Electricity in NH - No choice for residential customers (continued)

I did a recent post on electricity choice in New Hampshire and I mentioned that for residential ratepayers, New Hampshire is stuck in a restructuring limbo. The regulatory framework for residential choice is ready to go, but so far there are no power marketers willing to offer energy to residential customers.

The problems from our current lack of choice fall into two buckets. The first has to do with utilities having to guess the future in hopes of securing reasonable and stable electricity rates for consumers. The second potential problem revolves around PSNH's continued operation of generating resources and the allocation of costs for those resources to various types of ratepayers.

Do you go with the oil pre-buy option, or do you like to let it ride?

Reasonable people can disagree on the extent to which utilities should pre-buy their customers' electricity. Should utilities mostly use long term power purchase agreements? Should they favor shorter term agreements? Should they just roll the dice and buy power on the spot market? New Hampshire's limited electricity choice forces residential ratepayers into a one-size-fits-all approach that's a little like requiring everyone to enter into an oil pre-buy agreement. This may be ok for some, but it's probably not right for everyone.

The idea of paying a little extra to secure a steady supply of a commodity at a reasonble price is often used in business. During the 2008 oil price surge, Southwest Airlines was very adept at protecting itself from oil price increases by correctly hedging their jet fuel needs on the futures market. Meanwhile other airlines were forced to buy fuel at market prices, and they paid dearly. Still, this guessing game is far from a certainty and for each success story, there's a case of a company betting wrong or paying higher costs with no benefit.

Should your electric utility be an active or passive investor?

A hedging approach doesn't always make sense and it often increases costs. Another analogy comes from the world of stock market investing. There are two schools of thought in investment management, an active approach and a passive or index investing approach. The passive approach says that even professionals can't "out guess" the market and over time, the average performance of active managers will be no better than the market overall. In fact, research suggests that average returns from active management may be even less than market returns because of the added costs of trying to beat the market. These passive or index investing adherants think paying active managers is a bad idea that just pads the pockets of investment advisory firms.

This same debate could also be applied to procurement of electricity and is another reason why establishing a strong system of retail electric choice is important. Some folks may want to take a passive approach to energy procurement and avoid bets on future prices. Others may be confident that analysts can successfully predict future market conditions. They may want their energy provider to place bets on future electricity prices in hopes of getting lower rates or greater rate stability.

There are plenty of arguments for both sides in the passive vs active electricity procurement debate. To be sure, securing financing for a new power plant depends on long-term power purchase agreements to help mitigate risks, so it wouldn't be in anyone's interest for these contracts to go away completely. Still, regardless of which side is right, even without retail choice, regulators could require transition energy suppliers to separate out their "active management" activities and perhaps create multiple rate programs (offered by a single utility) to allow customers to chose the approach that works best for them.

Who should bear the cost and risks of upgrades to legacy plants?

There's another issue with New Hampshire's lack of residential energy choice. It has to do with PSNH's continued operation of "grandfathered" electriciy generating plants and revolves around who bears the cost and risks of upgrades to these plants. Under NH's original restructuring plan, PSNH divested itself of many generating assets, but was allowed to retain some older plants that had limited life left in them. Merrimack and Schiller stations (both coal plants) are two examples. The intent was that eventually, PSNH would retire all of their generating capability and leave power generation to non-utility independent power producers. Unfortunately, or perhaps fortunately, PSNH has been able to keep their legacy coal plants running at a reasonable cost. They've also done some upgrades over the years such as converting one of Schiller's coal units to biomass.

The result of this, so far, seems to be that PSNH's ownership of these legacy plants is actually helping to keep electricity costs down. Since these old plants are already paid for, burn mostly inexpensive coal and were built when regulations were less stringent, they're generally cheap to operate and couldn't easily be replaced. Although some would argue we're actually paying an additional environmental cost for these plants' electricity due to their high carbon emissions.

Merrimack Station and the unpriced "coal" option

Although things may have gone alright so far, additional issues arise as more expensive upgrades are done to these plants. For example, PSNH was mandated by the NH legislature to install a "scrubber" at the Merrimack Station plant to reduce the plant's mercury and sulphur emissions. Everyone agrees that lower sulphur and mercury emissions are a good thing, but as always, the question is - who will pay for it and who will bear the risk?

And here's the real problem. No one knows what's going to happen to the economics of coal-based power generation over the 15-20 year life of the $457 million scrubber project. If coal prices stay low, carbon emissions don't get priced, and oil and natural gas skyrocket, the scrubber project will seem like a great investment. We'll be glad we kept the plant going. On the other hand, if coal prices increase, natural gas prices decrease, or carbon emission prices skyrocket out of control, the scrubber project is likely to be a loser and the economics of using Merrimack Station for power generation could become very tenuous.

Nothing new there. Everyone knows there's risk and uncertainty with any large capital project. The problem shows up when you look at how each scenario is likely to play out given our current regulatory framework and competitive market. If the scrubber project turns out to be a good decision, PSNH will be able to offer lower rates and business customers, since they have a choice, are more likely to choose PSNH as their energy supplier. If the scrubber turns out to be an economic dud, and coal plants are shuttered because they aren't economical to run, business customers can just choose an energy supplier other than PSNH - one that's not saddled with the high costs of the scrubber. In either case, residential ratepayers are stuck buying their power from PSNH at whatever price they offer, even if that price includes the costs of an uneconomical scrubber. In finance, the ability to "choose the best option after the fact," without paying for it is referred to as an unpriced option. It's a heads businesses win, tails residential ratepayers lose situation.

Just to be sure I wasn't missing something, I checked in with the folks at New Hampshire's Office of Consumer Advocate. They brought two additional points to my attention that I hadn't considered. First, if PSNH's rates for residential ratepayers do increase above the competition due to the scrubber, it's possible that a competitive supplier will step in to sell power to residential ratepayers, since they'd be able to beat PSNH's prices. Another consideration is that if the costs of the scrubber are not being fairly allocated, the PUC and legislature may intervene and introduce stranded costs recovery rules to more fairly allocate the costs of the scrubber between residential and business ratepayers.