California Will Pay You Handsomely to Stay Off the Grid

(Bloomberg Opinion) -- California is calling for backup. And it will pay handsomely — in cash, pollution and political capital.

Governor Gavin Newsom has declared a state of emergency to avert blackouts over the next few months. A confluence of factors has exposed the vulnerabilities of the state’s grid, mostly centered on this summer’s unusually widespread hot and dry conditions. Hydropower reservoirs are low. Neighboring states may send less electricity California’s way. Customers with air-conditioning are cranking it up. Newsom warns there may be shortfalls of 3,500 megawatts during “extreme weather events” — on a roughly 50,000 megawatt-system — and maybe more next summer.

California’s policy of decarbonizing its energy system, in order to address those weather extremes, is running into sometimes paradoxical problems. “Transition” evokes a smooth process, but remaking a century-old energy system is anything but.

For example, solar power dominates the state’s electricity market during the day, but natural gas plants step in to meet the surge in net demand from the grid when evening falls. Yet those same gas plants face deteriorating economics as they are squeezed out of daylight hours and cycle up and down more often than designers envisaged (see this).

Innovations such as batteries and sophisticated demand management offer ways to balance decarbonization with keeping the lights on. But in the meantime, California is paying to keep gas turbines spinning. Earlier this year, the grid manager contracted with two old, inefficient gas plants just to back up the system, a clear sign of anxiety.

Now Newsom is effectively calling up the next line of defense: backup generators.

Among other measures, his declaration creates a temporary program through October to encourage “large energy users” to reduce their demand by shifting to in-house generators. Commit to a minimum level of reduction during grid emergencies or warnings, and they will be paid $2 for each kilowatt-hour avoided. That is … a lot. Industrial customers in California paid an average of 14.4 cents for each kilowatt-hour of power supplied to them in 2020. The state is now offering 14 times that to not supply them when necessary.

That’s like a California appreciation fund for generator providers such as Generac Holdings Inc., Caterpillar Inc. and the like. A 100 kilowatt-hour generator burning natural gas might make a short-run margin of about $190 an hour during those emergencies. In theory, roughly 150 hours of grid warnings or emergencies — about six days or so continuously — would be enough to pay off the cost of buying the generator .

In reality, such grid emergencies tend to be short; even last year’s blackouts were brief affairs. So unless the sky falls completely on California, our proud owner of a new generator set won’t be in the black inside of a week.

The chance to earn the occasional windfall is still a powerful incentive. That’s how peaker plant economics have worked for years. Perhaps more important is the fact that California has resorted to such inducements at all.

Set against the disruption caused by blackouts, paying the equivalent of $2,000 per megawatt-hour to avoid them may seem relatively cheap. And while the state deserves criticism for bad planning, certainly in the context of its goals, it’s now early August and something has to be done. 

Bad planning combined with extreme weather has left California in a hole. Set against the disruption caused by blackouts, paying the equivalent of $2,000 per megawatt-hour to avoid them may seem relatively cheap. Still, it is remarkable that Newsom is now offering state money to get businesses off the grid when needed.

In doing so, he’s (temporarily) pushing aside California’s emissions targets and air-quality rules to allow the use of power sources that are far less efficient (and thereby more polluting) than the gas power plants the state ultimately seeks to retire . That irony will not be lost on either environmentalists or fossil-fuel advocates. Meanwhile, paying factory-owners big rates to curb demand while ordinary residents are expected to volunteer their, er, grid-balancing services uncompensated may irk another set of already-irked constituents.

In short, it looks as if Newsom’s back is against the wall. He’s facing the state’s second-ever gubernatorial recall election in the state’s history, knowing full well that the last one, back in 2003, was rooted in a power crisis. Nonetheless, he’s compelled to do this. Perhaps that’s the real signal to go out and get some backup.

This rough math assumes a 100 kilowatt generator costing $30,000 and burning 1,280 cubic feet of gas per hour at full load. Assumes a natural gas price of $8.20 per thousand cubic feet, the trailing 12-month average through May 2021 for industrial users in California (source: Energy Information Administration).

Generators burning natural gas orpropane typically use about 13,000 BTU or more to generate a kilowatt-hour of electricity, versus about 7,000 BTU for a modern gas-fired power plant.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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