Subsidizing Coal Power: Propping Up a Dying Industry?

By Amelia Schlusser, Staff Attorney

The AEP-owned Gavin Coal Plant in Cheshire, Ohio.

It’s no secret that the coal industry is in trouble. Since 2012 more than four dozen U.S. coal companies have filed for bankruptcy. Coal-reliant investor-owned electric utilities are also starting to feel the pinch caused by coal’s declining value. Some utilities have started to ask for subsidies to prop up unprofitable coal plants. In Ohio, two utilities recently asked state regulators to approve anti-competitive subsidies that would enable the utilities’ aging coal-fired power plants to stay online.

Ohio and many other states have deregulated their electricity systems. The subsidies recently proposed by two of Ohio’s investor-owned utilities are at odds with the market dynamics at play in a restructured electricity market. Rather than sell power directly to a captive pool of retail consumers, utilities in restructured states sell their power through a wholesale energy market regulated by the Federal Energy Regulatory Commission (FERC). The basic idea of this type of system is that competition will result in increased efficiency and reduced costs; efficient generating resources produce lower-cost power, and thus outcompete less efficient, more expensive resources. The market should therefore dictate which generating resources stay online, and which are no longer cost-competitive to operate.

In recent years, market dynamics have created unprofitable conditions for aging coal-fired power plants. But rather than allow the market to dictate the fate of these facilities, the utility owners of these plants sought bailouts from state utility regulators.

Ohio utilities American Electric Power (AEP) and FirstEnergy recently sought approval from the Ohio PUC to enter into long-term contracts to purchase all of the output from aging coal plants, and pass the above market costs of these transactions onto consumers. The companies argued that these contracts were necessary to protect plant jobs and taxes in Ohio and hedge against potential natural gas price increases.

In April, Ohio energy regulators approved AEP’s and FirstEnergy’s proposals. According to Energywire, the Ohio Public Utility Commission (PUC) “said the orders represent a compromise that balances the interests of consumers and utilities at a time when the electricity industry is undergoing a significant transformation.”

FERC disagreed. In late April, it issued two orders (available here and here) effectively blocking AEP and FirstEnergy from entering into the long-term contracts (known as power purchase agreements, or PPAs). In issuing these orders, FERC found that while Ohio retail consumers still had the option of choosing their electricity provider, retail ratepayers would be required to pay generation-related charges incurred under the long-term contracts. Ratepayers would thus be “captive customers” of the utilities—even if they purchased electricity from alternative providers.

Market Dynamics and Monopolies

In states with traditionally regulated electricity systems, investor-owned utilities operate as regulated monopolies—they are granted exclusive service territories filled with captive ratepayers. In exchange for this monopoly franchise, the utilities agree to provide nondiscriminatory service to all customers within their service territories and allow states to regulate their retail electricity rates to ensure the rates are “just and reasonable.”

States with restructured electricity markets have removed this regulated monopoly dynamic. Utilities in these states have to compete for customers, and the rates they charge are determined by market forces. In restructured markets, utilities were forced to split up their monopoly franchises. In doing so, many utilities created separate subsidiaries to provide generation and retail services. To ensure that the market remains competitive, these subsidiaries (or “affiliates”) cannot give each other preferential treatment or rates.

Ohio is a restructured market. AEP and FirstEnergy are thus split into different “affiliates.” Some of these affiliates provide electricity generation from coal-fired power plants, and some serve retail customers. Because current market forces have made it difficult for the utilities’ coal plants to sell wholesale generation at a profit, the utilities essentially tried to reinstate their monopoly franchises through long-term power purchase agreements between their generation and retail subsidiaries. The Ohio PUC approved these contracts, but FERC rejected this anti-competitive behavior.

According to Energywire, FERC Commissioner Tony Clark believes that subsidizing unprofitable generating resources in deregulated markets creates an unsustainable regulatory structure. "If you have lots and lots of out-of-market constructs that basically negate the price formation that's happening in the market, you end up with a really, really unsustainable future," Clark said at a recent regulatory conference.

In response, the utilities are seeking an alternative solution—they are reportedly trying to convince Ohio to re-regulate its electricity system and reinstate their monopoly franchises.

If Ohio’s utilities think that re-subjecting themselves to state regulation will help ensure the continuing profitability of their coal plants, they may be setting themselves up for disappointment. While state utility regulators are required to set “just and reasonable” retail electricity rates, this does not mean that regulated utilities are guaranteed to earn a profit. The Supreme Court has long held that state regulators are not required to prop up a dying enterprise or adopt rates that restore value to an enterprise that has failed through operation of market forces.

Neither the presence nor lack of government regulation should be used as a tool to prop up a dying industry. Coal-fired power is an extremely polluting and environmentally destructive form of electricity. Until recently, the most compelling justification for relying on coal was that it’s cheap. With coal’s costs on the rise, why should ratepayers and taxpayers be asked to subsidize a dirty, outdated form of electricity generation?