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Long-term Energy Contracts Keep on Being a Bad Idea

It’s all the rage in energy public policy right now: Pass a law effectively mandating the construction of really big energy projects by requiring the local electric distribution companies to buy the energy for decades. Most of those proposed projects are for large offshore wind farms or from some other low-carbon energy source.

The latest example: In June, Rhode Island passed a law requiring its single electricity utility to enter into agreements to buy up to 1,000 MW of new offshore wind energy by the middle of this decade. Collectively, the New England states have the authorization to direct approximately 8,000 MW of these types of contracts.

To be clear, New England needs to make significant investments in large quantities of clean energy in order to combat climate change. However, here at NEPGA, we believe long-term contracts are not the way to fight this battle for a variety of reasons, including:

  1. They are insufficient to meet the need climate change poses.
  2. They are financially unsustainable.
  3. They undermine the competitive electricity markets, which have already significantly reduced carbon while also keeping the electric grid reliable and its prices competitive.

But we’re not the only ones who have concerns with the long-term contracts. It turns out that a relatively new regulatory proceeding in Massachusetts provides ample evidence that lawmakers throughout New England really should cool their jets on pursuing this policy any further.

Here are some things on our minds as we track this new proceeding, which is deciding which private company receives billions of dollars for offshore wind investments:

  • Are the right people making the call on these huge energy projects?
    • The contracting process is ripe for, and rife with, shenanigans, because the parties who choose the billion-dollar winners are also competing in the solicitation process.
    • This process is the energy infrastructure equivalent of letting Bill Belichick referee the Super Bowl with the Patriots playing. And giving him the authority to pick the winner, regardless of the score.
  • Just how risky are these contracts?
    • The utilities are arguing that the contracts force billions of dollars of risk not only onto consumers but the utilities themselves. The utilities say they are being asked to take on so much risk that they may not be in a financial position to take on other important initiatives unless they make a profit off the contracts.
    • It’s kind of like the utilities are a rich uncle who has been forced to co-sign on every mortgage, student loan, and home equity line of credit for the next three generations of his extended family. Eventually, no bank is going to want to work with him.
  • No, but really: how risky are these contracts?
    • Regulated utilities are generally and reliably profitable; after all, they have guaranteed rates of return every year. So why should they make any money just for entering into these contracts, given that all electric customers — and not utility’s shareholders — are on the hook to pay the costs?

These questions aren’t new, but they’re becoming more urgent and pointed as the size and costs of the contracts continue to grow and each new regulatory proceeding sheds new, harsh light on how the proverbial sausage is made.

Around Memorial Day, Eversource, along with two other electric distribution companies, (“EDCs”) announced that they had signed long-term contracts with the developers of two offshore wind farms: Mayflower Wind for 405 MW and Commonwealth Wind for 1,200 MW.

In part because the utilities choose the winner of each RFP, Massachusetts law requires the Commonwealth’s Attorney General’s Office and the Department of Energy Resources to hire an independent evaluator to ensure an open, fair, and transparent solicitation and bid selection process that is not unduly influenced by an affiliated company.

In June, that independent evaluator filed a report concluding the bids were, “for the most part,” fairly and objectively evaluated and that the projects were fairly selected. However, the report also identifies some “troubling” behavior by Eversource to “advance its position.” The IE report describes actions Eversource took to protect the interests of its own project – also a competitor in this RFP process.

Eversource has aggressively disputed those assertions.

The June report sounded familiar to some of us because the issue of impropriety on the evaluation teams was also raised four years ago, during a prior Massachusetts solicitation. There, the IE raised similar concerns and, ultimately, an Eversource project was picked—and later failed to be built. (Northern Pass.) The IE findings in 2018 and 2022 are strikingly similar.

So, it should come as no surprise that lawmakers are considering a bill that would remove the utilities from the evaluation team and require the Massachusetts Department of Energy Resources (DOER) to choose the winning projects. That is how it is done in several other states – most notably, Connecticut.

And it’s also not a surprise that, in that same proposed bill, Massachusetts lawmakers seek to reduce the amount of profit the utilities make from the contracts. Right now, utilities across New England are allowed to collect up to 2.75% of the value of the long-term contract as revenue. In Rhode Island, the legislature laid the groundwork to eliminate the adder. And in Massachusetts, the Attorney General’s Office has long argued that such an adder should at the very least be slashed.

It is in testimony justifying a 2.75% remuneration on the contracts announced in May that Eversource and the other utilities argue that, over time, the contracts are so risky that they eventually erode the utility’s ability to support future GHG-reduction goals.

Note on these costs: The price of the electrons coming from the wind farms selected in this process are much higher than the price of electrons purchased for the wholesale markets, and those higher prices are locked in for decades. That alone adds millions to consumers’ electric bills over what they would have otherwise paid for electricity.

Then, add that additional 2.75% for the utilities, and you’re considering millions more. Using figures related to the Vineyard Wind I and II project, our back-of-the-envelope math puts the cost just of the utility adder at $7 million per year – or $140 million over the life of the contract. How many heat pumps could that buy?

But, the utilities say, they deserve those millions because the contracts’ aggregate value “will become very conspicuous to capital market investors, bankers, and credit rating agencies in coming years, even though they are not obvious at present.” As a result, “the Contracts may indeed have adverse effects on the Companies’ ability to attract debt and equity over time when the present value of all the long-term purchase obligations become large relative to the size of the Companies’ equity.”

The utilities go so far in their testimony as to insinuate that these contracts are on track to be as damaging as those required by a now-infamous 1978 federal law, the Public Utility Regulatory Policy Act (“PURPA”). PURPA required utilities to enter into long-term contracts that at first seemed like good deals but over time turned out to be so costly that some utilities experienced credit downgrades, “in some cases to below investment grade.”

The fact that so many people are arguing about whether the utilities should be making a profit off of these contracts, and whether they can really be trusted to pick the winners, underscores a fundamental point: The regulatory proceedings around these solicitations are resource-intensive, take years to conclude before a single construction crew ever goes out to sea, and place huge bets on individual projects that are often delayed or even canceled. In fact, two of the biggest solicitations have failed or are on life-support, in spite of the millions ratepayers have already spent on them.

At NEPGA, we think there’s a better way. A recent, extensive study by the regional grid operator explored ways that we can remove 80% of our carbon from New England’s economy by 2040.

The study compared the total cost to society of a variety of pathways, including the status quo, in which states continue to require one-off contracts; a forward clean energy market; and a net carbon price. Bottom line: The status quo approach led to 40% higher social costs by 2040 than the other options.

Implementing a new approach to decarbonizing the economy in the ways studied by the ISO will be challenging and require a lot of good faith efforts by a wide variety of stakeholders. But, when one considers the morass of these regulatory proceedings, the delays developers face with siting, and the huge amounts of money the region is wasting with the status quo, it makes sense to find a new option.

You can read more about the ISO’s recent analysis here.

Posted in Blog.