Producing A Panacea Or A Pandora’s Box?

The traditional vertically integrated electric power monopoly model has held sway in North and South Carolina for decades. That may be about to change.

Late last month, South Carolina state senator Tom Davis called for the establishment of a regional transmission organization (RTO) that would disrupt the status quo, instead linking both Carolinas into a formal restructured competitive market. NYT columnist Justin Gillis hailed Davis as a “man of vision” for his remarks at the Solar Energy Industries Association’s national convention—where Davis shared the stage with officials from Duke Energy and Dominion Energy, as well as NC state representative John Szoka, who also spoke of the need to reform the monopoly model.

Creating an RTO in the Carolinas could have dramatic impacts on investment, power prices, generation mix, environmental effects, and the distribution of benefits and costs between shareholders and ratepayers within the region. Let’s take a closer look at what’s motivating consideration of the shift, how the conversation has played out so far in each state, whether the RTO solution is likely to prove a panacea or a Pandora’s box, and what alternatives Carolinians could consider.

Two Ways To Skin A Cat

There are fundamentally two forms of power market governance in the U.S. One is the traditional “regulated monopoly” model, in which vertically integrated public utilities are granted sole provider status for a service territory in exchange for a state utility commission having control over the rates the utility can charge. The other is the “restructured” or “competitive” model in which wholesale power markets are subject to competition among generators, with prices typically determined through time-specific auctions run by an RTO. Those markets may be further opened up to competition at the retail level.

The governance choice is made at the state level; 17 states have chosen to fully restructure by opening up wholesale and retail markets to competition, and 33 have opted to keep the regulated monopoly model.  Some of those 33 states, though, have a mix of the two—vertically-integrated monopolies that participate in competitive markets via an RTO.  North Carolina and South Carolina currently follow the traditional regulatory model without an RTO.

Why The Interest In Shaking Up The Carolinas Market?    

Right now, both Carolinas have electricity rates that are below the national average while the lights have been kept on pretty well when hurricanes do not have their way (as they have had for the last several years). So what’s the problem?

South Carolina ratepayers are currently faced with high costs from a nuclear construction fiasco. The project has been called largest financial failure in the history of South Carolina and is encouraging them to consider overturning how the power business works in their state.

Next door in North Carolina, the state’s largest utility, Duke Energy, is now seeking approval from the state utilities commission for a rate increase for the western part of its service territory to address grid upgrades, accelerating coal plant closures, and recovery of legacy costs associated with coal ash clean-ups.  Moreover, the company is seeking a change in North Carolina law to allow Duke Energy more flexibility on the timing of rate changes and the allowed rate of return on capital investments. Both moves have generated reactions about the equity of the current rate approval process and whether an alternative to the current regulatory model is in order.

Meanwhile, there’s the growing public demand for clean energy.

If we equate clean with low-carbon, both Carolinas are well below the national average for CO2 emissions per megawatt hour produced, due to their heavier contribution of nuclear and natural gas and renewables and lower reliance on coal.

But some argue that low-carbon energy investment would be more effectively fostered in a competitive wholesale market among independent producers that an RTO can provide than from the traditional rate-regulated investor-owned utility model that the Carolinas now follow.

What’s Happening Now?

Sen. Davis has argued that Santee Cooper, South Carolina’s state-owned electric and water utility dating back to the New Deal, should be sold to an investor-owned utility. Santee Cooper was one of the owners of the V.C. Summer nuclear plant near Columbia, SC whose construction was halted in 2017 after incurring $11 billion in costs and only a fraction of the way to completion.

In January, due partly to frustration over Santee Cooper management, Sen. Davis introduced the Energy Freedom Act, which was signed into law in May with bipartisan support. The law addresses rooftop solar, large-scale solar, community solar, and resource plan reporting. But Davis argues the bill is about more than solar, stating that “it’s really about something more fundamental: It is a first and important step away from the energy-production monopolies that have saddled South Carolinians with some of the highest electricity bills in the nation, and toward real competition through an open market of many buyers and many sellers that will provide downward pressure on the cost of producing energy.”

The South Carolina bill is not unlike North Carolina House Bill 589, which became law in 2017, requiring Duke Energy to procure a given amount of solar energy capacity through a competitive procurement process and also set up new programs for commercial, community, and residential solar.

This spring, each state’s legislature flirted with the RTO possibility. In April 2019, the South Carolina Senate agreed to form an RTO study committee to examine how residents and businesses could benefit from a competitive market structure, but that committee was not approved in the final version of the budget. For its part, the North Carolina House introduced H.B. 958, which would launch a study of the possible benefits of an RTO, in order to determine whether the state’s utilities commission should require utilities to participate in one. A small part of northeastern North Carolina is already part of the PJM RTO that operates in 13 states and Washington D.C., but the bill would consider mandatory RTO participation (though not necessarily in PJM). That bill is still in committee.

Meanwhile, just last week, one South Carolina power company took things into its own hands by joining PJM. Central Electric Power Cooperative is the wholesale provider to all 20 of South Carolina’s cooperatives, and it is Santee Cooper’s largest customer. The PJM membership will become official once Central Electric receives approval from the US Dept. of Agriculture’s Rural Utilities Service, and that’s expected sometime in November.

Central Electric said PJM membership will allow it to request feasibility studies of importing electricity generating capacity and energy from the RTO’s power pool. In its market participant category of membership, however, Central’s interest will be purely contractual, not operational. Central does not intend to commit resources into PJM, for instance, integrating its transmission system into PJM, which is not geographically adjacent. For now, they only intend to determine whether purchasing from PJM represents a low-cost and reliable power supply.

Will The RTO Solution Prove To Be a Panacea… Or A Pandora’s Box?

The underlying premise of power market restructuring into RTOs is that the competition will bring down prices. The logic is intuitive, but it is not clear that has actually played out since restructuring took hold in the 1990s.

A study published in 2015 by energy economists Severin Borenstein and James Bushnell looked at the first 20 years of restructuring experience and concluded that it had little effect on electricity prices compared to technical change and natural gas price movements.

Why might that be? By introducing competition via auctions, wholesale prices in an RTO are determined by the marginal cost of the last unit bid into the market. That has traditionally been natural gas units. In contrast, prices in traditionally regulated markets are based on average costs across the entire generation fleet, not just natural gas generators.

Consider what happened when natural gas prices were high in the early 2000s: rate increases in restructured states tied to wholesale prices determined on the margin were typically higher than average price increases in regulated states. Conversely, as natural gas prices have declined precipitously over the last decade, competitive markets’ rates have dropped more than those in regulated markets.

Borenstein and Bushnell argue that the main effects of restructuring have been distributional—who wins, who loses—rather than rate-reducing. When wholesale power prices rise, that gets passed on to consumers, but the owners of generating assets earn higher revenues. The reverse is true when prices fall, as we have seen when low prices put extreme pressure on generating assets operating in RTOs like PJM. Natural gas prices have stayed low for the better part of a decade, but not-too-distant history shows prices can be much higher and more volatile, meaning restructured states could be more exposed to future price swings.

Let’s consider another compelling motive for operating in an RTO: the wish to more effectively channel decarbonization by forcing open the competition from non-utility renewables producers, energy efficiency aggregators, and the like. Experience to date here has also been a mixed bag.

California has led the way on decarbonization. While it is a restructured state, it’s ambitious renewables mandates and a cap-and-trade system for carbon allowances have driven change more than has the structure of the market. North Carolina, meanwhile, is second to California (OK, a distant second) in terms of installed solar capacity and is a traditional regulated monopoly state. So the market governance form does not automatically dictate the pace of decarbonization; other factors like policy and suitability for renewable power generation matter a lot.

And restructuring could actually have some negative consequences for decarbonization efforts.

Nuclear energy is currently the largest single source of carbon-free electricity in the U.S. Nuclear plant closures are primarily occurring in states with RTOs where the low wholesale prices arising from competitive auction markets are forcing them out of business. However, the only states willing to build nuclear plants in the last three decades are two traditionally regulated states – South Carolina and Georgia. As mentioned, though, South Carolina’s Summer project ended badly and while construction continues on Georgia’s Vogtle plant, it has not fared much better. Nuclear generation is not without its own environmental challenges, of course, but the decarbonization task gets tougher without nuclear power on the table. Neither model guarantees this.

So… What Next?

The Carolinas have non-binary options for pursuing affordability goals and decarbonization efforts.

As a recent paper by colleagues at University of North Carolina and Duke argues, there are many ways to introduce competition into states that choose to maintain the regulated vertically integrated utility model.

As mentioned, several of the 33 states that regulate rates operate in a hybrid mode. They retain vertically integrated monopoly territory subject to rate regulation, but they operate in competitive wholesale markets via an RTO, such as the Midwest Independent System Operator (MISO) or Southwest Power Pool (SPP). This allows for cost-reducing competition on the wholesale end, while keeping the utility vertically integrated and maintaining rate regulation on the retail end.

There are also ways to mandate competition from non-utility producers within a “monopoly” state, as seen recently in both Carolinas. This has also really been around since the Public Utility Regulatory Policies Act of 1978 (PURPA). Indeed, it is North Carolina’s own interpretation and implementation of PURPA that has led to its number two position in solar capacity.

Here’s the bottom line: just as competitive markets under restructuring are not deregulated, rate-regulated states are not devoid of competition. In both cases, public policy interacts with whichever market system is in place to drive economic and environmental outcomes.

A rate-regulated state that allows a lot of third-party competition could achieve many of the same goals as a restructured state and might be more effective at protecting existing nuclear assets, at least until other carbon-free generation ramps up to the scale necessary to replace existing units. Some RTO states—such as New York, Illinois and now Ohio—have chosen to protect existing nuclear units with direct subsidies, which can have perverse ripple effects through the rest of the market.

New nuclear construction would take a different kind of solution—likely the introduction of technologies such as small modular (nuclear) reactors (SMRs), which have shown initial promise. The first operational SMR plant will be built in Idaho in the mid-2020s. If SMRs can compete on cost, then they should be able to fare well in either traditional or RTO markets.

Several states and utilities have declared it is their goal to achieve net zero carbon power by 2050. That kind of deep decarbonization will not be achieved simply by changing what type of power market is in place. It will require the introduction of policies reinforcing these goals and technologies that can serve that market inexpensively. Ultimately, though, as I write elsewhere, deeper decarbonization may necessitate an entirely different business model for utilities—one that is more like a services model than commodity production.

[This article benefited greatly from background research, discussions, and editorial feedback by Will Niver and Braden Welborn of the Duke University Energy Initiative and Kate Konschnik from Duke’s Nicholas Institute.]

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