Breaking News! California Electricity Prices are High

In case you missed it, a recent investigative piece in the LA Times unearthed the shocking fact that California retail electricity prices are high,  about 50% higher than the national average. The article’s main focus is on the fact that California has a lot more installed nameplate generation capacity then has historically been the norm. There are several causes identified in the piece.  Deregulation of the market in the late 1990’s is pointed to as a culprit. Somewhat inconsistently, the construction of regulated, rate-based plants also takes much of the blame. One factor that was barely mentioned, however,  was California’s renewable electricity policy.

The story of how California’s electric system got to its current state is indeed a long and gory one going back at least to the 1980’s. The system still suffers from some of the after effects of the 2000 era crisis.  The Long Term Procurement Process (LTPP) put in place in the wake of the crisis, and overseen by the CPUC, has been criticized from many sides.

However, since the power crisis of the early 2000’s settled down, the dominant policy driver in the electricity sector has unquestionably been a focus on developing renewable sources of electricity generation. As is well known (outside of the LA Times apparently), California has one of the country’s most aggressive renewable portfolio standards (RPS).  The RPS requires each firm that sells electricity to end-users to procure an increasing fraction (33% by 2020, 50% by 2030) of the energy they sell from renewable sources.

Desert Solar Array

The Times article’s focus on generation capacity does (a bit unwittingly) provide a nice starting point for a discussion about the cost and implications of this renewable energy policy. The policy, while undoubtedly effective at reducing the carbon intensity of the power sector, has also been quite disruptive to the economics of the sector.  It is forcing a rapid (and early) replacement of conventional sources with renewable, but variable, generation sources such as solar and wind. Since 2010, about 80% of new capacity has come from renewable sources and it’s likely that much of that capacity would not have been built if not for the RPS.  (Much of the remaining 20% has been coming online to replace the retired SONGS nuclear plant or capacity slated for retirement due to environmental issues with their water cooling  processes.)

newcap2010

New Capacity in California ISO by fuel type

Proponents of strong renewable standards have pointed to the fact that new contracts for renewable energy carry price tags that are (at worst) only modestly above those for a new conventional natural gas power plant. However comparing the cost of a brand-new solar plant to that of a brand-new gas plant overlooks two important facts.  First, renewable, variable output sources offer very different operational capabilities than conventional sources.  Second, right now we don’t really need new capacity of any kind, and are in fact struggling to find ways to compensate the generators that are already here.

The renewable portfolio standard provides an interesting contrast to the federal mileage standards on vehicles. Both require the replacement of older legacy, high-carbon sources with newer,  lower-carbon ones. However automobile standards work by requiring people to buy more fuel-efficient cars when they decide to buy a new car. Renewable portfolio standards require utilities to buy low-carbon energy by a certain deadline rather than when they are deciding to “trade-in” their old power plants. In California at least, the result has been a much more rapid turnover of legacy sources to the newer, cleaner ones. Another implication, however is the fact that the system now has a large amount of what can appear to be excess capacity. This is because renewable policies are rapidly forcing new “green” capacity into a market that was more or less fully resourced before the mandates really started taking effect.

I don’t mean to imply that the “replace it now” approach is definitively worse.  Research has shown that standards applied only to new purchases can inefficiently extend the lifetimes of older technology, from cars to power plants.  This can significantly dilute the environmental benefits of a technology mandate.  In contrast, instead of extending the lifetimes of old plants, the RPS is in effect forcing the early mothballing of legacy capacity. This improves the environmental impact, but also increases costs, sometimes in subtle ways. The effect grows larger with stricter mandates. At higher percentages, the RPS starts to displace increasingly newer (and cleaner) sources of generation.  The economic effects can be mitigated by allowing for renewable energy generated elsewhere in the country to count toward RPS compliance, but California has largely rejected such policies.

Largely due to the RPS, we have a surge of new, low marginal cost energy, flooding into a wholesale market that already had enough generic energy, thereby driving down wholesale prices. Since wholesale prices cannot support the cost of this much generation (new and old), increasingly the gap must be  made up through rising margins between wholesale and retail prices.  Utilities and other retailers have to pay  high market prices for new renewables instead of being able to “buy low” on the wholesale market.  Because all retailers face the same regulation, they pass these costs on to end users. And this doesn’t even consider the costs of new transmission, most of which is being added to boost the power system’s ability to access and absorb large amounts of renewable energy. Transmission costs, which are also charged through to electricity end users as part of the retail prices cited in the Times article, will continue to grow in coming years. The Tehachapi transmission project alone is projected to cost over $2 Billion.

The result is the seemingly perverse situation where customer rates are rising while (conventional) generation sources are simultaneously struggling for revenue and threatening to retire. Such conditions are a recurring theme on this blog and are often drivers of significant change. Unfortunately, despite the glut of electrical energy, we will likely still need the conventional capacity to handle the ramping and back-up needs created by the increased reliance on variable sources (wind and solar).

One of the debates lurking in the background is who should be responsible for the cost of these disruptions. Richard Schmalensee has observed that deregulation may make it easier for State policy makers and regulators to ignore wholesale market effects. This is because the assets being stranded today are largely owned by non-utility generation companies in contrast to the late 1990’s when the stranded assets were a joint problem of regulated utilities and their rate payers.

California led the way with developing renewable energy in the 1980’s,  with the deregulation of the power sector in the 1990’s and 2000’s, and now with high-volume renewable mandates since 2010. We are learning a lot about how to physically manage and finance a cleaner energy system. We also need be realistic about the costs of such policies.  When you combine the cost of policies of the past with the aggressive goals for the future, you get retail electricity prices that, yes, continue to be pretty darn high.

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