Maintaining Generation Adequacy in a Restructuring U.S. Electricity Industry

Abstract

Historically, decisions on the amounts, locations, types, and timing of investments in new generation have been made by vertically integrated utilities with approval from state public utility commissions. As the U.S. electricity industry is restructured, these decisions are being fragmented and dispersed among a variety of organizations. As generation is deregulated and becomes increasingly competitive, decisions on whether to build new generators and to retire, maintain, or repower existing units will increasingly be made by unregulated for-profit corporations. These decisions will be based largely on investor assessments of future profitability and only secondarily on regional reliability requirements. In addition, some customers will choose to face real-time (spot) prices and will respond to the occasionally very high prices by reducing electricity use at those times. Market-determined generation levels will, relative to centrally mandated reserve margins, lead to: (1) more volatile energy prices; (2) lower electricity costs and prices; and (3) a generation mix with more baseload, and less peaking, capacity. During the transition from a vertically integrated, regulated industry to a deintegrated, competitive industry, government regulators and system operators may continue to impose minimum-installed-capacity requirements on load-serving entities. As the industry gains experience with customer responses to real-time pricing and with operation of competitive intrahour energy markets, these requirements will likely disappear. We quantitatively analyzed these issues with the Oak Ridge Competitive Electricity Dispatch model (ORCED). Model results show that the optimal reserve margin depends on various factors, including fuel prices, initial mix of generation capacity, and customer response to electricity prices (load shapes and system load factor). Because the correct reserve margin depends on these generally unpredictable factors, mandated reserve margins might be too high, leading to higher electricity costs and prices. Absent mandated reserve margins, electricity prices and costs decline with increasing customer response to prices during high-demand periods. The issues discussed here are primarily transitional rather than enduring. However, the transition from a highly regulated, vertically integrated industry to one dominated by competition is likely to take another five to ten years.