As Market Fault Lines Emerge, Where Could Stranded Costs Develop?
S&P Global Market Intelligence recently highlighted the possibility that stranded costs in the electric sector could emerge again, 20 years after a wholesale restructuring of the industry that was intended to mitigate this type of risk. A recent S&P Global Market Intelligence webinar, Grid Transformation and Stranded Assets: Why They Could Be Back and Bigger Than Ever, delved into historical and future potential stranded costs and related market developments.
This article, the second in a two-part series, examines regional market factors that may lead to future stranded costs.
Demand growth as an underlying risk factor for stranded costs
What are the factors that drive stranded asset risk in the modern era? Often the factors present today are not so different from factors that gave rise to stranded assets in the 1980s and 1990s. Low demand growth, in particular, presents a risk today. Since 2015, Market Intelligence estimates that aggregate annual demand growth projections have been revised downward from 1.0% annually over the next 10 years to 0.6% annually. This means that the market now needs about 35 GW less capacity than it was planning for five years ago.
The main impact of a lack of electricity demand growth is intensified competition between different generating asset classes. This competition has been most intense over the last five years between coal and natural gas generation, but renewable generation is likely to emerge as a competitor for scarce megawatt-hours of demand growth as well. As wind and solar plants add zero-marginal-cost generation to the grid, Market Intelligence estimates they will absorb roughly half of the incremental growth of generation, leaving conventional generation resources such as coal and natural gas to fight over the remaining sliver. The loser of this three-way competition will likely have stranded costs, and it is possible that stranded costs could arise across all three asset classes.
Resource adequacy in restructured and regulated markets — a risk for natural gas assets?
In addition to market share competition between generators, competing policy constructs with regard to resource adequacy may be consequential. The PJM Interconnection put in place an annual capacity auction once it became clear that not enough new generation was being built under its restructured market. The Electric Reliability Council of Texas retained its energy-only market, building an administrative scarcity curve that could be added to hourly prices in order to maintain a price signal for long-term investment. In both markets, the merchant generation sector responded by adding gas-fired generation and shedding coal-fired generation. But while PJM reserve margins remain high by industry standards, ERCOT’s reserve margins for the upcoming summer are the lowest in its history, following a 2018 summer when reserve margins were hardly better. If ERCOT is able to manage its market at low reserve margins, it may shape the debate going forward about how much capacity is needed to maintain reserves in a market with greater geographic and resource diversity such as the Eastern Interconnect.