

If there is an emergency associated with potential, permanent, and imminent loss of non-carbon-emitting nuclear generation, the president or the secretary could introduce and forcefully back new congressional policy that would allow for a pricing of carbon into electricity production costs of RTOs, or seek approval of a clean-energy standard that supports all forms of zero and low-carbon electricity. Or they could encourage the Environmental Protection Agency to move expeditiously to seek a lifting of the court-ordered stay on the Clean Power Plan.

Although any of these approaches might mitigate the financial stresses affecting the existing and new non-emitting resources in an era of low natural gas prices, we think it is highly unlikely that the Trump administration will make such moves. This is unfortunate, because if the president and/or the Secretary of Energy accept(s) the requests to save the PJM coal and nuclear plants in the ways proposed, then there will undoubtedly be adverse and unintended consequences for other market participants and for the sustainability of organized wholesale markets.

The views expressed in RFF blog posts are those of the authors and should not be attributed to Resources for the Future.