While the two-settlement processes for capacity payments rolled out by PJM Interconnect and ISO New England (ISO-NE) create uncertainty for variable output resources, they might not have any significant detrimental impact on their development, according to ICF International.
The consulting firm examined the issue in a white paper titled “Renewables in Performance Incentivized Markets.”
For renewables, performance-incentivized capacity markets present increased risk; however, potential new monetary opportunities from over-performance could outweigh the underlying risks, ICF said in the paper.
Carefully developed bidding strategy is required—bids must take into account risk tolerance, grid and unit output profiles, and capacity prices, ICF said.
The capacity market provides “missing money” for resources and supplements energy market sales. Resources, including renewables, recover a portion of their fixed and capital costs from the capacity market after netting energy margins.
Some market participants believe that the implementation of performance incentives in the PJM and ISO-NE capacity markets will hurt the economics and development of variable output resources, namely wind and solar.
The authors of the ICF report (Josh Ghosh, Himanshu Pande, George Katsigiannakis, and Judah Rose) say this isn’t necessarily so.
For thermal resources, capacity markets are often seen as a driver of new entry and exit in a region; the same does not hold true for renewables, ICF said. Factors such as state Renewable Portfolio Standards (RPS), along with state and federal incentives such as the renewed Production Tax Credit or Investment Tax Credit, play a significant role in encouraging renewable activity in a region.
“Many market participants are concerned that the penalties associated with underperformance would outweigh the base capacity revenues for such resources,” ICF said.
The authors find, however, that other factors off-set the downside posed by the threat of underperformance.
“First, renewable resources can actually reap additional benefits through bonus payments for the large portion of their capacity that is uncommitted,” ICF said. “These bonuses depend on several factors, such as their performance and the performance of other units. Second, independent system operators (ISOs) provide more flexibility to renewable resources than thermal resources in the capacity markets.”
Third, any adverse effects are limited because of the secondary role capacity payments have played for these resources, ICF said.
“This is in part because these resources often have an additional mechanism, compared to a thermal resource, to meet their missing money requirements, namely renewable energy credit (REC) markets,” ICF said in the white paper.
ICF also explained how bonus payments can help renewable projects.
“For example, in PJM, a 50 MW wind unit with a capacity commitment of 13 MW will have 37 MW of uncommitted capacity,” ICF said. “If there are 30 scarcity hours and enough underperforming resources, this unit could earn a bonus of up to $1.5 million on top of its capacity payment, assuming it provides output of 25 MW during each scarcity hour,” ICF said.
“In this example, the share of capacity revenue to total revenue can increase from 2% to 4% to up to approximately 18%,” ICF said.