Is Fuel Diversity a False God?

Fuel diversity is a topic that comes up often in discussions of electricity policy, generally thought to be a worthwhile, even indispensable, attribute in an energy system. A new analysis by R Street, a Washington free-market think tank, questions the conventional fealty toward fuel diversity, arguing that “a diverse fuel supply is not, in and of itself, a valid policy objective and at best only serves as a poor proxy for other goals.”

The paper by Devin Hartman, formerly an economic analyst at the Federal Energy Regulatory Commission and staffer at the Indiana Utility Regulatory Commission, notes that policymakers in electricity “often presume that diversity in electricity supply is inherently beneficial, even a necessity.” Hartman adds, “There is little empirical evidence to support the claimed association between supply diversity and electricity-market performance.” Rather than focusing on diversity, says Hartman, policymakers “should instead support targeted reforms that provide proper incentives for risk management and reliability….”

Devin Hartman

Devin Hartman

Looking at risk, Hartman says that gas and oil have historically seen greater fuel price volatility than coal and nuclear. Wind and solar have greater supply volatility because of their intermittent performance. Shifting from a heavy coal and nuclear portfolio, as PJM has experienced, toward gas and wind, “can increase both fuel diversity and price volatility.” The dash to gas has often made gas a “more economical” choice than oil coal and nukes, “but such trends introduce an expanded element of fuel-price risk.”

When it comes to reliability, argues Hartman, “A portfolio with low fuel diversity may perform far more reliably than one with high diversity.” PJM’s independent market monitor has said that “diversity is not a synonym for reliability.”

On the other hand, as Midcontinent Independent System Operator CEO John Bear told me in a recent conversation, both nuclear and coal come with built-in energy storage, which he sees as a significant asset lacking in other generating technologies (other than hydro or geothermal). Nuclear fuel is long-lasting, able to continue when intermittent resources are unavailable. Coal plants typically have a 30-day fuel supply on site. Storage for wind and solar generation is not yet close to economic.

Natural gas reliability is a tricky question. Gas generators, Hartman says, generally have a strong record of reliable performance. And natural gas is stored in large volumes. But deliverability problems can interrupt gas supplies to generators. “Where this has happened,” says Hartman, “it’s been due to very specific circumstances unrelated to the degree to which the entire system depends on natural gas.” Remedies to gas shortages are “very situation specific.”

Looking at the way some economic interests – coal and nuclear, to the point – have argued for their value as fuel-diversified assets, says Hartman, “risks cooption by special interests who seek policies that promote a preferred fuel type (or vice versa) thus degrading market performance. There already have been many economically inefficient policy interventions taken under the banner of fuel diversity.”

What should policymakers do? Hartman argues, “Market mechanisms are ideal tools to signal behavioral improvements. That begins by ensuring regulatory and market structures assign risk to those making investment decisions, not socializing it across ratepayers or other market participants.”

According to Hartman, “Market signals, not political interventions, will guide investment decisions that achieve reliability as least-cost and provide the right incentives for the private sector to manage risk.”

R Street describes itself as a “free-market think tank with a pragmatic approach to public policy challenges.” Founded by former employees of the Heartland Institute, R Street says it had 2014 revenues of $2.8 million.