Measuring Diversity

The controversial grid study currently underway at the behest of US Energy Secretary Rick Perry repeats a familiar talking point of the coal industry: that the decline in coal is reducing diversity.

In his memo requesting the study, Perry states that experts have “highlighted the diminishing diversity of our nation’s electric generation mix, and what that could mean for baseload power and grid resilience.”

This is echoed by EPA Administrator Scott Pruitt. “Utility companies across this country need fuel diversity,” he told Fox TV. “You need solid hydrocarbons on-site that you can store, so when peak demand rises, you’ve got solid hydrocarbons to draw on.”

Fuel diversity is usually a pretty safe talking point. But equating coal with diversity has one problem: it’s wrong.

 

Why diversity?

As one industry report puts it, “The economic benefits of diverse power supply illustrate that the conventional wisdom of not putting all your eggs in one basket applies to power production in much the same way as it does to investing,” echoing a broad consensus among policymakers and industry leaders.

Using more gas, wind, and solar means we are putting our eggs in more baskets. If anything, the coal basket has been too big for too long.

 

For power generation, the most important baskets are fuel choices and generation technologies. The initial choice of generation technology can lock in exposure to fuel purchases for decades to come, which can make up a significant amount of operating costs. If fuel prices fluctuate, generation companies, and their customers, can be exposed to significant financial risk.

Fuel and technology choice can also expose a generator to operational risks. Thermal power plants with large water demands are impacted by drought or changing water quality regulations. Wind and solar generation are affected by changes in the weather. Every kind of technology is exposed to mechanical failures or natural disasters, causing unplanned outages.

Regulatory risk is also a big problem, especially as we stumble toward solutions to climate change. While the Trump Administration will hold up progress as long as they can, utilities and investors plan decades ahead, and have already concluded that regulations are inevitable.

Thanks to the many ways we have to produce electricity, the power sector is the most diverse part of the energy system, much more so than transportation or heat. And with generators running the gamut from a massive nuclear plant to a rooftop solar panel, we have many options, and the risks that each option bears are very different. Combining them in a diverse portfolio can mitigate risks of all kinds.

 

Measuring diversity

This is all pretty straightforward. Even so, the discussion about fuel diversity rarely gets past talking points and assertions. It is rarely actually measured, even though it is easy to.

The debate has taken me back to a simple concept I learned in grad school in Wisconsin, known as the Herfindahl-Hirschman Index, or HHI. The HHI is a simple analytical tool used to measure diversity in markets (as well as in ecosystems and religions).

It is used by financial regulators to measure the degree of concentration in an industry, to judge whether a merger would create too much monopoly power.

As the US Department of Justice describes it:

“The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. For example, for a market consisting of four firms with shares of 30, 30, 20, and 20 percent, the HHI is 2,600 (302 + 302 + 202 + 202 = 2,600).

The HHI takes into account the relative size distribution of the firms in a market. It approaches zero when a market is occupied by a large number of firms of relatively equal size and reaches its maximum of 10,000 points when a market is controlled by a single firm. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases.”

The Energy Information Administration (EIA) tracks data on power generation within each state, dating back to 1949. By calculating HHI scores, we can see the relative diversity of the fuel mix in each state and over time.

Results vary widely. Highly diverse states, like Maine, Alabama, North Carolina, and Minnesota get most of their power from a mix of at least three different fuel sources. In Minnesota, for example, coal is the largest single source, but nuclear, wind and natural gas make significant contributions.  Maine gets nearly equal amounts from biomass, natural gas, and hydroelectric power, with a growing contribution from wind power.

The least diverse states, like Indiana and Kentucky, are heavily reliant on a single fuel source, in this case coal. States can also be heavily reliant on natural gas, like Florida and Massachusetts, or hydro power, like Idaho.

This fuel diversity is reflected in the HHI scores for each state. Very diverse states have scores as low as 2500, in Maine. The least diverse states rely on only a single fuel, typically coal and in some cases natural gas. Their scores can be over 7000, well beyond what economists would call “highly concentrated.”

It is important to note, however, that EIA only tracks fuel mix data for the states where power is generated, and not for the states where it is consumed. So electricity imports and exports are not reflected in this analysis. This gives a distorted view of states that are major exporters of one kind of electricity, like West Virginia and Wyoming, or for very small states that rely on regional suppliers, like Delaware, Rhode Island, and DC.

Also, EIA does not track energy efficiency as a resource. The effectiveness of energy efficiency programs has also been increasing, keeping overall electricity demand flat, and serving as the “first fuel” for diversification.

For the US overall, diversity in the power supply is increasing, as coal becomes less dominant and natural gas and renewables play a more prominent role. The power supply is more diverse than ever, hitting the lowest score last year since EIA data began (2679), lower even than the late 1970s, when oil was a significant part of the supply and nuclear was growing.

 

 

Future trends are likely to maintain or increase diversity as carbon emissions are reduced. EIA forecasts show even lower levels of coal by 2040, with substantial growth from natural gas and renewables and ongoing improvements in energy efficiency. In EIA’s Annual Energy Outlook 2015, for example, the reference case for the year 2040 has an HHI score of 2941, while the Clean Power Plan case scores at 3141, well below the historic average of 3366.

 

Caveats, of course

Of course, a diverse fuel mix is only one aspect of a healthy power portfolio. You also want a set of characteristics that compensate for each other, to reduce risk. You want dispatchable plants to go with non-dispatchable ones like wind and solar, big plants that can tap economies of scale along with smaller distributed plants, and plants spread out in various locations on the grid to reduce congestion.

You want fuel sources whose prices are uncorrelated, or even counter-cyclical, with one falling if another goes up. Or that don’t compete with other sources of demand, like winter heating. Or plants that don’t shut down due to drought. Or that don’t carry the risk of catastrophic failure. And so on.

It’s a complicated question, and the HHI is just a simple indicator.

As the Edison Electric Institute, the trade group for utilities, says “Fuel diversity helps to protect electric companies and their customers from contingencies such as fuel unavailability, fuel price fluctuations, and changes in regulatory practices that can drive up the cost of a particular fuel. Fuel diversity also helps to ensure stability and reliability in electricity supply and strengthens national security. The industry relies on a variety of fuels for power generation. No individual fuel is capable of providing the energy to meet all of our nation’s electricity demands.”

Clearly, every fuel source and technology in the power sector has pros and cons. The solution is prudent planning and diversity.

This makes for a dull talking point, but it’s true. The decline of coal and the rise of gas, wind, solar, and efficiency is a good thing, not just for the environment, but for reducing risks in the power sector.

 

OPTIONAL MAP