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Published in Michigan Environmental Law Journal, Fall 2017, Vol. 35, No. 2, Issue 103 [view full issue].
Cite: 35 Mich Env Law J 2 (2017)

Making Energy Fun Again! A FAQ on Michigan's Updated Implementation of the Public Utility Regulatory Policies Act

by Margrethe Kearney, Senior Staff Attorney, Environmental Law & Policy Center

Jeffrey Hammons, Associate Attorney, Environmental Law & Policy Center

Q: What is PURPA?

A: An alien from outer space that eats people. A PURPA People Eater! Just kidding. PURPA stands for the Public Utility Regulatory Policies Act, enacted by Congress in 1978. Congress enacted Section 210 of PURPA to encourage the development of small renewable energy and cogeneration and to reduce reliance on fossil fuels, thereby increasing American energy independence. Even though PURPA was enacted in 1978, I believe those goals remain important to Americans today.

Q: How does PURPA encourage development of renewable energy and cogeneration?

A: What is amazing about PURPA is that it encourages renewable energy and cogeneration with a simple and unexpected tool: competition. In states like Michigan, only a few utilities have the authority to sell power. PURPA tasks states—here the Michigan Public Service Commission— with setting what is called the "avoided cost" of energy. The avoided cost of energy represents the cost to the utility of the energy that it sells to its customers. PURPA requires utilities to purchase from small renewable energy producers and cogenerators (referred to in the law as "qualifying facilities," or "QFs") and the rate for such purchase is based on the utilities' avoided cost. PURPA created an incentive for utilities to manage their costs and created an incentive for low cost renewable energy generation.

Q: What does the avoided cost include?

A: Avoided cost obviously includes the cost of building a power plant to generate power, but it also includes the costs of transmission, losses that occur as the energy travels over power lines, the cost of complying with environmental laws that protect air and water quality, and the cost of "hedging" against future volatility in fuel prices. These are some significant costs a utility avoids by purchasing power from a QF, and there are also other costs, too, depending on a multitude of additional factors too numerous to list here.

Q: Why do those projects need PURPA? If QFs can make energy at the same or lower cost than the utility, why can QFs not sell it to people in Michigan?

A: In states like Michigan, where 90% of the market for electricity is a regulated monopoly, without PURPA, a small renewable energy project cannot merely connect to the grid and sell power to its community. Some competitive markets have developed since PURPA was enacted, but small renewable projects and cogenerators do not have access to those markets. In addition, the short-term prices in those markets do not truly reflect a utility's costs of producing power in a regulated state like Michigan. In Michigan, actual utility costs are recovered from customers through rates approved by the Commission for the majority of the market—not through prices set on a competitive market.

Q: Why does PURPA require utilities to purchase power from QFs? If the QF can really produce that power at or below the utility's own price, the utility would have an incentive to buy that power and lower prices to customers, right?

A: Unfortunately, there is not much of an incentive for regulated utilities in Michigan to buy power from a QF and lower prices for customers. PURPA recognized that there is an inherent preference for utilities to build their own generation and this self-generation preference creates barriers to non-utility generation—even where that generation is cost effective. Utilities make money by investing capital in building generating plants and infrastructure, and then recovering those costs in rates charged to customers. If utilities are buying energy and capacity from QFs, then utilities do not need to build as much or at all, which cuts into their revenue stream. If a utility is buying energy and capacity from small power producers and cogenerators, and then distributing it to consumers, there is not as much of an opportunity for the utility to make money off of that transaction.

Q: So, does PURPA increase prices for customers?

A: No, because the rate is based on avoided costs, it is equivalent to what the utility and its customers would already pay for the same energy and capacity. In addition, both customers and society benefit from increased energy independence, increased renewable energy and cogeneration development, and a reduction in fossil fuel dependence. The whole idea of avoided cost is that the utility is paying a QF what it would have cost the utility to generate that power on its own. As a result, there should not be any immediate effect on customer prices. Actually, over time, the utility will recognize that, as its own costs of generating power increase, there are an increasing number of QF projects that are cost effective under those higher prices. Therefore, the utility and its preference for self-generation will actually have an incentive to decrease costs. Hence, the conclusion that PURPA's requirement that a utility purchase QF power actually creates competition in what is otherwise a monopoly market, and this can help drive prices down in the end for customers.

Q: Prices should go down for customers if avoided cost was set lower than the utility's own costs, right? Why not just set it really, really low?

A: The problem is that a rate that is too low will not be sufficient to encourage development of QF capacity, even if the QF capacity costs less (in total or to ratepayers) than the utility's planned new generation. There would be a whole group of QF projects that produce power at a lower cost than the utility, but above the really, really low avoided cost. Those projects would never be built, and we would miss out on the benefits those QF projects provide.

Q: How does the Michigan Commission set avoided costs?

A: The Commission recently opened dockets for each of Michigan's regulated utilities to set a methodology for avoided costs. Not all of those cases are over, so for some of the utilities we do not know the avoided cost formulation yet. But for the two largest utilities, DTE and Consumers, the Commission concluded that avoided cost should be calculated based on a proxy plant. Because avoided costs have two components—capacity and energy—the Commission used a different proxy unit for each of those components. The cost of a natural gas combustion turbine (NGCT) is proxy for avoided capacity cost. The variable cost of a larger unit—a combined cycle natural gas plant (NGCC)—is the proxy for avoided energy cost. The idea is that if a utility just needed capacity, it would build a NGCT, which is less expensive to build but smaller. Therefore using this fossil fuel-type of plant as a proxy for capacity conforms to PURPA's requirement and intent. Similarly, if a utility needed energy, it would want to build a NGCC. Of course, if you are going to build a larger, more expensive NGCC to use the energy, you need to account for the higher costs to do that, so there is an adder to the energy cost to account for that.

Q: Once the avoided cost is set, how does the utility actually get the power? Does the QF just show up on their doorstep, power in hand?

A: Not exactly. First, a QF needs to interconnect to the grid, and there is an entire process for doing that. It is important that the interconnection process follow the most up-to-date standards, but it is also important that the process not become unnecessarily difficult for QFs. Utilities should not be able to discourage QF projects and sidestep its PURPA requirements by implementing a difficult interconnection process. Once the QF is connected to the grid, then it could determine how much energy and capacity to provide and when. It is common for QFs to enter into long-term contracts with utilities, called Power Purchase Agreements (PPAs). A project of up to 2 MW can use what is referred to as the "standard offer," which means the parties do not need to negotiate a contract with the utility. For those smaller projects, the utility and the QF are both subject to the terms and conditions of the standard offer, without the need to negotiate. This process reduces transaction costs, which creates the transparency and certainty necessary to encourage development of these small renewable energy facilities.

Q: Why is it important for QFs to be able to enter into long-term contracts?

A: Long-term contracts are important for a lot of reasons. First, when there is a long-term contract, the utility can factor that contract into its long-term planning. That is good for customers, because it keeps utilities from building too many power plants. Second, long-term contracts allow the QF to get financing for the project. Whereas a utility knows it will be able to finance a power plant over its useful life, so too, do QFs need to be able to show that they have a long-term commitment from the utility in order to get financing for their own projects. In Michigan, a QF is entitled to up to a 20-year contract. Not providing long-term contracts would unfairly discriminate against QFs and undermine the goals of PURPA.

Q: How does Michigan compare to other states in setting avoided cost?

A: Even though PURPA requires states to periodically review avoided cost, most states have not paid much attention to it over the past few decades. This is partially due to the fact that, up until the last decade, renewable energy costs were higher than utility avoided costs. Now that renewable costs keep falling, interest in PURPA has renewed. It is encouraging that the Michigan Commission is taking the time to review avoided costs and thoroughly consider the right methodology. Other states, such as North Carolina, have seen strong and beneficial growth in renewable energy, especially solar, after setting fair avoided cost rates. A strong avoided cost rate will have a huge impact on Michigan's future energy independence and protect Michiganders from the harmful impacts of fossil fuel generation. And it can do all that without raising costs to customers!