The proposal would provide extra revenues for some generators, but potentially increase consumer costs.
Last year two Houston electric companies, NRG and Calpine, rolled out a report that proposed dramatic changes to the state’s wholesale power market. We’ve discussed some of their proposals previously — see, for instance, our article on the “Operating Reserve Demand Curve” — but haven’t yet dug into one relating to something called “marginal line losses.”
Why should you care about this? In a word: money. We’ll get to the details in just a moment, but first understand that NRG, Calpine and certain others for a long time have advocated for changes to the state’s power market that will increase revenues for generation companies. This is important, they argue, because it will give these companies more of an incentive to build additional power plants to keep up with demand.
Generators frame their proposed market changes as answers to what’s known as the “missing money” problem — that is, the theoretical notion that as currently configured, the state’s wholesale power system does not create enough money (in the form of generator profits) to ensure the system’s own long-term reliability. Thus, the issue is one of economics, of money, and many of the related questions — for instance, what value should society place on electric reliability? — are economic ones.
MARGINAL LINE LOSSES
Now to understand the NRG and Calpine line-loss proposal, first keep in mind this central fact about electricity grids: a certain amount of power is always lost during transmission. Also, keep in mind this related rule of thumb: the amount of lost energy typically stands in direct proportion to the length of the transmission line that carries it. That is, the longer the line, the more power that evaporates along the way. This power loss is due to line resistance, ambient temperature and other factors.
Under current rules, ERCOT (that is, the organization that oversees the state’s primary power grid) determines the cost for these line losses and then spreads that cost in an equitable fashion across its system — no matter the distance between electric generator and electric user. This arrangement is akin to our system for sending mail: whether your letter is going across the state or across the country, the cost of sending it remains the same. This method of accounting for transmission losses encourages ERCOT-wide competition among generators, competition that neither favors nor disadvantages generators based on their geographical location.
But under the proposal floated in the NRG and Calpine report, this method would change. Instead of spreading out line losses equitably across the system, the Houston companies’ proposal would take into account distances between electricity consumers and generators when divvying up costs. NRG and Calpine argue that this would be more economically efficient. But all else held equal, this also would disadvantage wind generators and others in the Panhandle and far West Texas, while benefiting NRG’s and Calpine’s plants closer to Houston. For this reason, some critics have called their plan self-serving.
But critics have voiced other concerns as well.
- The proposal would give a financial edge to generators already operating in and around Houston, but do little to encourage more construction there. That’s because the proposal in no way changes existing geographical and regulatory barriers to building plants in the state’s most populous areas — barriers that make new plant construction in those regions very difficult. That is, the plan would provide incentives for new plant construction in those areas of the state where plant construction is least feasible.
- Conversely, the plan would dampen plant investment signals in areas where new construction is more feasible. Generation companies for years have chosen to invest in certain areas of the state based, in part, on ERCOT’s rules for marginal line losses. Changing those rules in such a major way would undermine those investment decisions and discourage future investment in those regions.
- ERCOT traditionally has accounted for lost electricity using averages of electricity actually lost during transmission and distribution. Using those averages, ERCOT then charged electricity providers — like retailers and public-owned utilities — for a percent of the total power lost in proportion to the amount of the grid’s electricity that the provider sells to its customers. By contrast, marginal loss accounting employs calculated losses, and under such a system ERCOT conceivably would collect twice the amount of money it currently collects to cover transmission losses, according to estimates. In this way it creates winners and losers based on considerations that in some ways are arbitrary.
- The Environmental Defense Fund points to a study stating the proposal could potentially cause the state to forego nearly $5 billion in energy cost savings over the next 20 years. “There no need to dramatically change the market to benefit the two companies sponsoring the marginal-losses proposal,” the organization states on its website.
- Some observers note that the ERCOT market works reasonably well, and urge caution before embarking on major changes. They cite, for instance, a recent study conducted by the Brattle Group (on behalf of ERCOT) that states that “the current market design will support more than sufficient reserve margins from an economic perspective.”
To read more about the marginal line loss proposal and other “price formation” rules in the ERCOT market, check out the documents found here on the PUC website. More about the issue and related ones also be found here, here and here.
— R.A. Dyer