Energy markets excel through bomb cyclone


Another frigid test produced another reliable display from competitive electricity markets. Whether it’s a polar vortex or the latest bombogenesis—unquestionably the coolest word of the new year—markets are at their best when demand is high and supply is tight. In fact, the “bomb cyclone” underscores the robustness of markets without subsidies, despite heavy retirements of legacy power plants.

It’s important to note that no one or two power resources saved the day. Rather, a broad portfolio of resources combined to keep the lights on, as with all severe weather events. These portfolios have had extensive turnover since the 2014 polar vortex, and yet the lights stayed on thanks to voluntary, low-cost investments from the private sector. This makes the case for empowering markets, not subverting them through interventions to prop up politically favored resources.

Nevertheless, the cold has reheated degenerative arguments over fuel types. This is political banter, not legitimate policy conversation. But if the banter infects policy, such as with the U.S. Energy Department’s anti-competitive proposal to subsidize unprofitable coal and nuclear plants, then interventions undermine market signals for grid reliability and increase costs by billions.

The bomb cyclone demonstrated that markets reward any resource that performs well during stressed conditions. Power price escalations, which mirror spikes in natural gas prices, provide large revenue bumps for non-gas resources commensurate to their value during stressed grid conditions. For coal, a common profitability measure is a “dark spread,” which is the difference between its fuel costs and wholesale power prices. Using an average fuel efficiency rate of 10,493 British thermal units/kilowatt-hour, the recent cold spell yielded profits for a typical coal plant in tremendous excess of any other period this past year.

coal plant profit

Source: Derived from data in the Dark Spread Model of S&P Global Market Intelligence

Note: Cost of power based on energy prices in the Western Hub of PJM Interconnection, LLC

Huge, temporary net revenues for power plants are not excessive windfall profits but rather key market signals that reward dependable power plants when they’re needed most. If that’s enough to keep them profitable, then they shouldn’t be retired. But if their revenues remain insufficient, the market has signaled that their value during cold spells isn’t enough to justify retaining them. Instead, lower-cost resources will take their place.

In the mid-Atlantic and Northeast, constrained pipelines caused spot prices for natural gas to escalate rapidly. This caused “price inversions,” where oil and coal generators, which are typically more expensive to operate than efficient gas plants, become temporarily less expensive than gas plants. Markets swiftly accounted for this by dispatching coal and oil plants ahead of more expensive gas plants.

Several media outlets and public officials conflated dispatch with generation availability, which misleads the reliability discussion. Just because coal and oil operate more during cold spells doesn’t imply they are more reliable. It just means it’s more economical to dispatch them ahead of gas plants when gas prices are high. Only if certain types of plants are less available to operate—for example, if there were a large disparity in power-plant outage rates across fuel types—could one begin to make a reliability critique by fuel type. Even then, the conversation should focus on whether markets send the right signals overall, not to intervene to save particular fuel types.

The only way markets undervalue resources during severe weather events is if market prices fail to reflect economic fundamentals or the scarcity value of grid conditions. Such price-formation problems wouldn’t mean certain fuel groups or technologies were specifically undervalued. It would mean any resource producing or reducing power was undervalued.

Market prices generally reflect system conditions quite accurately. Prices provide crucial signals of resource value to private capital during stressed conditions, which drives voluntary investments in a manner that meets reliability needs in innovative, low-cost ways. In contrast, monopolies use central planning to make investments that meet reliability needs at much higher cost. For example, monopolies often overprocure expensive “firm” pipeline service to fuel gas plants, whereas competitive generators procure the least-cost combination of firm pipeline service, oil-fired back-up generation, liquefied natural gas imports and other means to bolster gas supply.

Yet the market advantage diminishes when political interventions—such as subsidizing oil inventories, pipeline expansion or retention of unprofitable coal and nuclear plants—suppress price signals that deter voluntary investment. This raises the costs of meeting reliability needs and, in some cases, perversely affects reliability. In short, markets handle cold shocks just fine, but they struggle with political shocks.

Market rules have improved this decade to rectify price formation deficiencies, but some fuel-neutral reforms could further enhance the economic efficiency and reliability of markets. Ironically, political interventions harm price formation, working at cross-purposes with constructive policy reforms. Continued improvement in market rules, coupled with better political discipline, will ensure the market advantage grows to keep consumers warm, their options open and their pocketbooks full.

Image by Andrew F. Kazmierski



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