DOE: Price Caps May Do More Harm Than Good in CA

The implementation of price-cap proposals intended to aid California's beleaguered wholesale electricity markets could lead to a significant rise in the number of power outages in the state this summer by reducing available generating supplies, according to a new report issued by the Department of Energy's (DOE) Office of Policy. It warned that a $150/MWh "hard cap," which some Capitol Hill lawmakers had endorsed, could idle as much as 3,600 MW of natural gas-fired capacity in California, depending on the price of natural gas this summer.

The report, "The Impact of Wholesale Electricity Price Controls on California Summer Reliability," was prepared by the DOE at the request of Sen. Frank Murkowski (R-AK) and follows on the heels of an order issued by FERC last week that extends its power market mitigation program across the western states 24 hours a day, seven days a week through September 2002. The DOE study utilized a method that takes into account variable weather patterns, historical data on planned outages and industry standard probabilistic reliability tools. The report's reference case scenario estimates that California residents are likely to experience 113 hours of rolling outages this summer, with an average size of approximately 1,900 MW.

The DOE's analysis looks at two specific price cap proposals that have been publicly floated as ways in which to tackle the West's ongoing energy crisis. One widely discussed proposal would put in place a $150/MWh hard price cap, while a second plan would implement a cost-plus-$25 price cap. Under the latter scenario, each generator would be paid its variable costs plus $25/MWh.

The DOE report concludes that under the $150/MWh hard cap proposal, many natural gas-fired units would not be able to recover all their operating costs because of high natural gas prices in California. Companies that operate these units would choose to shut the units down rather than lose money for each kilowatt hour sold, the report adds. Roughly 1,300 MW to 3,600 MW of existing generating capacity in California would immediately stop operating under a $150/MWh price cap if natural gas prices were between $8 and $11/MMBtu. In general, the affected plants would be peaking units -- combustion turbines or oil/gas steam units that have high operating costs. A price cap at this level would more than double the expected hours of electricity outages, from a total of 113 hours to 235 hours from June through September after accounting for demand response programs. In addition, the report concludes that the average size of the outage would increase by roughly 230 MW, equivalent to about 175,000 additional households.

The DOE analysis is equally pessimistic about the potential impact of a cost-plus-$25 price cap. The report asserts such a cap would have significant effects on new investments, could disrupt the operation of existing units unable to maintain the strictures of their bond covenants and could force the abandonment of existing units whose going forward costs exceed the $25/MW payment. Although existing units would continue to operate because they would be able to recover their variable operating costs -- and because the DOE assumes that the $25/MWh payment exceeds going forward costs -- the report concludes that a firm would not build a new power plant unless it expected to recover both its variable and fixed costs.

While the forecast under the cost-plus-$25 scenario is not as dramatic as the one under the $150/MWh hard cap scenario, the expected impacts are considerable, the study said. Specifically, the report said that if none of the peaking plants proposed under an emergency power plant siting program is licensed, electricity outages are likely to be 25% higher than if all the proposed peaking units are built. The average size of the outages expected rises from 1,979 MW to 2,094 MW, equivalent to around 85,000 additional households affected.

DOE staff noted that because there is significant uncertainty surrounding the study's estimates, the report also includes an optimistic scenario and a pessimistic scenario. Under the DOE's optimistic scenario, the expected number of outages falls significantly to 14 hours for the entire summer and the average size of each outage falls to 1,700 MW affecting 1.14 million households, a decrease of 165,000 from the reference scenario. The optimistic scenario assumes a number of positive trends, including additional new generation capacity and more hydropower availability. In contrast, under the pessimistic scenario, the expected number of outages could increase from 113 hours in the reference scenario to 479 hours, while the average size of each outage could rise from about 1,900 to 2,600 MW. That increase would affect 1.95 million households, 550,000 more than the reference scenario. The pessimistic scenario assumes several variables, including more qualified facilities shut down for financial reasons and fewer net imports.

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