A simple regulatory fix to the coming power crisis

Our electric regulatory model is broken. It preferentially deploys expensive power sources before cheap ones. It compares the variable costs of dirty fuels to the all-in costs of clean fuels and deludes itself into thinking that the dirty, expensive power is economically advantaged. It places the interests of utility shareholders above the interests of other potential investors in our power grid, massively skewing capital allocation, even while it insulates utility investors from the disciplines imposed by a competitive market.

These problems arise fundamentally from the over-regulation of our electric sector, which has created stable utilities, but virtually no opportunities for the kind of economic “upside” necessary to attract entrepreneurs into the sector. This ought to be good news; after all, we Americans are really good at taking risks, deploying our prodigious entrepreneurial talents and making big financial bets. The problems we face all play to our strengths. Unfortunately, any positive change to our system is by definition deregulatory — a word that has been politically poisoned by the botched restructuring (don’t call it dereg!) in California and Enron’s machinations. As factually irrelevant as those bogeymen may be to any discussion of deregulation, they present formidable political obstacles to reform — and only the most quixotic windmill-tilter chases reforms that are politically untenable to both sides of the aisle.

Houston, we have a solution.

The outline below describes a regulatory structure that we have been developing, built upon existing “standard offer” programs in California and Ontario, and extending based on recent and on-going conversations with a broad swathe of utility executives and regulators. We expect to shortly announce the roll-out of this plan with a major U.S. utility, and continue to refine and enhance for maximum viability. We’d also like to hear from you. Tell us what flaws you see in this, but more importantly, suggest tweaks to improve, subject to a few ground rules:

1. Greenhouse gas reduction is critical to the long-term health of the planet, or at least our species’ inhabitation thereof. Suggestions that this tenet might be up for debate are not welcome.
2. Societies’ interests are best served by profitably reducing GHG emissions to the extent we can. Policies that start from a debate over who must lose are non-starters.
3. Goals trump paths. We’re not interested in cherry picking technologies — even those that we happen to have a vested interest in. We are interested in policies that define success and then leave the market to figure out which route to take.
4. Competitive markets are more important than the long-term health of any specific business, and provide quicker, cheaper solutions than any top-down regulatory approach.

If you disagree with those points, you won’t find us very receptive. But within those points, we welcome your thoughts on how to strengthen the policy proposal outlined below.

We hold these truths …

Harry Truman said famously that you can get a lot done if you don’t care who gets the credit. Getting to this point first means setting up a goal in which lots of folks can claim victory (and therefore have an incentive to take credit). When it comes to electric system reform, this means that politically-viable reforms need not only to create economic and environmental value to society, but also need to recognize the economic interests of regulated utilities and the political interests of regulators.

Clearly, our existing regulatory model has failed to deploy the cheapest or cleanest generation sources. But just because that’s true doesn’t mean there’s much to be gained by rubbing the noses of the regulated or the regulator in that fact. However, if we don’t reform, we are going to deploy technologies that will massively increase both electricity costs and associated CO2 emissions.

As such, I’d suggest the following framework foes any near-term regulatory reform of the electric sector:

1. Keep the regulator involved. Our nation’s electric regulators pride themselves — not entirely without justification — in their knowledge of the complexities of our electric system, capital costs of competing technologies, and capital needs of the industry. Let’s use that knowledge to our advantage, rather than "de-Baathify" the system.
2. Keep the utility whole. The biggest opposition to electric sector reform has historically come from the electric industry, out of a fear that they will lose customers in a competitive market. While it is tempting to brush this off with a “welcome to my world, bub!” Hallmark card, one still must admit that the massive capital invested in our electric system — however flawed it may be — is at risk if customers run to other suppliers. Utility opposition can be substantially reduced if we craft regulations that avoid this financial pressure.
3. Level the playing field. A big part of the reason that we build economically foolish generation is because of the equity guarantees given to regulated utilities, which make foolish technologies appear comparatively sane due to differential capital costs. (In other words, if your bank likes you more than mine likes me, you might find it easier to build a power plant than I, even though I am clearly smarter than you when it comes to power plant technology selection and construction.) It’s politically hard to take that away, but one can structure contracts with non-utility players to make them comparably attractive to the lending community.

The Clean Energy Standard Offer Program

With that in mind, we have developed the Clean Energy Standard Offer Program. Its basic principles are as follows:

1. Each year, the regulatory agency (this could be FERC, the state utility commission, or some other entity as appropriate) calculates the delivered, all-in price per MWh of the best generation options they either considered or approved in the prior year. Delivered, in the sense that it must include the cost of the wires to get the generation from the plant to the load. All-in inclusive of capital recovery, profit, pollution control — this should represent the costs that electric customers will have to pay on the margin for that generator. Note that in current markets, this price is substantially higher than the average retail rate, since the latter includes lots of existing generation that is already fully or partially amortized. But since this is the competing cost of new generation, it sets a “price-to-beat” for any non-utility offer.
2. The state then provides long-term (15 year +) contracts to any eligible power plant at 80 percent of the price per MWh calculated above. These contracts may be entered into by the local government or the local utility as appropriate. Note though that in all cases, any power sold on these contracts is implicitly at a 20 percent discount relative to the best power plant that would have been built in our existing regulatory model — thus guaranteeing that society benefits from any power plant built under this program.
3. Eligibility is limited only to power plants that consume one-half or less of the fossil fuel per MWh as the U.S. grid average. This ensures that any eligible plant is dramatically lowering the fossil-intensivity (and hence CO2 emissions ) of the U.S. power grid, while driving down the cost of electricity.
4. Any utility customer who installs (or engages a third-party to install) an eligible generator on their premises must continue to buy 100 percent of their power from the utility. This is designed to separate the societal benefit of clean power from the financial solvency of the local utility. It’s a neat trick that recognizes that the financial settlement of a power contract does not have to have any direct relationship on where current from the generator flows.
5. As a condition of eligibility, a qualifying generator must decline any other state or federal incentives. This ensures that the net societal cost of the plant is always less than the alternative supply.
6. Any eligible facility must be interconnected by the utility to the grid at the utility’s expense, provided that the utility may recover those costs through their rate base. In all current interconnection standards, utilities are allowed discretion to protect their asset (the grid), but the interconnecting customer must pay the costs. This creates a misalignment of incentives, no different than if you were allowed to tell your neighbor what plants they ought to buy to beautify the border between your lawns. This provision not only removes the misalignment, but also ensures that interconnection for all generation is treated the same way, regardless of ownership.

Impacts

Note what the CESOP does. All traditional renewables are eligible, as are thermally-matched CHP, waste heat recovery, and any other technology we haven’t yet thought of. The goal of lower fossil-intensivity is rewarded without getting caught up in a specific path. Further, it subverts the argument that non-utility power sources aren’t economically viable, since any participating power plant is, by definition, at least 20 percent cheaper on a delivered basis than the central alternative.

But it still retains a role for the regulator, who is still obliged to use their efforts to deploy the cheapest possible technology they can identify within their regulatory paradigm. The better they do at their job, the better off society is as we deploy ever-cheaper power. And it still retains a role for the utility to manage and operate the grid, with sufficient compensation for their efforts.

Perhaps most importantly though, it dramatically levels the playing field for the local power plant. A big, expensive, central coal plant has the perverse luxury of very cheap money, granted at the moment the utility regulator says “yup, you can build that”, since it then gets guaranteed rates set by the government. By contrast, a cost-effective local power plant selling power to a local industrial or residential user must pay very high borrowing costs due to the comparatively higher credit risk of their host. (Joe’s Paper Company being much more likely to miss a couple payments than New York State.) By granting clean energy plants with the same underlying credit risk as the utility — but still holding them accountable for performance, since they won’t get paid unless they produce those MWh — the CESOP makes it dramatically easier to finance clean power while still keeping competitive pressure upon the industry.

So now it’s your turn. Where do you see holes? Where can we improve? (And if you have no criticisms, use the space below for hagiography as necessary.)