State Policies and Electricity Markets: Harmony or Conflict?

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May 8, 2017 by Miles Farmer, Clean Energy Attorney 

The Federal Energy Regulatory Commission (FERC) is examining the intersection between state energy policies and the wholesale electricity markets it regulates. How FERC will ultimately address state policies is unclear (especially with three empty commissioner seats), but what is clear is that its future actions could either impede or facilitate states’ ability to advance renewable energy, particularly in the Eastern United States.

FERC Commissioners and staff solicited views at a two day conference in early May on whether and how state policies conflict with FERC’s market structures. While there was consensus that changes to FERC’s rules are necessary, participants disagreed widely over what those changes should be, and even over the nature of the problems at issue.

Background on FERC and state authority over electricity regulation

States and FERC share authority over electricity policy. States make decisions about the overall mix of power plants and other options like energy efficiency that will be used to meet electricity demand. State leadership has been critical to advancing clean energy: 29 states and the District of Columbia have adopted Renewable Portfolio Standards that mandate or encourage various levels of renewable energy in the electricity supplied to customers.

In contrast, FERC regulates wholesale electricity rates, which generally are the prices for sales of electricity from power plants to utilities that, in turn, resell it to homes and businesses under state law requirements.

Recent state decisions to financially support nuclear and coal power plants have increased FERC’s scrutiny of the potential effects of these actions on wholesale power markets. (Illinois, for example, recently enacted a policy to subsidize nuclear plants, in part to prevent a spike in carbon emissions). However, FERC’s review also affects other state policies, such as renewable energy standards. As states increase the percentages of their generation coming from specific technologies for different reasons, FERC is examining the impacts of those decisions on its market design.

The question is particularly relevant in the Northeast, Mid-Atlantic, and portions of the Midwest, where FERC oversees three wholesale power markets that cover over 25 percent of the nation’s electric load. The New England, New York, and PJM grid operators administer FERC-regulated markets known as capacity markets, which are designed to ensure that we have enough electricity to keep the lights on when demand is the highest (like hot summer days when air conditioners are running full blast). Utilities and other market participants pay generators and other resources the lowest price possible for their capacity, which is a promise to meet demand when called upon at some point in the near future. For PJM and New England, for example, it’s a 12-month period three years in the future. They then design the market rules so that the auction arrives at a price sufficient to incent the construction or preservation of enough power plants and other resources (like programs to deliver promised energy reductions when needed known as “demand response”) (see this blog for more on how capacity markets work).

Regional-Transmission-Organizations-Map-Snapshot

Why were capacity markets a focus of the FERC conference? They regulate electricity supply levels, which are also influenced by state policies. The FERC conference highlighted this and effects of the intertwined relationship between state policies and FERC markets.

Capacity markets are a one-size fits all approach that often ignore state and customer needs

While a variety of resources can sell capacity into these markets (more on how PJM’s rules are flawed here), natural gas plants are basically the only type of generator they have caused to be built. That’s a poor fit for states who want to scale up their renewable energy supply, and for utilities who want to hedge risk by investing in a variety of resources (see one utility’s comments on the value of more purchase options here). A big topic of conversation at the conference was whether FERC’s market design can be adjusted to better harmonize with the clean energy procurement desires of states and customers. The process for adopting such changes raises thorny legal issues, and FERC needs to be careful not to increase prices for customers or create more problems than it solves.

FERC’s rules can frustrate state policies and are applied inconsistently

Another major topic related to how capacity markets account for resources that receive revenue through state policies. The current market rules are inconsistent (as explained here and here). Without clearly articulating its rationale for doing so, FERC has effectively barred some state-supported resources from entering the markets. FERC has approved rules that subject new renewables units in New England that exceed a low 200 megawatt threshold to a complex bid entry test that threatens their ability to participate in the market. However, power plants supported by fossil fuel subsidies have been largely permitted to freely bid into the markets (discussed here).

This policy was criticized at the technical conference, and we encourage the Commission to find a more consistent way forward. As NRDC and others successfully argued in a complaint at FERC, such rules threaten the ability of market participants to sell different products in state and federal markets (see here). They also frustrate state clean energy policies by forcing states to pay too much to meet their electricity needs. When state-supported resources are excluded from the markets, prices are set at levels that assume they don’t exist, incenting the construction of more power plants than needed to meet system needs.

The FERC rules were originally created to prevent unfair market manipulation, and were extended when some states enacted policies that expressly manipulating the wholesale price (see this blog). But state policies that further environmental benefits through clean energy are not presenting a market manipulation issue. While it may be possible for FERC to address the most blatant attempts to manipulate prices, it should avoid interfering with state policies that do not do so. Currently, the market rules do not distinguish among policies in a non-discriminatory manner and they undermine many state objectives, such as making electricity supply cleaner, that go beyond FERC’s purview.

Market design must ensure system reliability

FERC Commissioner Cheryl LaFleur identified another potential concern behind her prior support of FERC’s rules that blocked market bids from some state supported generators: the tendency of state policies to depress prices could in her view create problems down the road if they cause needed generators to retire. This hasn’t happened so far (all three regions have more resources than necessary to keep the lights on), and other market factors like low natural gas prices have had a far greater suppressive effect on prices (discussed here). But there is a legitimate question in the long run: how should capacity market design assumptions account for state policies in order to send a price signal that will attract power plants needed for reliability purposes. Or, as suggested by some at the conference, should these regions move to a fundamentally different model that ensures system reliability in another way?

Some are pressing FERC to undermine states’ clean energy objectives

A third concern articulated by some conference participants is that state policies may unfairly favor some types of generators at the expense of others. They would have FERC apply rules that block state preferred resources from selling into the regional capacity markets, so as to remedy this allegedly unfair treatment.

This concern, when leveled against renewables policies, is inappropriate. State policies to advance clean energy account for many benefits that are not priced in FERC’s markets. In this respect, fossil fuel power plants that do not have to pay for their pollution have long enjoyed the benefits of unfair competition, above and beyond the many more hidden subsidies that affect the prices for those resources. Further, market actors generally compete to deliver renewable energy credits created by state policies.

Renewable Portfolio Standards opponents argued that FERC should do something to transform these policies into technology-neutral carbon pricing, saying that a price should be put on carbon if that’s what states want to achieve. While the option of FERC facilitating a state policy to price carbon or otherwise tailoring wholesale electricity market design to better serve state goals is worthy of serious consideration, it would not be reasonable to coerce states into different policy choices by threatening their renewables programs. Whether to price carbon or achieve benefits through a different policy design is a question for state legislatures and regulators, not FERC.

State renewable energy policies often distinguish among carbon avoiding technologies for good reason, given the hard to quantify but very serious safety, global security and environmental risks and impacts of nuclear technology, and the severe impact on ecosystems of hydroelectric power plants.

Looking Ahead

FERC’s technical conference highlighted that opponents of state energy policies could seek to attack them not just in court (more on that here and in briefs we have filed defending state authority here and here), but also at FERC. As FERC considers these issues, we urge it to keep paramount the goal of harmonizing markets with state policies. FERC should respect states’ sovereignty to set energy and environmental policy, not frustrate it.

The views expressed in this blog are those of the author, and do not necessarily represent the views of the Sustainable FERC Project or Natural Resources Defense Council.

Written by Miles Farmer