Overhauling the Energy Grid, or, Why Cap-and-Trade Won’t Cut It

Tuesday, 07/13/2010 - 12:07 pm by Wallace C. Turbeville | One Comment

Energy legislation has to radically transform the electric grid.

While the centerpiece of the proposed energy legislation is “Cap-and-Trade,” a power pricing system and infrastructure that accommodate clean energy are prerequisites for an energy overhaul. Green energy will not reach its potential until facilities can be routinely financed with private capital. The key is the energy grid. Its physical configuration must be changed to support green energy. And, as the hub of the wholesale power market, the grid can be a vehicle to reconcile prices continuously so that the social value of clean energy is measured and recognized as it changes over time.

Cap-and-Trade is no silver bullet. From a purely political perspective, carbon pricing is vulnerable to being characterized as a “tax.” Making the case that it is really recovery of a social cost is a challenge, to say the least. Subsidies and disincentives are imprecisely calibrated to overcome the significant obstacles inherent to clean energy projects over their lifecycles. Because of inevitable political compromise, they are also likely to be inadequate.

Meanwhile, green energy production has long been a promise and not a reality. It represents only about 3% of all power production. Replacing our current vehicular fleet with vehicles powered in whole or in part by rechargeable batteries will require more power production. Promising green energy is good politics. Boosting the green percentage at the same time as overall production is increasing requires a new approach.

As mandated in 1992 legislation, fair access to the transmission grid for all sources of generation now drives the organizational structure of the industry. Under the structure, all generation sources are theoretically available to meet demand wherever it exists. Power is allocated to retail distributors as needed. Priority for granting generators access to the grid is determined by engineering limitations. But the principle prioritization logic is based on cost. Regional system operators regulate the mix of generation sources using an internet-based system known as the Open Access Same-Time Information System (or, OASIS). Generation and load (supply and demand) must continuously be in balance or the system shuts down, ultimately resulting in a blackout. This means that OASIS must work virtually in real time.

OASIS works well to achieve an optimal mix based on engineering constraints and costs. The actual transmission grid is another story. Ownership is anachronistically based on the business organization structures prior to open access. Over 500 entities own pieces of the grid, primarily private utilities, municipalities, rural cooperatives and federal agencies which distribute power to customers. Investment decisions and policies relating to fees for use are understandably influenced by the parochial views of the owners. Transmission assets do not generate profits on their own; they are a means to the end of buying or generating power and selling it to customers. Local ownership of transmission infrastructure is not strategically important to distribution utilities so long as access to supply is assured and clear, fair and predictable rules governing cost allocation are put in place.

The Federal Energy Regulatory Commission has identified the outdated ownership structure as an impediment to maintaining a grid that is responsive to the evolving patterns of generation and consumption. Improving and expanding the grid is inherently difficult because of its large capital cost and thorny land use issues. Matters are made worse by bickering over cost allocation. Balkanized ownership is also troubling because of the security issues related to the grid. Cyber attacks on the management systems are important concerns, but strategic transmission paths are also subject to lower-tech physical threats.

The FERC appropriately views the transmission grid as similar to the interstate highway system. Interstates benefit the entire nation, not just localities. So it is with the power grid.

Green generation faces many obstacles. Although these facilities do not require fuel, capital costs per kilowatt hour produced are typically so high that total cost compares unfavorably with carbon-fueled alternatives. The cost difference depends on the price of coal, gas and oil. Therefore, the cost deficit changes over time.

But there are other obstacles which may be more daunting. Generally, green generation must be located where the source of energy (wind, solar etc.) is found. Convenience of the site to the grid is highly unlikely. In fact, green generation sites are typically in very remote locations. This means transmission construction, often over long distances, will be required. Under current practices, the cost must be borne by the customers served by that generation, directly burdening green power.

Other obstacles relate to the requirement that generation must be constantly balanced with demand as demand changes minute by minute. Take wind generation as an example.

• Windmills are susceptible to lightning strikes.
• As a weather front passes, wind increases and then dramatically falls off, and output fluctuates accordingly.
• Wind speed is highest in early morning hours, a low point in intra-day demand cycles. Power generated at these times fetches a lower price.

Because of these uncertainties, wind generators cannot guarantee output on a day-ahead basis. The risk of penalties is too great. Consequently, grid managers must pay other generators to standby to meet demand the next day, if needed. The costs are highest for hours of peak usage. These standby costs are charged to the wind generator whose unreliable capacity caused the problem.

The transmission grid touches all of these obstacles.

We are in the process of deciding that energy generated without greenhouse emissions has benefits for society which outweigh the disadvantages of carbon-based fuels. A system which implements this decision should have several characteristics:

• Reconciliation of costs between green and carbon-fueled generation must be flexible, since fuel costs vary and innovation could improve the competitiveness of green generation.
• Transmission construction costs should be allocated broadly rather than burdening the green generator specifically. Green energy is a society-wide concern and costs should not be localized.
• Transmission expansion should be efficient and based on a national policy that promotes green generation.
• Costs arising from transitory reliability issues (such as weather) should be borne broadly, since the benefits of green energy are societal.
• Innovations that store power generated during hours of low demand for use during peaks allows for a more efficient generation mix. It also helps green facilities that do not always generate power during demand times. The grid must accommodate flows into and out of storage.
• Access to the grid cannot be based solely on engineering constraints and cost. Environmental policy must be a consideration. The rules employed by “OASIS 2.0″ should be transparent and predictable.

All of this suggests that the transmission grid should be owned centrally and that allocation of costs for use should be determined based on national policy. Charges to green generators should be potentially negative (in other words, payments) if the policy demands it.

There is a role for Cap-and-Trade and financial incentives. Carbon pricing dis-incentivizes industrial emissions as well as carbon-based generation. Financial incentives are useful to foster research and development and start-ups. But a new structure for transmission is more efficient and powerful. It enables a strategic plan for transmission expansion to integrate green generation facilities and allocation of costs broadly, reflecting the benefits to the whole society. It also can be the vehicle for dynamic reconciliation of power prices to reflect the social value of greenhouse gas reduction. On this basis, green power generation is subject to the same general costs and risks as carbon based generation. Importantly, it can be financed with private capital. The scale and pace of green generation will be increased so that there is a reasonable chance that it can replace carbon-based generation and goals can be achieved.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.