State Subsidies and Electricity Markets

In a Regulation article in 2013, Johnathan Lesser described how subsidies to renewable energy generators could actually increase electricity prices by reducing the profits and thus the long run supply of unsubsidized conventional alternatives like natural gas generators. 

According to Catherine Wolfram of the University of California, Berkeley Haas School of Business, the predictions of Lesser have become reality. Natural gas generators in The Pennsylvania-New Jersey-Maryland (PJM) regional electricity market have not received revenues sufficient to cover their capital costs in most years since 2009. Under such circumstances existing plants eventually will cease operation and no new plants will be built. Higher prices and uncertain supply are inevitable.

Calpine, an operator of natural gas plants, asked the Federal Energy Regulatory Commission (FERC) to require PJM to fix the generation capacity market—a government created market that pays firms for reserve generation capacity—to account for the subsidized competitors. Last month, FERC agreed with Calpine that the capacity market is currently “unjust and unreasonable” and issued an order requiring PJM to extend a price floor, which so far only applies to natural gas generators, to all resource types.

However, the FERC order falls short of the first best option: eliminating subsidies to all resources. Federal regulators, Congress, and states should work to repeal the regulations, mandates, and subsidies that complicate the capacity market. An even bolder move would be to mimic Texas, which has no capacity market; generators are paid only for the energy they generate. 

Written with research assistance from David Kemp.