The clean energy transition will require much of the nation’s generation capital stock to turn over in coming years. That investment requires entities who are willing to buy the power on a long-term basis and provide lenders with revenue certainty. In the 14 states with retail competition, there is a missing element of the market structure that prevents this normal market process from functioning: a lack of credit-worthy buyers with the incentive and ability to procure power on a long-term basis. This missing link in the chain needs to be filled in by states wishing to pursue clean energy and preserve retail competition.
One-third of retail electricity customers live in states where they are allowed to choose their own electricity supplier. There is reason to believe that the retail competition model can be very helpful for the clean energy transition because it tends to find ways to engage retail customers’ demand into responding to wholesale prices using smart thermostats, alternative pricing schedules and a wider variety of services to fit different customers’ ability to respond to system needs. However, flaws in most retail competition regulations hinder the model’s ability to lead to real generation investment.
The breakdown occurs between wholesale and retail markets because the retail suppliers generally lack the incentive and ability to sign long-term power contracts. In all restructured states with the exception of Texas, consumers have a free option to return to the heavily subsidized, monopoly utility-provided default service. The free option for customers to “leave the retail market” undermines any incentive for competitive retailers to plan to serve customers over any significant and sustained period of time. Moreover, utilities often subsidize their default service by not including the cost of many of business functions in the price. Instead, they will frequently pass on those costs to all consumers in distribution rates that are explicitly allowed in a rate case. This results in a subsidy of about 1-2 cents per kWh that suppliers must overcome in order to compete with the default service pricing. In one recent example, various experts estimated Baltimore Gas and Electric’s (BGE) default service incurs costs of about $170 million annually, of which the utility proposed only passing $12.3 million to default service customers. The remaining $158 million was embedded in BGE’s distribution rates, which are paid by all customers. Ensuring a full allocation of retail operating costs on those choosing the default service is the only way to enable retail choice providers to fairly compete.
A second problem with most retail competition rules is low credit-worthiness standards on retail suppliers. If a supplier can sign up retail customers but is financially ill-equipped to procure power to serve them, they are essentially leaning on the wholesale market and creating a shortage of power when the region needs it. As soon as wholesale prices rise, they can go bankrupt, leaving customers without a supplier and the regional electricity grid without sufficient physical power.
In the Mid-Atlantic through Northeast states, the lack of retailers with the incentive and ability to sign long-term contracts has led to a gap in the market that RTOs and ISOs have filled in with their own forms of long term resource procurement: “capacity markets.” For nearly two decades, the development of generation resources in the organized wholesale markets have relied on the capacity markets to support investments in those resources. Now, in light of recent developments at FERC, that support system might be coming to an end, especially with respect to many renewable generation assets. Recent changes to wholesale capacity markets imposed by FERC across PJM, NYISO, and ISO-NE are causing such a consumer and state revolt that at least seven states are discussing pulling out of capacity markets altogether.
To make the retail competition model work, states with retail choice need to review and upgrade certain policies. Two key policy changes, identified in a recent paper we co-authored for the Wind Solar Alliance, could instill the needed incentive and ability of retailers to perform their critical function of securing long term supply arrangements: (1) leveling the playing field between default and competitive electricity service; and (2) ensuring that retail suppliers are sufficiently credit-worthy to enter into the long-term contracts that wind and solar project developers need to finance new power plants. Implemented together, these changes would also help lessen states’ reliance on wholesale capacity markets, which would also benefit all consumers.
Texas is one state where these two features are in place: the playing field is level between competitive and default service, and creditworthiness standards are high. Texas requires either net worth standards or letters of credit to license retail providers, while some other states only require only a surety bond for licensing. The difference between the approaches is stark, with the Texas market more fully incentivizing prudent management practices. This includes appropriate investment in long-term energy hedges. In Texas, the chain is unbroken between the retail customer signing up with a retail supplier and the retail supplier procuring long-term energy in contracts that enable the financing of new generation.
Achieving the high levels of renewable energy growth that many states are demanding will not happen without the long-term power purchase agreements that renewable developers needs to bring their projects to market. States now have an opportunity to evaluate both their retail and wholesale market structures and we believe that these reforms critical first steps towards delivering markets that enable the low-cost clean energy their customers want.