(How) Should We Use It? – Energy Institute Blog

Should we really build clean generation just to let it sit idle?

There was a lot going on in Sacramento in June, as the legislature rushed to pass its new budget amid furious negotiations focused largely on what to do with California’s record-breaking budget surplus. One “modest” part of the surplus – what’s a few Billion here or there? – has been directed to a newly formed strategic electricity reserve. What is a strategic electricity reserve, you may ask?  I appeared at a budget committee hearing on this topic in early June, and my sense was that there were a lot more questions than answers on this topic.  

The general framework will be that California’s Department of Water Resources (DWR) will be empowered to contract for, or even purchase, electricity supply resources. It also appears that some of these resources will come from a set of aging natural gas plants that have been slated to retire due to the impacts of their “once-through cooling” (OTC) systems on coastal ecosystems. Most of the opposition to these proposals has come from the environmental community, which has objected to what they see as an overreliance on fossil fueled resources.  

The fate of the OTC plants has been in limbo for some time, however, and their looming retirements have generated ulcers over the implications for reliability within the California ISO system for almost a decade. The blackouts on August 14-15, 2020, triggered by supply shortfalls, brought these abstract concerns into sharp focus, and the plants were granted environmental waivers to continue operating through 2023. It now appears that at least some of these plants may stick around beyond then as part of the strategic reserve, although that would still require further regulatory approval. The legislature has also signaled that the law would require DWR to prioritize zero-emission resources over fossil fuel resources.

There are many other aspects of the state-owned strategic reserve that have not received as much attention, however, and many questions remain about the implications of such a reserve for the future of California’s reliability planning, and for what’s left of its deregulated power market. At the hearing I framed these uncertainties around three broad questions:

Why Do We Need a Strategic Reserve if We Already Have Resource Adequacy Requirements?

The June 1 hearing featured awkward testimony from the institutions responsible for ensuring California’s electricity resource adequacy (RA) explaining how the system would be inadequate without this substantial new injection of public funds. The California Public Utilities Commission (CPUC) already has fairly broad powers to order the electricity providers it oversees to procure the level and types of resources which forecasts from the California Energy Commission (CEC) say are necessary for reliable service. The formation of a significant new, publicly-owned, strategic reserve is either a tacit admission that this existing system has failed, or a move to subsidize some of the costs of reliability with the budget surplus.  

Certainly, moving some of the costs contained in electricity rates to the tax base is not a bad idea. My colleagues at EI have made a strong case that many activities funded by electricity bills, such as wildfire hardening and low income energy purchase subsidies, should be paid out of the general fund. But given that about 2/3 of the revenues collected in a typical electric bill pays for infrastructure and other social costs provided by uncompetitive monopoly providers, it is notable that the big application of public funds here will go toward paying a share of the minority of electric utility services that have largely been procured through (somewhat) competitive markets.

When expansive new powers are called for to meet what are characterized as urgent needs, it is natural to ask “how did we get to this point”? The messaging around this seems to be that the RA process was intended to meet “normal” needs while the reserve is needed to meet the extraordinary challenges introduced by climate change. Left unanswered, at least at the hearing, was the question of why, if a consensus over a need for more reliable supply has now emerged, the existing RA machinery could not have been adjusted and deployed to force additional procurement. One possible answer to that question is that the resources put in the reserve will be used differently than other resources. This leads to the next question.

How will the resources in the strategic reserve be procured and operated in the wholesale power market?

The California market has long struggled to find the right balance between regulatory supervision, market incentives, and customer choice. With the exception of the post-crisis period in 2001 (an episode that does not evoke fond memories), regulators have not had to think about how to integrate large-scale participation of a state agency directly into the market. When taxpayer money is directed to make investments in a market, the natural question is about what impact public investments like this one will have on power market prices, and consequently on private investment in generation and storage.  

The answer to this question needs to be handled very carefully, as there is already precedent for State supported electricity contracts being vacated by the Federal Energy Regulatory Commission (FERC) because they were deemed to interfere with interstate commerce. At a high level, taxpayer money isn’t supposed to be used to subsidize “local” businesses in ways that could give them unfair advantages in interstate markets. If the strategic reserve is seen to be somehow suppressing prices of either capacity or energy in California’s wholesale electricity market, it may run into problems with FERC.

There may be a way to navigate this issue by positioning the resources as truly additional capacity to be deployed only when prices are at their maximum limits.  The Governor and Legislature are highlighting that this is the intent, emphasizing that the reserve will be used “only as a last resort.” They also state that the “Reserve will operate on top of and after procurement by load-serving entities,” and are clearly trying to signal that the DWR’s activities will not impact market demand, or prices.

 What is the “last resort” in electricity markets? That’s a question that lies at the heart of many debates about resource adequacy over the years.  It might mean a price trigger. In the energy market, for example, resources in the reserve could be required to bid the maximum allowable (bid capped) price, effectively ensuring they operate only when prices reach their maximum (price capped) levels. This “break-glass-only-in-case-of emergency” usage might also mollify environmental critics worried about the emissions from gas plants in the reserve. Still, the temptation to draw upon a strategic reserve when prices are high, but not yet into reserve deficiencies will be powerful, and may be difficult to credibly resist.  

However, it is worth pointing out that such a limited deployment also greatly restricts the value of the resources being procured, particularly if they are clean energy or storage resources with low marginal costs. Even under the more gloomy projections, there just aren’t that many hours of true supply shortfall, and debates continue about the actual economic costs of well-managed, transitory, load-shedding. By contrast, the costs to customers of the Public Safety Power Shutoffs, motivated by wildfire prevention, are much higher, given the number of customers losing power for days at a time. The money going to the strategic reserve will do nothing to prevent those. It is also worth considering that much cheaper options for enhancing reliability through widespread adoption of truly dynamic retail pricing continue to be ignored.  

How will the existence of a strategic reserve affect reliability planning going forward?

Now that we have a new reserve, what role will it play in planning and investment going forward? This question is tied in with the “how did we get here” question. Will the RA process continue to address only “regular” needs and the reserve be responsible for dealing with the unexpected impacts of climate change? Or will the RA process be further adapted to accommodate the growing uncertainty brought by droughts, heat-waves, and a rapidly diversifying generation fleet?

Another aspect of this question that I have not heard raised is that many electricity customers in California are served by entities operating outside of the CPUC/CEC/CAISO reliability planning process. These entities choose their own reserve margins and make their own plans to meet them. Representatives of the Los Angeles Department of Water and Power (LADWP) and the Sacramento Municipal Utility District (SMUD), the state’s two largest publicly-owned utilities, were conspicuously absent from the hearing I attended, so we did not get to hear whether they felt like they needed a strategic reserve, or whether they felt their current resource plans were more than adequate. Either way, their citizens will be contributing to the cost of the strategic reserve. They will also continue to have large discretion over their own reliability planning going forward.  

There is a classic risk here for what economists call “moral hazard.” For example, if we give everyone free flood insurance, we get more houses in flood plains. If we give California electricity providers a “free” strategic reserve, and everyone pushes the reliability envelope too far, we could find ourselves in a situation where we perpetually need to rely upon the “emergency” reserve, and it becomes an institutionalized part of the State’s grid.

The difficult reality is that reliability planning is a very uncertain enterprise, and there are lots of ways in which reasonable people could disagree. Historically, reliability focused institutions like the CAISO have taken more “hawkish” stances on reliability while cost-focused institutions like the CPUC, and the electricity providers themselves have pushed back on some requirements on the basis of costs. The large municipal utilities, like LADWP, contain both camps in-house. It is hard to see how the existence of a large state-owned reserve could not influence this process of give-and-take, and resolve some of these arguments on the side of pushing the reliability envelope (e.g. running with smaller reserve margins or making generous assumptions about resource capabilities) just a little bit more.  

To Reserve or Not Reserve

There seems to be growing recognition that supply shortfalls in California are a real, and increasing risk, at least in the short-term. Keeping some old generation capacity around, with the expectation of almost never using it,  seems reasonable if it can be done in a cost-effective manner that doesn’t derail the primary process of planning and investment. Investing significant capital into new storage and renewable capacity that we plan to almost never use seems more problematic. The point of clean energy projects is to use them as a first resort, not a last resort.

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Suggested citation: Bushnell, James. “California’s Strategic Electricity Reserve: (How) Should We Use It?” Energy Institute Blog, UC Berkeley, July 18, 2022, https://energyathaas.wordpress.com/2022/07/18/californias-strategic-electricity-reserve-how-should-we-use-it/