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Contracting and Investment in Electric Generation: Insights for Wholesale Markets

This cross-industry assessment by Robert Stoddard evaluates the role of long-term contracts in electric generation investments. It discusses the impact of contracting decisions, commoditization, and regulatory failures on the industry. Conclusions highlight the benefits of voluntary contracts, open access to transmission grids, and managing risk effectively. The study also addresses challenges such as regulatory uncertainty and potential principal-agent issues. Overall, it emphasizes the importance of rational contracting for resource adequacy and competitive outcomes.

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Contracting and Investment in Electric Generation: Insights for Wholesale Markets

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  1. Contracting and Investment:A Cross-Industry Assessment Robert Stoddard Vice President, Energy & Environment March 3, 2009

  2. Some industries exhibit similar characteristics to electric generation. Homogenous, commodity-like, product Fixed location (often) Product not easily stored All industries above, like electric generation, require large and lumpy capital investments

  3. Some industries rely on long-term contracts for investment and some do not.

  4. Commoditization, specialization, and number of participants influence the contracting decision. Legend

  5. Electric Generation should not require LT contracts to elicit investment. • Buyers are numerous, despite certain transmission constraints • Electricity is essentially a standardized commodity Eliminates potential “hold up” problem Eliminates potential “asset specificity” problem Regulatory failures, however, have caused a under-investment in electric generation.

  6. Conclusions for Wholesale Electricity Markets • Long-term contracts are not required for long-term resource adequacy • Homogenous product • Open access to transmission grid • Many buyers and sellers prevent hold-up problems • Contracts desirable and rational as risk-management • Improves price certainty for both parties • Lower risk to developer decreases financing costs (a benefit similar to forward capacity markets) • Voluntary contracts allow all customers to manage risk optimally • Principal-agent issues may arise with LSEs, however, leading to sub-optimal contracts • Open question around contracting for customers who take regulated service • Regulatory uncertainty can interfere with competitive outcomes • Creates uncertainty about “rules of the game,” adding risk for investors • Competitive buyers may defer purchases in hopes of regulatory guarantees / backstops that shift risk to consumers involuntarily

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