The electricity crunch in New England that I wrote about on Feb. 15 persists, and it is clearly related to a shortage of natural gas pipeline capacity relative to growing demand. But experts say the root cause is something more complicated: a structural flaw in the regional electric market.
The gas industry, the electricity generators and the Independent System Operator – New England, which runs the grid, all say there is a problem, although they are not quite in agreement on how to solve it. The details are important because the phenomenon could spread around the country.
The problem in New England, which has resulted in electricity prices that are four times higher than normal for sustained periods, is that all of the pipeline transmission capacity has been purchased by the local gas distribution companies that sell gas for home heating and retail uses. When those companies need all that capacity to meet customer demand during a cold snap, there is nothing left over for them to sell to the gas-fired electricity generators.
The two sets of companies are a bit like the grasshopper and the ant in Aesop’s fable. The hard-working ant, or local distribution company, survives the winter, but the grasshopper, or merchant generator, does not.
In theory, those merchant generators, which are independently owned and compete in selling to the electric companies that sell power at the retail level, could solve the problem by buying capacity themselves. But in practice, the electric market discourages them from doing so, experts say.
The reason is that the merchant generators operate in a competitive market and cannot afford the burden of buying constant transmission capacity; it is a bit like buying a train ticket for a trip every day of the year even though you don’t make the journey every day. A merchant generator who bought such capacity would be very competitive for the few weeks a year when capacity is tight, but not for the rest of the year.
By contrast, the gas distribution companies are monopolies regulated by public service commissions and can simply fold their pipeline charges into electricity rates.
“The fundamental problem when you look at the New England market is economics,’’ said Donald F. Santa Jr., president of the Interstate Natural Gas Association of America, the trade association of the pipeline owners.
“The way the electric market is now structured, there is little premium placed on reliability and on compensating generators for that,’’ he said. “There’s no real incentive for them to hold firm capacity, and if they do, you can argue it puts them at a competitive disadvantage relative to their peers.’’
And that is because of another quirk in the market. Other kinds of investment in transportation are made because the investor senses there will be a market and wants to capture the business and make a profit, but gas pipelines are built only when contracts are in hand from shippers.
“We don’t build on spec,” as a spokeswoman for the pipeline group, Cathy Landry, put it.
The pipeline owners agree that demand for gas has grown far faster than their ability to transport it, and that they should either lay new pipe or add compressor stations to squeeze more gas through existing pipe. The trend in New England is not very different from the trend in the Midwest. New York is in a slightly different situation; local rules require that gas generators be able to run on fuel oil as well in a pinch.
New England generators used to avoid this problem by stocking up on diesel oil, but environmental rules discourage this. (The “gas” in “gas-fired generator” does not refer to natural gas, but to the physical form of the gas being burned; fuel oil, although stored as a liquid, can be turned into a gas.) And at the moment, if New England generators spend the extra money to build and fill a tank, they are not compensated for that.
The group that represents the local gas companies, the American Gas Association, agrees that a structural problem exists. “Our nation has access to abundant supplies of natural gas and a robust network of 2.4 million miles of natural gas pipelines that reliably deliver this fuel,” Dave McCurdy, its president and chief executive, said in a statement. “Until power generation markets appropriately incentivize continued infrastructure investments, New England will struggle to meet the growing energy needs in the region.”
In other words, the market should pay more for electricity from a generator that has invested in making its power supply reliable than for the same product from a generator that can only produce when the weather is warm and gas demand is low.
Even the power generators agree. Yet Dan Dolan, a spokesman for the New England Power Generators Association, said the devil is in the details: how should the market be structured to compensate the grasshopper for becoming an ant?
The Independent System Operator is thinking of both incentives and disincentives. New England, like New York State and the market to the south, PJM, (which used to stand for Pennsylvania-Jersey-Maryland), has a market for electric energy but also for capacity.
Companies that buy electricity, like utilities that distribute it to homes and businesses, also pay for generating capacity equal to their expected demand. So independent generators collect a fee for simply having capacity available as well as a fee for the energy they produce.
At the New England Independent System Operator, Vamsi Chadalavada, the chief operating officer, said companies that collect the capacity fee must be able to get fuel and produce electricity when called upon. “If we call upon them and they do not deliver, there has to be a significant consequence,” he said. Companies that cannot produce would pay penalties, he said, and that money would go to companies that do.
“If I stand to lose hundreds of thousands of dollars any given day, I’m going to do everything within my capability to make sure that doesn’t happen,” Mr. Chadalavada said. Generators would therefore buy firm gas transmission capacity or make other kinds of investments to ensure reliability.
This post has been revised to reflect the following correction:
Correction: February 25, 2013
An earlier version of this article misspelled the first name of the spokeswoman for the Interstate Natural Gas Association of America. She is Cathy Landry, not Kathy.
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