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Push for generation subsidies could shift power market costs, panelists say

SNL Image

Steam drifts from the cooling tower of FirstEnergy Corp.'s Davis-Besse Nuclear Power Station in Oak Harbor, Ohio in April 2017. The facility is slated for retirement in 2020, pending government support.
Source: Associated Press

Policies aimed at subsidizing select generating resources in competitive markets run the risk of shifting larger swaths of generation's cost burden to ratepayers instead of private plant owners, market observers say.

Speaking at the S&P Global Platts Northeast Power and Gas Forum in New York on June 1, market analysts, investors and grid operators appeared to agree that the willingness of state and federal policymakers to offer resource-specific revenue support for certain coal-fired and nuclear plants has stimulated a rent-seeking environment in which obtaining subsidies is increasingly a key element of owning and operating the asset.

"The choices [of states] to buy specific technologies with specific legislation … it has a dark underside," Matthew White, chief economist at ISO New England, said May 31. "It is shifting the risk back on to the captive consumers who cannot escape those high costs, instead of shifting it onto private capital who voluntarily chooses and diversifies to take on those risks."

That trend is broadly likely to prompt management teams to be more aware of opportunities to harness political support for aging generating facilities, whether as a resilience and reliability play or for supporting low-carbon goals.

"I would expect to see continued expansion of these state-level subsidy programs," Julien Dumoulin-Smith, head of U.S. power, utilities and alternative energy research at Bank of America Merrill Lynch, said, pointing to the equity market's increasing comfort with "quasi-contracted" nuclear-heavy utilities, such as Exelon Corp. and Public Service Enterprise Group Inc., which have successfully lobbied states for compensation tied to the carbon attributes of aging nuclear facilities. "Who benefits, by how much and who pays, that's the real question."

Dumoulin-Smith flagged Ohio and Illinois as likely venues where state-level policy support could materialize for reliability attributes, given deeper politicization of the issue at the federal level and through 2018 gubernatorial races, and with accelerating retirements of coal-fired and nuclear plants.

"The big point is that everyone, to the extent to which there are opportunities, is trying to get paid a subsidy in the form of a long-term contract that de-risks assets," Dumoulin-Smith added. "Discount rates go down in a meaningful way, and that's very appealing, even for those who used to be committed to markets."

The impact of state policies in competitive markets has called into question who bears the ultimate cost for government contracts over the long term, while driving a wedge between retirement and new-build cycles in key markets like PJM Interconnection, Midcontinent ISO and ISO New England. The result, some say, could place the economic burden of underwriting the fixed-costs for aging units back to ratepayers, rather than plant owners.

The Trump administration has demonstrated its political will to support aging nuclear and coal units in the name of resilience and reliability, most recently through a suite of policy mechanisms contemplated by the Department of Energy. Meanwhile the reaction by states opposed to the president's energy agenda is to focus on policies encouraging renewable growth and decarbonization. As a result, the value of conventional thermal generation on the grid may be further obscured due to excess utility-scale and behind-the-meter renewable resources that could gnaw into the margins of certain gas-fired units further up the curve.

"For every action at the federal level, you are seeing a reaction in the states," Bob Mancini, Carlyle Power Partners co-head and managing director, said, pointing to expanding renewable mandates in California, New York and Massachusetts as key examples.

The convergence of subsidies in competitive markets with the deluge of bilaterally procured renewable capacity has created a market environment that puts what many regard as an outsize share of the value of merchant assets in capacity payments, where available.

"These markets from a regulatory and market design perspective, are largely broken, and that makes it very hard to invest," Mancini added.