Friday, April 29, 2016

20/20 Hindsight.

With the recent news regarding AEP CEO Nick Akins comments regarding electric restructuring and guaranteed returns, I thought it might be worthwhile to update this blog entry from last April.  As I look at it, I'm not sure that I'd actually change anything I said back then, so here we go with a bit of a rerun.  My updates from here on out are in italics.  Let's see if anyone is listening...

Well, Ohio's deregulation of generation got dealt a kick in the teeth by FERC back in April, when FERC disallowed Ohio's guaranteed returns on generating units plan for AEP and First Energy.  Now Nick Akins is talking about selling off plants (if they can in today's market) and going to the legislature to get restructuring changed.  Back when this post first came out, I had a suggestion for how Ohio's restructuring could have been done in a way that would have avoided the whole question of confiscation, and would (probably) have been OKed at FERC.  (I say probably because I have learned never to assume any Federal Agency decision.)

As I said back in April "Shoulda seen this coming."

Since I was involved pretty deeply in the initial unbundling of electric generation in Ohio, working with then-Ohio PUC Chairman Craig Glazer and various legislators, I feel kinda responsible for this.

The problem at hand is that these generating plants were built under one set of economic rules, and deregulation of generation changes the rules of the game.

The plants at issue were built under rules that said that the Utility could earn a guaranteed return on their undepreciated investment in facilities that are "used-and-useful" in the provision of service.

Had those plants been built under a competitive environment, they would have been built differently, possibly in different places, or using different technologies, and the companies building them would have accepted the inherent risks, and would have hoped to receive a return consistent with accepting those risks.

The fly in the ointment is the constitutional issue of confiscation.  By forcing companies to move "guaranteed return" equipment into a competitive market's risk/reward structure, there was a likelihood of an outcome that would have been deemed confiscatory.

There is also the possibility of companies earning far greater returns under competition than they would under regulation, at least for a time. (Theoretically, massive returns bring competitors into a market, moderating those returns.)  However, massive returns lead to customers with flaming torches and pitchforks marching on the legislature and/or PUC, because you've changed the rules of the game for customers, too.

So you need to bring competitors in, without inflating the available returns. You end up priming the market with an arrangement requiring utilities to sell power to their competitors at a discount from their retail rates, so that those competitors can mark it up a smidgen and make a profit from doing nothing but reselling.

The whole thing became a huge morass of hedges, boundaries and rules, and was open for gamesmanship.

We could have done it better, and we still could.

As the title says, hindsight is 20/20.  If I had known then what I know now, here's what I would have suggested be done.  (I might not have been listened to, but that's another issue.)

I think we could still do it, though it would piss off some of the "competitive generation suppliers" (many of whom don't actually provide generation, they just do arbitrage).

  1. Pick a date.  Any date.  Call it Date X.  
  2. All Generation with plans submitted to the Power Siting Board after Date X will be competitive generation, and not subject to either guaranteed or capped returns.  It is deregulated.
  3. All Generation in operation as of Date X will continue as fully regulated generation until its depreciated original cost is equivalent, on a $/MW basis, with generation currently being proposed.  At that point, it becomes deregulated.
  4. Any Generation in an intermediate state (between "plans submitted" and "in operation") on Date X will be placed into one or the other group based on an evidentiary hearing before the PUC, on whether that plant would have been undertaken in a competitive market, and whether a reasonable competitor would proceed under the new rules.  A plant that would not be built under competition, but was needed, would go forward as a regulated plant.
  5. A cost recovery mechanism would be established for those plants that are abandoned by regulated utilities as a direct result of the rules change and the decision made in (4).
Why do I think this would work?
  • Yes, the date is arbitrary, but right now there aren't a lot of generators being built that the exact date would affect and would fall under (5).  
  • The rules for making a decision to build or operate would be known far enough in advance of making the decision that confiscation would not be a real issue.
  • Each generating station would operate under a set of rules that were in place when it was built.
  • The transition to a fully competitive marketplace for generation would be gradual, and natural.
The one change that I might make to this if I were writing it anew today would be to change "Date X" to the January, 2001, the date the original Ohio restructuring legislation took effect.  The entire marketplace was effectively on notice at that point that the rules had changed.

I invite your thoughts, speculation, and even catcalls.  Just be civil about it.

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