The modern electricity grid is a marvel of human ingenuity and engineering. The grid runs virtually without fail 24 hours a day, 7 days a week, 365 days a year. It delivers reliable and increasingly clean power to our homes, community & civic centers, and businesses, without most of us even stopping to realize its importance, its existence, or its value.
A basic understanding of how the grid works is valuable for commercial, industrial, & institutional (C&I) buyers when it comes to choosing renewable energy. One of the most fundamental concepts is that energy is a commodity. Just like any other tradeable good, there are wholesale electricity markets and retail electricity markets. How these markets intersect—and how they drive choice, accessibility, and cost—fundamentally impact how a company can acquire its energy.
A second key concept to understanding the grid is regulation. Some parts of the U.S. grid are fully regulated, meaning that the wholesale markets are constrained by vertically integrated monopolies where only local utilities are able to generate and transmit electricity. In these areas, utilities generally own and operate all of the generators, transmission lines, and distribution networks which take electricity from the power plants and deliver them to homes and businesses. The result is that there is little-to-no flexibility and competition on the grid in these markets.
Other parts of the grid are deregulated, meaning that they are competitive, organized electricity markets. In these areas, when power is generated, it becomes part of the wholesale electricity market where it is traded like any other commodity by the players granted permission to operate in that specific market. These electricity grids, also known as Regional Transmission Organizations (RTOs) or Independent System Operators (ISOs) are considered to be interconnected, which allows for broad-based trading of electricity across geographies. This means that any licensed entity—from a utility to a power marketer to an Independent Power Producer—can buy and/or sell electricity in the wholesale market.
Deregulated Energy Markets in the United States
RTOs and ISOs are responsible for facilitating competition among wholesale electricity suppliers, providing access to transmission lines, monitoring the use of transmission lines, and moving energy across the grid. By necessity, RTOs/ISOs are neutral parties, agnostic to the type of electricity moving through the grid. Since the grid is interconnected, however, trades within the RTO/ISO regions are considered multi-state deals and treated as interstate sales. As a result, the grid has a regulatory body—the Federal Energy Regulatory Commission (FERC) —that oversees the trading and distribution of wholesale electricity in all areas of the interconnection (with the exception of Texas, where an entire interconnection region lies within a single state). Another agency, the North American Reliability Corporation (NERC) develops, monitors, and enforces the power system operation standards that keep the grid running smoothly.
There is also retail deregulation. Retail deregulation occurs on a state-by-state basis. In states without retail deregulation, end users purchasing retail electricity are constrained in who they purchase from (typically this is the utility). In a deregulated retail state, there is greater choice for purchasers. As a result, consumer demand is driving considerable interest in renewables, so much so that new states are considering deregulation (or, at the very least, are developing green utility tariff programs that allow retail market participants to take advantage of renewable technologies).
How Deregulation Affects Consumer Choice
Prior to the 1970’s, all electricity markets were part of a regulated monopoly controlled by utilities and overseen by public utility commissions (PUCs)/public service commissions (PSCs). When a C&I consumer purchased retail electricity, they purchased it from their utility and didn’t have the choice to work directly with the wholesale market. However, the energy crisis of that decade spurred Congress to enact the Public Utilities Regulatory Policies Act (PURPA) in 1973, which allowed 17 original states to opt to deregulate their wholesale electricity markets (further legislation in the 1990’s opened up retail competition in individual states, beginning with California).
In deregulated wholesale electricity markets, independent power producers (IPPs), non-utility generators (NUGs), and grid operators work to create a market-based, competitive system that puts downward pressure on electricity prices, invites innovation, and ensures more consistent grid success. Deregulation has also bolstered renewable energy adoption since generators such as wind farms are no longer constrained by the utility monopoly in these markets in the same way and consumers are provided with a choice in where they obtain their electricity.
In fully regulated regions—the Southeast, Southwest, Inter-Mountain West, and Northwest—utilities have retained monopolistic control over and vertical integration of generation, transmission, and distribution of electricity. As a result, the uptake of renewable generation has been managed, and in many cases limited, by these entities.
Historically, because renewables were more expensive than conventional fuels, utilities would typically only invest in them if a state had a renewable portfolio standard (RPS), which requires utilities to increase the portion of their grid mix made up of renewables. As the price of wind and solar technologies continues to fall, however, more and more utilities are seeking to include renewables in their grid mix as a mechanism to control costs and comply with PUC rate caps in regulated retail states.
How Retail/Wholesale Deregulation Affects Commercial Renewables Acquisition
For the commercial & industrial (C&I) buyer, the primary driver of interest in renewables has been the power purchase agreement (PPA). PPAs allow a buyer—or offtaker—to contract directly with a renewable generator in deregulated wholesale electricity markets. The offtaker agrees to a specific amount of generation, at a fixed price, over a 10-20 year term. Whenever the market price of power exceeds the fixed price of the contract, the offtaker gets a rebate; whenever the market price of power falls below the fixed price, the offtaker pays the generator for the difference. This is commonly known as a contract for differences or a fixed-for-floating swap.
The type of PPA a C&I buyer chooses is constrained by the geography of both its operations and the project location it wishes to purchase:
- If a buyer wishes to use a direct (aka physical or retail-sleeved) PPA, its operational location must be in a deregulated retail market that shares a deregulated grid with the generator. Companies that have operations in retail regulated states cannot enter into a direct PPA.
- A virtual (aka financial or synthetic) PPA, on the other hand, is a transaction performed on the wholesale market. Since a virtual PPA is not a retail contract, the means by which the offtaker receives retail power is not affected. Thus, virtual PPAs are available to companies located anywhere in the U.S.–so long as the project owner/generator is located within any of the deregulated RTO/ISO grid regions.
Both PPA types are structured somewhat similarly and can convey similar economic and environmental benefits. However, a consequence of regulation is that C&I buyers located in regulated retail areas that choose financial PPAs may be contracting for power physically generated elsewhere, in a deregulated wholesale region. The co-benefits of that generation—things like the economic boost of a new build project, the reduction in pollution as a result of shifting to clean generation, even the decrease in water needed for a wind or solar plant (compared to a conventional generation plant)—are tied to the geographic region where the project is built.
For some C&I buyers, these co-benefits are a valuable piece of the overall project terms. Some buyers with considerable political and economic clout who choose projects that include these benefits—such as Google and Apple—have been influential on utility decision-making in regulated electricity markets. Buyers can further impact the grid by lobbying for retail deregulation in the states where they operate. This not only creates a competitive, free market system but also enhances opportunities for innovation while amplifying the many benefits of renewables.
Customer choice can be further confused by the fact that a C&I buyer may have facilities within regulated retail states, but the state itself is within a wholesale deregulated region (such as Indiana, Michigan, Wisconsin, Minnesota, and the Dakotas), which are all within the Midwest ISO (MISO) but have state retail regulation. Although these states are located in a deregulated wholesale region, because the retail market is not deregulated, buyers with operations in these regions must rely on the virtual PPA.
With the advantages of deregulated markets, it’s no wonder that there have been recent calls for other U.S. regions (including Nevada and Wisconsin) to deregulate. Countries are impacted by these market pressures as well, most notably Mexico, which elected to deregulate in 2014.
Contact us to learn more about the opportunities for renewable energy acquisition in these deregulated areas.
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