UBS mulls competitive power; likes what it sees in PJM, ERCOT

In a recent analysis, UBS Investment Research looked at incentives for new capacity in merchant markets and concluded that the notion of competition for independent power producers (IPPs) is “fundamentally shifting.”

With nearly every market now contemplating something akin to a capacity market, “we see a fundamental re-evaluation as to the merits and approach around ‘restructuring’ of power generation,” UBS said in an April 29 review led by Analyst Julien Dumoulin-Smith.

“We believe regions that are truly ‘committed’ to deregulation warrant premium cash flow multiples; while Texas (ERCOT) stands out at the top of our list, PJM remains near the top as well,” UBS said in the analysis.

Regulators in these two important markets have largely remained committed to deregulation, UBS said. There are exceptions to this rule, UBS said, pointing to New Jersey and Maryland efforts to tip PJM “back towards a regulated construct.”

“Meanwhile, we see cash flows produced by IPPs in states such as California, New York, and New England as more risky given uncertainty around new supply—and possessing less upside, as ‘new entrant’ economics appear unlikely given states efforts to contract for capacity needs well in advance of price signals,” according to UBS.

UBS suggests many states are taking more formulaic approaches to procuring energy capacity. States such as New York might eventually turn to something akin to traditional integrated resource plans, said Dumoulin-Smith.

“A trend towards broader re-regulation of the industry is the seemingly necessary shift towards more visible, stable cash flows,” UBS said. “Capacity constructs are primarily needed to retain existing capacity market, rather than build new plants—and have done a remarkable job at doing such,” the firm added.

Capacity markets are not a panacea to increasing money for generators, but do serve as a way to smooth out the volatility associated with power and gas prices, UBS said.

Markets like Texas, with real underlying power growth, look the most attractive for new entrants, UBS said.

“We believe the new model for deregulation will increasingly focus on competitive bid processes on fixed capital investments, forcing incumbent utilities to ‘prove’ their proposed capital projects are competitive,” UBS said. “We believe this trend has been growing for some time, as nominally deregulated markets such as California and New York have trended towards solicitations for new generation to contract for new capacity, rather than allowing ‘market’ forces to determine when and where to build,” the firm added.

“What’s next in the ‘re-regulation’ of Generation? Formally acknowledging such by regulators—as has already been understood in California, where the CPUC [California Public Utilities Commission] solicits for generation using a long term procurement plan (LTPP),” according to UBS. “We believe New England and New York could follow suit eventually.”

Current use of “ad-hoc RFPs coordinated by state power agencies is clearly less than ideal,” UBS said. More formal resource planning would provide more reliable expectation when states go out on the market for new construction, UBS said.

One major unknown in the generation landscape is emerging field of distributed generation, where customers are going partially off-grid to serve their needs.

“Specifically, we see net metering tariffs and incentives to drive home investment of solar modules as requiring a restructuring of the variable compensation schemes used to sell electricity,” UBS said. This trend is a growing issue in places like California, the firm added.

About Wayne Barber 4201 Articles
Wayne Barber, Chief Analyst for the GenerationHub, has been covering power generation, energy and natural resources issues at national publications for more than 20 years. Prior to joining PennWell he was editor of Generation Markets Week at SNL Financial for nine years. He has also worked as a business journalist at both McGraw-Hill and Financial Times Energy. Wayne also worked as a newspaper reporter for several years. During his career has visited nuclear reactors and coal mines as well as coal and natural gas power plants. Wayne can be reached at