ISO New England is making progress on a number of fronts in promoting capacity markets, said Robert Ethier, Vice President of Market Development at ISO-NE in testimony filed Sept. 19 at the Federal Energy Regulatory Commission.
“To date, New England’s capacity market has achieved the high-level goals that capacity markets are designed to accomplish,” Ethier wrote. “It has procured resources needed to meet the region’s capacity requirement. It has addressed the so-called ‘missing money’ problem and paid resources for providing capacity. It has effectively replaced out-of-market reliability must-run (‘RMR’) contracts with market-based compensation. And it has allowed entry of new resources and created a platform on which demand response can participate as a resource. The mechanics of the New England market are working.” The capacity market does, however, require improvement in three areas, Ethier added: product definition, resource performance, and price formation.
In New England’s restructured electricity system, the capacity market has two central, related goals: to ensure that there are sufficient resources to meet New England’s electricity demand and reliability standards; and to ensure that the first objective is achieved in a cost-effective manner.
In addition to these primary design goals, a reduction in RMR contracts was a critical objective of the commission, state regulators in New England, and ISO-NE when developing the current capacity market, Ethier noted. Furthermore, in designing New England’s capacity market, ISO-NE is seeking to foster competition by creating a playing field that is as level as possible with respect to technology types, types of investors, and existing versus new entrants.
With respect to the first goal of the capacity market – ensuring that there are sufficient resources to meet New England’s electricity demand and reliability standards – the metrics are straightforward, he added. To succeed, the market must procure sufficient capacity in each capacity zone to meet the region’s installed capacity requirement. Specifically, the region needs to satisfy the appropriate regional resource adequacy criteria established by various reliability organizations. With respect to reliability, the simplest metric is whether there has been any outage caused by resource unavailability (i.e., is the region meeting the 1-event-in-10-years standard?).
“Using these measures, there is ample evidence that the capacity market in New England has been a success,” Ethier said. “We have run seven primary auctions, numerous reconfiguration auctions, and have completed three full capacity commitment periods. We have obtained sufficient resources in each auction to meet capacity requirements and there have not been any outages due to lack of resources. We have seen the participation of diverse resources in the market. Demand response and energy efficiency have received significant capacity supply obligations and have performed well. Significant uprates of existing units have taken place, which are a low cost means of obtaining new capacity.”
When the NEMA-Boston capacity zone was short of resources to meet that area’s needs, a new combined cycle power plant bid into the auction and received a capacity supply obligation, Ethier noted. However, simply counting megawatts is not enough. If the capacity is installed, but does not perform reliably when needed, then the reliability standards will not be met, he added. So there must be enough capacity, and in aggregate it must perform well enough to allow reliable system operation.
With respect to the second goal of the capacity market – ensuring that the first goal is met in a cost-effective manner – the metrics to measure success are more complicated, Ethier said. There are three important perspectives to consider in analyzing whether capacity costs are appropriate.
- First, from the perspective of the market administrator, the capacity market is successful to the extent that the lowest cost resources are developed and brought to market. This is efficiency – whether the market results in an outcome in which society’s resources are deployed in the most cost-effective way. Evidence indicates that many low-cost resources have indeed been developed under FCM, indicating that New England’s capacity market is a success. This includes uprates and significant amounts of demand response, each of which has entered the capacity market at prices far below those estimated for the cost of a new generating resource. For example, in the most recent primary auction, the capacity market procured approximately 1,600 MW of passive demand resources, which include energy efficiency, and many hundreds of megawatts of active demand resources.
- Second, from the perspective of the resource owners, the capacity market is successful if in the long-run owners expect to receive adequate risk-adjusted return on their investments, comparable to the returns obtained from similarly large-scale and similarly risky investments in other sectors of the economy. If this is not the case, then the market cannot achieve its principal objective of procuring sufficient resources to meet demand and reliability needs. It is difficult to evaluate the success of the capacity market pursuant to this metric, however, because the region has had a significant surplus of capacity, lowering capacity prices, since the inception of the market. Some of this surplus is the result of the continued participation of existing resources, and some is the result of new out-of-market entry. This suggests that the recently implemented minimum offer price rules are an important component in ensuring that the market provides appropriate long-run investment signals. As the surplus diminishes over time, capacity prices could increase sharply. Such volatility in capacity revenues for resource owners makes it more difficult to assess returns, in addition to creating a more challenging business environment for resource owners (as well as uncertain costs to consumers). It is desirable to dampen the price volatility in the market to reduce the risk for investors, and thereby reduce the cost of entering the market. For these reasons, ISO-NE will be considering with stakeholders whether to implement a demand curve as part of the capacity market design.
- Third, from the consumer perspective, the capacity market is successful if the total expenditures by consumers are no greater than needed to assure that the most economic resources enter the market. Given the surplus capacity in recent years as well as the administrative floor price that has been in place in all primary capacity auctions conducted to date, it is also difficult to evaluate the success of the capacity market using this metric. On one hand, with the persistence of the price floor through the seventh capacity auction and the fact that, with the exception of one zone in one auction, the floor has been reached in each auction, the evidence demonstrates that resource owners are receiving at least the market value of capacity. Some customer groups have argued that, in fact, reaching the price floor demonstrates that resource owners are receiving excess compensation. On the other hand, a significant volume of out-of-market capacity has gone into service, adding to the region’s capacity surplus and causing controversy regarding the price suppression from such capacity. FERC, in extending the price floor in the FCM, recognized that out-of-market capacity could affect capacity prices and undermine investor returns. While this has been echoed by resource owners, who contend that out-of-market capacity has suppressed price and undermined investment in the region, the states have argued that they have the right to build desired capacity and that the market design should not penalize consumers for such actions, Ethier noted. ISO-NE hopes, however, that with the new minimum offer price rules in place and with the imminent elimination of the price floor (beginning with the eighth primary auction, to be conducted in February 2014), these issues have been resolved, he added.