The Federal Energy Regulatory Commission (FERC) held a high-stakes conference May 1 and 2 to address the contentious interplay of state policies and interstate wholesale-electricity markets. The week prior, Energy Secretary Rick Perry announced his department might intervene in state energy planning to protect baseload coal and nuclear generation.

Ironically, market experts speaking before FERC identified state interventions to bail out coal and nuclear as the most damaging form of intervention. Market experts noted that state subsidies and mandates for renewables also continue to stress market performance, but do not displace system “capacity” needs the same way that baseload subsidies do.

This marks a fundamental debate over the role of government in competitive electricity marks, which happens to intersect with federalist themes in various ways. In the case of the Northeast and some Mid-Atlantic states, FERC seeks to uphold the competitive functionality of electricity markets, while some states have undertaken anti-competitive interventions to dictate outcomes that are better determined by markets. On the flip side, the prospect of federal intervention in state energy planning runs completely counter to conservative arguments against the Clean Power Plan, even if they are (incorrectly) made in the name of national security.

This paints a convoluted picture for federalists, but the pro-market case is clear – interventions at both the state and federal level are unwarranted and destroy wealth.

At the FERC conference, state representatives reiterated their support for relying on markets because of the clear economic benefits (i.e., little to no sign of “re-regulation” interest). Yet they also wanted to preserve the option to pick government-preferred investments, which runs counter to the very premise of liberalized electricity markets. Constructively, states expressed a willingness to engage in dialogue, which was marked by identifying policy principles, but they struggled to articulate what those objectives were.

Much of the challenge that state representatives—often, commissioners of public utility commissions—had in articulating an energy vision consistent with market principles is that politicians back in their states often support industrial policy (i.e., government explicitly picking winners), creating a difficult agenda to reconcile with FERC’s obligation to uphold competition. The most common policy theme was to reduce emissions, yet the states largely rebuffed market-compatible approaches to reducing emissions – namely, emissions pricing. A couple states brought up the need for state actions to improve reliability, claiming (contrary to the evidence) that markets aren’t able to provide reliable service. They rehashed generic slogans, like the need for fuel diversity, which has no direct bearing on whether an electricity system is reliable.

Competitive electricity markets are complex and poorly understood by state and federal policymakers. Given the rapid transition of electricity technologies and fuels, coupled with the persistent political obsession to dictate what this mix “ought” to be, the scene is set for half-truths and false narratives to prevail. Whether it’s progressives pushing for more renewables, confused conservatives supporting interventions to preserve baseload or any other such combination, all these narratives fundamentally miss the point that the goal of smart policy is to encourage well-functioning markets.

Fortunately, the narrative that we should level the playing field and let technologies compete on their merits still holds some political weight. Some FERC reforms could move in that direction, such as enabling participation of energy storage and pricing of fast-start resources. However, FERC reforms to appease the industrial-policy ambitions of some states (or the U.S. Department of Energy) would fundamentally deviate from the core objectives of competitive electricity markets. This could easily result in extensive unintended consequences. It’s not FERC’s job to validate state policy, but it must pass judgement on anti-competitive conduct. Conference participants offered ideas on this definition, and FERC would be wise to continue that dialogue.

There continues to be an immense need to educate state and federal policymakers on how electricity markets function and of the consequences of industrial policy, especially ad hoc subsidies. While the uptick in state interventions stirred controversy, it has also spurred productive dialogue in the Northeast and between the states and FERC. The conference demonstrated a clear need and willingness among states, stakeholders and current FERC commissioners to continue and deepen such a dialogue.

The concern of the Northeastern and some Mid-Atlantic states to reduce emissions is laudable. Pollution is a valid market failure that can be corrected, efficiently, by market-based policies. Such policies have excelled in competitive markets, where strong cost-reduction incentives have driven emissions reductions and innovations that lower the cost of emissions abatement. That’s an example of where state and federal interests align, as well-functioning markets that internalize all costs create the most benefit for society. But many policymakers do not understand these benefits clearly, and FERC and states should engage market experts in forums that help foster and disseminate this research. One example to highlight is Texas, which has seen reductions in costs and emissions without the controversy and distortions of industrial policy.

Encouragingly, Perry noted that the president asked him to reshape U.S. energy policy in the mold of Texas, where he spent 14 years as governor. Texas relies on competitive markets to signal power-plant investments and price-responsive demand. These markets do not explicitly value baseload, nor should they. Rather, they value reliable operations by providing revenues to resources that perform, especially when supply scarcity drives price spikes.

The Texas markets handsomely rewarded baseload coal and nuclear in the past, when they were highly competitive during periods of higher-priced natural gas. Now, inexpensive gas and cost declines for gas generation and renewables (the latter partially resulting from subsidies) have heavily cut into baseload margins, even driving some into retirement. Yet, according to the independent monitor of the Texas market, the reliability outlook remains strong, as more gas and wind-generation come online (and, in the long term, solar). Meanwhile, consumer costs have tanked. The monitor emphasizes that the new resource mix underscores the need for efficient price formation. This is the product of quality market design (e.g., “scarcity pricing” to account for the market failure of having adequate resources) and market discipline, as interventions can dramatically distort investment decisions and freeze capital markets.

Perry would serve America well by encouraging the Texas model. Over the past few years, Texas has bolstered its scarcity pricing, while Texas legislators and regulators have let the market work. The Northeast and Mid-Atlantic have not done so, causing the need for FERC’s conference to address the uptick in disruptive state interventions. Once FERC re-establishes a quorum, it will face the tasks of improving price formation and moderating the effects of state interventions. Competitive markets will drive costs reductions, innovation and emissions reductions, but only if state and federal policymakers keep interventions at bay. As Marlo Lewis Jr. of the Competitive Enterprise Institute recently remarked, “subsidizing uneconomic energy to the detriment of consumers and taxpayers is no way to drain the swamp.”

Image by Crush Rush

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