October 15, 2006

Restricting bids for new capacity raises costs, lowers reliability

—By Steven F. Greenwald and Christopher A. Hilen

 

Most sponsors of bid solicitations seek to attract the maximum number of high-quality bids. Basic economic principles tell us that the greater the number of respondents to a solicitation, the greater the competition and the greater the benefits to the solicitor.

Somewhat counterintuitively, and notwithstanding California's need for more electricity supply, the state's utilities are the latest (but undoubtedly not the last) to bar existing power plants and some plants under construction from submitting bids to satisfy long-term requests for procurement of generating capacity.
 

Short-sighted strategy

The utilities justify this exclusion on the basis that their long-term requests for offers (RFOs) are seeking incremental generating capacity, and that awarding a contract to an existing power plant does not lead to any new construction.

From short-term and exercise-of-market-power perspectives, this justification offers superficial appeal. An existing power plant does not need a contract to obtain construction financing. Furthermore, fully appreciative of their monopsony buying power, utilities are aware that an existing power plant has no meaningful alternative market for long-term sales contracts other than the incumbent utility. Thus, deprived of a long-term contract, the existing generator can only, absent shutting down altogether, sell its energy in spot markets, in effect allowing the control area, and the utility, to use its capacity at no cost.

These justifications ignore the longer-term negative effects of excluding existing power plants from utility procurement RFOs. The approval by regulators of these exclusionary and monopolistic practices, rather than encouraging the development of new generation, increases procurement costs, retards development of new generation, and hampers system reliability.