The Real Problem with the Harrison Coal Dump – It’s All About Risk

FirstEnergy went through the charade of filing what it called a “resource plan” with the WV PSC to justify the Harrison Power Station deal.  Back in September, I examined the fake plan.  As I clearly demonstrated in that post, FirstEnergy cooked up their phony plan to do one thing – make sure that the Harrison plant deal came out ahead of all the other alternatives.

The biggest problem with FirstEnergy’s scheme is that it locks WV rate payers into one source for the needed 900 megawatts of power for at least the next 26 years, maybe longer.  Considering the wide range of flexible and cheaper alternatives available, making that kind of long term investment in any single resource, let alone expensive coal-fired power, is a very risky proposition.

The other big problem with buying 80% of a coal plant is that you are stuck with that capacity.  You can run it less of the time, but you still have to pay for all that idle capacity, whether it is running or not.  The Harrison deal will create exactly that problem.  Although Mon Power only needs a little over 900 megawatts of capacity, but FirstEnergy wants to transfer a total of about 1200 megawatts of capacity to WV rate payers.  So the obvious question to ask is why do they want to dump 80% on us when they only need 60%.  Here is the answer to that question.

As with Century, the FirstEnergy Harrison case is all about risk.  Here is what Consumer Advocate Byron Harris told Charleston Gazette reporter Megan Workman back in October, referring to Century’s plans to shift their electric bill onto APCo’s rate payers:

“They’ve proposed what they call two different alternatives but, in reality, they’re after what they’ve been after all along, which is to ship all of their business risks onto the customers of Appalachia[n] Power,” said Byron Harris, executive director of the PSC’s Consumer Advocate Division.

So how can the WV PSC reduce the risk to rate payers in the FirstEnergy Harrison coal dump?  By ordering a plan that maximizes flexibility of resources and focuses on lost cost and least risk alternatives.  Former WV Consumer Advocate Billy Jack Gregg has already pointed to this solution in testimony he presented in a related case.

The CAD filed comments on the Company’s proposed asset swap on October 31, 2012, in WV PSC Case No. 11-1274-E-P. In those comments the CAD stated that while the Company’s plan provides a useful starting point for discussions about future capacity alternatives, the proposed asset swap had numerous flaws. The CAD comments listed the following concerns:
1. The Company doesn’t need additional capacity resources until at least mid-2014;
2. The Company failed to seek out demand and supply-side resources through a market process;
3. The net book value of the Harrison plant was grossly inflated; and
4. The Company used unrealistic assumptions in evaluating the economics of future combined-cycle natural gas generation.

I agree with all of these concerns. It is particularly outrageous that First Energy would attempt to sell back to ratepayers in West Virginia the deregulated portion of the Harrison plant at prices that are roughly double the regulated net book value of the exact same plant. It is also puzzling that the Company would not take this opportunity to add natural gas fueled generation to its capacity portfolio. Natural gas futures prices remain at a low level and the Marcellus shale natural gas field covers a large portion of FE’s West Virginia service territory.

Mr. Gregg points directly to diversity and flexibility of capacity resources as the real solution to FirstEnergy’s capacity needs.  He says that current electricity prices and capacity prices on PJM’s markets are so low that they are currently the cheapest source of capacity.  In item 4, he politely states that FirstEnergy rigged its fake plan to disqualify new gas generation from consideration.

So there is an opportunity to use diversity as a real asset here.  The cheapest solution for FirstEnergy in the short run is to just buy power and capacity on the wholesale market.  Prices may rise in a few years, but purchasing power for the next three years would give FirstEnergy exactly the time they need to build a new combined cycle natural gas plant.  Two 450 megawatt units would provide them with all the power capacity they need.

Or, better yet, the WV PSC could require FirstEnergy to institute aggressive efficiency, demand response and combined heat and power programs to reduce needed capacity by, say, 100 megawatts.  This capacity reduction could also be boosted if the PSC instituted feed-in tariffs to encourage homeowners and businesses to install solar capacity over the next 20 years, which could account for another, say 20 megawatts.

If there were still capacity shortfalls, the PSC could consider transfer of a much smaller share of the Harrison plant to Mon Power, but, as Mr. Gregg points out, at the actual book value of the plant, not the ridiculously inflated price that FirstEnergy wants.

This hybrid resource plan minimizes cost, maximizes flexibility and minimizes risk.

If you want to see a good discussion of how important managing risk is to power company regulation, take a look at this report by the former Chairman of the Colorado PSC, Practicing Risk-Aware Electricity Regulation: What Every State Regulator Needs to Know.  You will have to register to get the free download of the report, but it is well worth the trouble.

Here are some suggestions for regulators from the report.

PRACTICING RISK-AWARE REGULATION:
SEVEN ESSENTIAL STRATEGIES FOR STATE REGULATORS MANAGING RISK INTELLIGENTLY IS ARGUABLY THE MAIN DUTY OF REGULATORS WHO OVERSEE UTILITY INVESTMENT. EFFECTIVELY MANAGING RISK IS NOT SIMPLY ACHIEVING THE LEAST COST TODAY, BUT RATHER IS PART OF A STRATEGY TO MINIMIZE OVERALL COSTS OVER THE LONG TERM. WE IDENTIFY SEVEN ESSENTIAL STRATEGIES THAT REGULATORS SHOULD EMPLOY TO MANAGE AND MINIMIZE RISK:

DIVERSIFYING UTILITY SUPPLY PORTFOLIOS with an emphasis on low-carbon resources and energy efficiency. Diversification—investing in different asset classes with different risk profiles— is what allows investors to reduce risk (or “volatility”) in their investment portfolios. Similarly, diversifying a utility portfolio by including various supply and demand-side resources that behave
independently from each other in different future scenarios reduces the portfolio’s overall risk.

UTILIZING ROBUST PLANNING PROCESSES for all utility investment. In many vertically integrated markets and in some organized markets, regulators use “integrated resource planning” (IRP) to oversee utilities’ capital investments. IRP is an important tool to ensure that the utilities, regulators and other stakeholders have a common understanding of a full spectrum of utility resource options; that the options are examined in a structured, disciplined way; that demand-side resources get equal consideration alongside supply-side resources; and that the “nal resource plan is understood by all.

EMPLOYING TRANSPARENT RATEMAKING PRACTICES that reveal risk. For example, allowing a current return on construction work in progress (CWIP) to enable utilities to enhance large projects doesn’t actually reduce risk but rather transfers it from the utility to consumers.13 While analysts and some regulators favor this approach, its use can obscure a project’s risk and create a “moral hazard” for utilities to undertake more risky investments. Utility investment in the lowest cost and lowest-risk resource, energy efficiency, requires regulatory adjustments that may include decoupling utility revenues from sales and performance-based financial incentives.

USING FINANCIAL AND PHYSICAL HEDGES, including long-term contracts. These allow utilities to lock in a price (e.g., for fuel), thereby avoiding the risk of higher market prices later. But these options must be used carefully since using them can foreclose an opportunity to enjoy lower market prices.

HOLDING UTILITIES ACCOUNTABLE for their obligations and commitments. This helps to create a consistent, stable regulatory environment, which is highly valued in the marketplace and ensures that agreed-upon resource plans become reality.

OPERATING IN ACTIVE, “LEGISLATIVE” MODE, continually seeking out and addressing risk. In “judicial mode,” a regulator takes in evidence in formal settings and resolves disputes; in contrast, a regulator operating in “legislative mode” proactively seeks to gather all relevant information and to “nd solutions to future challenges.

REFORMING AND RE-INVENTING RATEMAKING POLICIES as appropriate. Today’s energy industry faces disruptions similar to those experienced by the telecommunications industry over the past two decades, which led regulators to modernize their tools and experiment with various types of incentive regulation. One area where electricity regulators might pro”tably question existing practices is rate design; existing pricing structures should be reviewed for the incentives they provide for customers and the outcomes they create for utilities.

The WV PSC would do well to follow them in all cases, but particularly in the Harrison plant case.

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