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Missing Money

If you work in electricity markets and someone mentions “missing money,” it doesn’t make you think of a lost wallet or a sticky-fingered bank teller. Instead it evokes regulatory policies that lower the revenues electric generation companies can make in wholesale markets. Missing money is more than just a concern of corporate CEOs and shareholders. It could soon be a serious impediment to a low-carbon economy.

MissingMoney2Money has been going missing for many years, according to owners of power plants.  They’ve used the term for more than a decade to refer to the fact that wholesale electricity markets have price caps (mostly between $1,000 and $10,000 per MWh) that constrain how much sellers can make when supply is tight. Without that income, generators argue, it may not be profitable to build new capacity, or extend the life of existing capacity, that is needed to meet demand.

More recently, the definition of missing money has been expanded to include the price impacts of subsidized or mandated renewables generation. In California, New York and many other states, wind and solar are pushing down wholesale prices and making continued operation of some nuclear and fossil fuel generation unprofitable.

That may make some environmentalists cheer, but it makes many regulators worry, because wind and sun are not very predictable or controllable. In some cases, grid operators have said those conventional generators are needed to assure that demand can be met locally or systemwide and have offered them out-of-market payments to stay open.

For instance, new subsidies are under consideration for some nuclear plants to compensate for their missing money, but those proposals are triggering objections from gas-fired and coal-fired generators, because keeping the nukes open worsens their own missing money problem.


California’s Topaz Solar Farm

In a meeting I attended a few years ago, a solar advocate stated proudly that when solar enters a market wholesale prices always drop. I wondered aloud how producers in food, auto, steel, or any other industry would feel about government policy that drives down prices in their markets by subsidizing or mandating the use of higher-cost supply. (At the time, the solar power was much higher cost, even accounting for most estimates of the costs of GHG emissions from fossil-based sources.)

Of course, governments intervene in many energy and energy-related markets with mandates and restrictions that affect firms unevenly.

  • Automakers must meet the federal Corporate Average Fuel Economy standard;
  • Gasoline sellers must blend in ethanol to meet the federal renewable fuels standard (as well as the Low Carbon Fuel Standard in California, and the 10% ethanol minimum in Minnesota, among other state mandates);
  • The electric vehicle mandate in California lowers the demand for gasoline (and raises the demand for electricity), as well as lowering demand for conventional vehicles;
  • Some areas now require increased use of biogas (captured methane from landfills, dairy farms, and other natural sources) to replace fossil-based natural gas;
  • Energy efficiency programs lower the demand for electricity everywhere.

Yet, you don’t hear talk of the missing money problem in the auto, oil refining and retailing, or natural gas markets, even when regulations reduce demand for their output.

Missing money is often discussed in terms of fairness: When policies change and the values of existing investments are affected, are losers due some compensation? That is a more pressing question in electricity, where the accelerated renewables rollouts in some places have lowered the quantities incumbents sell and dramatically reduced the wholesale prices they receive (as Meredith discussed last May).

MissingMoney3Still, what makes electricity truly different is not the fairness issue, but the electrical engineering: supply and demand must balance every second in order to keep the grid stable. The grid operator has few, and very blunt, instruments to affect demand, so it relies almost entirely on controlling supply. In the short run, missing money can threaten the viability of plants that are needed for balancing the system, potentially requiring much more expensive alternative supply options, or forced reductions in demand.

There is also a long-run efficiency concern: If firms see an unstable regulatory environment where capital values can swing wildly with regulatory decisions (what former Duke Energy CEO, Jim Rogers, calls “stroke-of-the-pen risk”) they are less inclined to invest, even if capacity is desperately needed and may be well-remunerated in the short run.

These problems will almost certainly worsen in places where renewable energy targets are increasing, like Hawai’i with its 100% target by 2045, and California, which may soon adopt a similar goal.

In other industries if government policies reduce investment in supply capacity, prices rise and consumers purchase less for a while. That sort of market adjustment is not an option in electricity markets as they are currently configured.

So, if a state wants to ramp up renewables, but the missing money problem is such a political, economic, and, ultimately, operational barrier, why not offer compensation for the disappeared dollars. Ah, if only it were that easy…

You see, at some point every firm discovers they are missing money. They invest in a market and then demand turns out to be softer than they expected, or other firms also invest in the market creating over-supply, or their costs rise (or their competitors’ costs fall), or they run into unforeseen logistical problems, or any number of other reasons that firms lose money. Money goes missing due to bad management or just bad luck.

All of those reasons are present in electricity markets as well, and are part of why many generators’ income statements look more red than black these days.  How big a part? That’s a very tough question to answer.  Soft demand, for instance, interacts with expanded renewables to push down wholesale prices.  Any attempt to allocate responsibility will be subject to great uncertainty and, with much money on the line, to endless dispute. Plus, it will depend on what you think generators should have known and when they should have known it about renewable energy policies.

And even if we could sort all that out, there would be a disturbing asymmetry in such a compensation policy. We don’t tax a gas plant’s “found money” when mercury restrictions drive out coal-fired competitors, or levy a fee on nuclear plants in markets that start to price CO2 emissions, thereby driving up the market price and their profits.

Ok, even if we don’t compensate losers in general, can we address the grid reliability issues that may result?

MissingMoney1Yes we can, but it’s not pretty and may not look much like a market.  At the system level, it means the grid operator procures “capacity” (or requires retail electricity suppliers to do so). Capacity is the ability to deliver electricity, though the obligation to do so is sometimes not fully specified or doesn’t match up well with what’s actually needed for grid reliability.  (A new Energy Institute working paper (WP-278) does an excellent job of explaining this murky topic.)

For particular local supply concerns, the grid operator identifies generation that is especially critical and signs contracts for their services in a bilateral negotiation. The plant operator’s threat is to shut down, so it may exaggerate its costs in order to push up the contract price, while the grid operator wants to get a reasonable price, but still assure that the operator is able to cover its costs. Starts to sound a lot like regulation, doesn’t it?  In fact, it can lead back to cost-of-service compensation for the plant. Everything old is new again.

My point is not that it’s impossible to address the missing money problem(s), or that we should give up on competitive wholesale electricity markets. Research has shown that electricity markets create a lot of economic value (in efficient operation of fossil generation and nuclear generation, as well as efficient dispatch of electricity grids).

But at the same time, we need to move to lower carbon generation technologies. That will create economic disruption even if we do it primarily through a price on carbon, and especially if we don’t. If we are lucky, solutions will be worked out that keep grid disruption to a minimum and maintain incentives for efficient investment. But that will require thoughtful understanding of the missing money problem and careful weighing of the array of imperfect policy responses.

I tweet news and research on energy most days @BorensteinS


Severin Borenstein View All

Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. He chaired the California Energy Commission's Petroleum Market Advisory Committee from 2015 until its completion in 2017. Currently, he is a member of the Bay Area Air Quality Management District's Advisory Council and a member of the Board of Governors of the California Independent System Operator.

28 thoughts on “Missing Money Leave a comment

  1. I am an engineer with an interest in energy; and I have virtually no economics background. So I am a little out of my depth.

    But you seem to imply that the majority (or at least a large component) of the missing money issue is due to over regulation. Is there any way to quantify this? As total renewable energy usage in the US has only increased by about 5% since 2005, and I am pretty sure the majority of this increase is due to ethanol production as a gasoline additive. Furthermore, natural gas usage has seen a massive increase over the past decade, while coal usage has been reduced; finally, there has been an overall energy decrease in the US since the 08 crash. I guess what I am saying is there have been many changes recently, and is there any way to identify which factors are contributing to the missing money issue?

  2. Severin, it appears to me your description of a “missing money” problem makes a simple problem exceedingly and unnecessarily complicated. You see, I have a “missing money” problem, too. If I could simply accumulate the missing money I deserve, I would be able to take off more time from work, travel more, etc.

    But there’s a fundamental difference between the work I do to earn it, and the services and products energy companies supply to earn theirs. Despite all of the complicated machinations undertaken to devise truly competitive “electricity markets”, they don’t exist. As long as the same wires provide the same essential 120V AC to the same people, competitive electricity markets are little more than an elaborate myth, promulgated by various parties, to milk captive ratepayers out of as much money as possible.

    Your observation that power plants have noticed the missing money problem for “more than a decade” is significant – it was 2005 when the Bush administration repealed the Public Utility Holding Company Act, in theory (or pretense) to create competitive electricity markets. What it did instead was to vastly complicate regulation of the natural monopoly the U.S. grid has been, and always will be. Before 2005, utilities were granted a cost-plus profit framework which they gratefully accepted in exchange for a competition-free non-market. It limited the possibilities for growth, while virtually eliminating risk – a tradeoff which worked exceptionally well for 70 years.

    How to fix the messy status quo? First, it involves recognizing PUHCA of 1935 for the exceptional solution it was and reinstating it. Second, it involves identifying problems like climate change which affect all of society, and addressing them on an even-handed basis. Socialism, in the form of a Pigovian carbon tax which penalizes carbon emitters in proportion to the harm they cause.

    Handing venture capitalists control of the grid is a recipe for disaster, a lesson already learned over a century ago. But with an American public so conspicuously history-challenged it will likely have to be a lesson learned again – and again.

  3. Thanks Severin for an interesting and thoughtful article. Australia has higher price caps $AUD14,000 per MWh) than I am aware of in other wholesale energy markets. In South Australia but also in Queensland there is evidence that extreme wholesale prices seem to quite often reflect a contrived scarcity. Extreme prices in a few settlement periods have had a major impact on average annual wholesale prices. For example in South Australia in some years, average annual wholesale market prices more than doubled as a result of the prices achieved in just 72 half-hourly trading periods in the year. Concerns about missing money can not be must be weighed against the incentives to exercise market power if extraordinary prices can be achieved. In other words a theory on missing money must also take into account the competitiveness of the wholesale market.

  4. “Missing” money is a bit of a euphemism. As you say, money goes missing from bad management and bad luck. But when the cause is bad (but politically expedient) policies, it’s more like stolen money, albeit the constitutional takings clause doesn’t apply.

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