The bad news is that state public policies often do undermine competitive electricity markets. The good news is that the harm can be mitigated.
States have become increasingly active in pursuing environmental goals by subsidizing investment in renewable energy generation, including solar, wind, and hydroelectric resources. This subsidized entry of capacity is problematic to the extent the subsidized entry alters the supply and demand balance in the wholesale electricity market, thereby significantly changing prices and other market outcomes. This undermines the ability of the markets to form efficient long-term price signals.
Market participants must rely on these market outcomes over the long-term when deciding whether to invest in new resources, make capital improvements to existing resources, build new transmission facilities, or make other long-term decisions. Hence, public intervention in the market alters the risk profile for all of these decisions and, therefore, can hinder market participants’ response to the markets’ economic signals.
These public policies are generally premised upon reducing negative environmental emissions that are not fully priced into the current markets. However, even if the subsidies for clean energy technologies can be justified by the value of the externalities they reduce, the implementation of the policies can create inefficient costs and risk for market participants that own or invest in conventional resources. The risk arises because the public policy intervention can create artificial supply surpluses in local areas or throughout the market. These surpluses can lead to devastating effects on the revenues of conventional generators and undermine their willingness to invest in and maintain conventional resources that remain necessary to serve electricity needs.
One solution to mitigate these adverse effects is to avoid sustained capacity surpluses by coordinating the entry and exit of generation resources to maintain the balance between supply and demand. In practice, this means:
- Deterring the entry of subsidized resources that cannot be justified by unpriced benefits (such as emissions reductions);
- Facilitating the retirement of conventional resources in quantities that will offset the new resources entering to achieve legitimate public policy objectives.
Coordination of entry and exit supports the integrity and performance of the market by protecting existing and new participants’ market expectations of prices and revenues because it minimizes artificial, policy-induced surpluses. Potomac Economics has worked with ISO New England to develop this type of coordinated approach, which is the first of its kind in the industry.