May 16, 2011 | last updated June 1, 2012 10:09 am

CT officials call for electricity pricing reform

ISO New England monitors real-time power demand from its control room in Holyoke, Mass.
State Sen. John Fonfara, D-Hartford, co-chair of the legislature's Energy & Technology Committee

Nearly half of Connecticut's electricity comes from inexpensive nuclear power, yet businesses and residents here pay the second highest electricity prices in the nation.

Something is wrong with this picture and state energy officials out to cut rates are focusing on the pricing model used by the regional electric system.

System administrator ISO New England argues its pricing model — which pays for every megawatt hour at the price of the most expensive megawatt purchased — is designed to reward the most efficient power generators and encourage investment in the competitive electricity market.

Connecticut officials, however, say the model fails because nobody is building new power plants in New England, a notoriously difficult undertaking.

Although Connecticut's arguments have fallen on deaf ears for years, the state's prospects of achieving electricity pricing reform improved when Dan Esty was appointed the commissioner of the proposed Department of Energy & Environmental Protection. Esty, a former energy policy advisor to President Barack Obama, opposes the way ISO New England prices electricity.

ISO New England's model — called uniform clearing price — pays the same price to all power generators feeding electricity onto the grid at any given moment. That price is set by the highest cost power plant.

Under ISO's system, if one generator bids to sell its electricity at $20 per megawatt hour and ISO contracted with all power generators whose bids were $60 per megawatt hour or less, then everyone gets paid the $60 per megawatt hour — including the generator who bid $20.

New England doesn't have enough low-cost base load power plants to meet its real-time demand, so the prices are, in effect, set by the higher cost natural gas plants. In times of peak demand such as summer, the system relies on peaker plants — inefficient, expensive generators that only operate when demand and prices are high.

"One of the big reasons why our prices here in Connecticut are as high as they are is because there is a huge difference in the costs of operating a nuclear plant vs. the costs of operating a peaker plant," said State Sen. John Fonfara, D-Hartford, co-chair of the legislature's Energy & Technology Committee.

For owners of power generated by low-cost base load plants — such as the nuclear Millstone Power Station in Waterford — the uniform clearing price model results in huge gains over the operating costs. In ISO New England auctions, many owners of base load power will bid $0 to ensure they are paid the eventual clearing price.

Connecticut's wholesale electricity prices are in line with the rest of New England, said Marcia Blomberg, spokeswoman for ISO New England. The 5.1 cents per kilowatt hour in Connecticut is 2 percent above the average wholesale price for the region.

Connecticut's high retail electricity costs — the second highest in the nation behind Hawaii — are more the result of congestion and line losses than wholesale prices, Blomberg said.

Each state also has individual taxes, fees and requirements on electricity, which increases the retail cost.

Economists widely consider uniform clearing price to be the best model in a competitive market, not just for electricity but for all commodities, said Steven Stoft, a California-based economists specializing in energy. It rewards low-cost production.

"That is just how a normal market works," Stoft said. "Everyone sells at the same price, and everyone buys at the same price."

In order to maximize their profit under uniform clearing price, a manufacturer of a product will seek to produce that commodity as cheaply as possible. As new manufacturers enter the market, they will adopt best practices to keep their costs low.

The other alternative to uniform clearing price in the competitive electricity market is pay-as-bid. Under this system, a power generator bidding $20 per megawatt hour gets paid $20 per megawatt hour. Another generator bidding $60 per megawatts receives $60 per megawatt hour.

The problem with pay-as-bid is electricity generators won't be content with covering their costs; they will want to maximize their profits, Stoft said. If even their costs are $20 per megawatt hour, generators will bid as high a price they believe will be accepted.

The model then devolves into a "Guess the clearing price model," Stoft said. At that point, the results are nearly the same as the uniform clearing price model with less transparency and more mistake-prone. A low-cost generator bidding wrong can be left out of the system while a high-cost generator bidding low can't cover operating costs.

Fonfara said he would rather take his chances on pay-as-bid rather than on a model where Connecticut is guaranteed to pay high prices.

The Federal Energy Regulatory Commission has approved the uniform clearing price model for ISO New England, and it is widely used by other ISOs throughout the country, said Craig Cano, FERC spokesman.

The ISO system in New York — the system Connecticut officials have talked about opting into if the state leaves ISO New England — also uses Uniform Clearing Price when buying electricity. NYISO occasionally considers other models, but officials there believe clearing price is best for consumers.

"The uniform clearing price auction drives generators to reduce their operating costs and maximize their efficiency so they can compete successfully," said David Flanagan, NYISO spokesman. "Generators whose bids don't get selected receive no compensation in the energy market."

The difference between New York and New England is New York has enough low-cost base load power to keep electricity prices reasonable except for times of extreme demand, Fonfara said. New England doesn't have that luxury, as natural gas plants set the clearing price 90 percent of the time.

This is where a key provision of uniform clearing price fails, Fonfara said.

By rewarding the lowest cost generators, the model is designed to encourage further development in those types of generation. As more low-cost base load power plants — nuclear, hydroelectric, coal — come online, that will drive down the clearing price.

But new power plants rarely come online in New England, Fonfara said, even the more expensive natural gas plants. In this region's political climate, using low-cost resources such as nuclear or coal for a new power plant is virtually impossible.

With no low-cost plants coming online, Connecticut will continue to receive 45 percent of its power from nuclear while paying high natural gas prices.

Fonfara's solution to the uniform clearing price problems is a modification of the model. Instead of having one auction for all generators, he proposes two separate auctions: one for base load and intermediate plants and another for peaker plants.

Under that separate bid auction, the low-cost base load generators still can recover their high capital costs — Dominion paid $1.3 billion for the Millstone Power Station — and Connecticut ratepayers aren't chained to the prices set by higher cost plants, Fonfara said.

The economic problem with Fonfara's solution, Stoft said, is the low-cost generators lose their reward, and the market loses its incentive to invest in best practices.

"If you are always taking money away from the winners, then you only have losers and non-losers," Stoft said.

Instead of discriminating against types of generation, Stoft suggests using long-term, forward contracts to keep costs from fluctuating. Low-cost generators are still rewarded with the high-level prices in these forward capacity auctions, but the ratepayers are spared from the price spikes when real-time demand peaks.

ISO New England started its forward capacity auctions in 2008, signing existing and future power generators to secure the power supply three years in advance. These measures are expected to keep prices in check, although the full impact isn't anticipated for a number of years.

Despite these efforts, Fonfara said Connecticut should study the impact ISO policies have on the state and bring the results to FERC and the U.S. Congress, Fonfara said.

With Esty wanting to study ISO New England's role in Connecticut electricity prices, Fonfara is encouraged his three-year battle against the system will final tip in the state's favor.

"Esty has a good relationship in Washington and on the FERC, and I look forward to his intervention there," Fonfara said. "The fact that he wants to put some time into this is very, very encouraging."


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