Hancock misses the value of electricity surcharge

Jay Hancock's column in the Sunday Sun leaves three misimpressions about the payments that we Maryland consumers make to encourage the growth electric power plant capacity ("Obscure electricity charge enriches power sellers," Oct. 24).

The first misimpression is that there's no economic rationale for these payments. In fact, most energy economists agree that they are essential. Without them, too few power plants would be built, and we would risk blackouts.

The column asks a reasonable question: Why is this true for power markets and not for, say, gasoline or milk markets? The reason, omitted in the column, is that electricity prices are capped at such a low level that the power plants needed only during the few hottest days of the year cannot possibly make enough money to cover their capital costs. We need price caps to prevent the type of market manipulation seen during the 2000-2001 California power crisis.

However, they mean that we'll suffer shortages unless we encourage capacity construction in another way. Capacity payments are insurance premiums to make sure the lights stay on. This approach to encourage new capacity is not unique to Maryland; it is also used in most of the country's organized power markets.

The second misimpression is that the payments have been ineffective. In fact they've changed Maryland's power landscape in several ways and have helped turn a shortage of capacity into a surplus. One huge change is the recent gusher of so-called "demand response," such as the air conditioner controls that BGE has busily been installing in many of homes. This has been amply documented in the recent Maryland Public Service Commission hearings. It turns out that using less during peak times is cheaper than building new plants. This demand response, as well as several delays in plant retirements motivated by the payments, has helped turn central Maryland's shortage in the March 2008 capacity auction (when 1 percent less capacity was purchased than was needed) to a surplus in the latest capacity auction (when capacity exceeded the target by more than 2 percent).

Furthermore, several new power lines are planned to bring power into the state (the first in decades), incented in part by the capacity payments. Although as heavy importers of power we pay more than other regions, these changes have caused capacity prices to be below what is needed to build new plants. This is as it should be — if new power plants can't compete with other ways of meeting our power demands, we shouldn't build them.

Third, the article implies that large existing suppliers of capacity abuse the market. In fact, the independent entity that monitors our region's power market has recently confirmed that the capacity market has behaved competitively and resulted in substantial improvement in the supply-demand balance in Maryland and the region.

A well-designed power market must allow our demands to be met from surprising sources if they are cheaper than the traditional solution of "build, baby, build." Our region's electric capacity market has successfully done that at costs below that of new power plants.

Benjamin F. Hobbs, Baltimore

The writer is Schad Professor of Environmental Management in the Institute of Environment, Energy, Sustainability & Health at Johns Hopkins University.

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