By Mike Hogan, Michael O'Boyle, and Sonia Aggarwal
Competitive
wholesale power markets are meant to sustain needed investment based on
market participants hedging risks in response to transparent pricing in
the energy and ancillary services markets (“the energy market”).
In
practice it has been challenging to ensure that market prices fully
reflect actual market conditions. This has led to concerns that some of
the money and risk exposure needed to drive investment is "missing”
from the energy markets. Some market operators have responded by
introducing “capacity markets,” which are intended to bridge the gap
between revenues available from energy markets and the all-in cost of
desired capacity. Capacity markets offer commitments, still short-term
relative to most investment timescales, to make fixed payments for the
right to call on the resource when needed. In so doing, they “levelize”
a portion of expected revenues that would otherwise have been volatile
and difficult to predict. They also transfer some of the role of
determining both the amount and type of investment needed from the
market to a central administrator.
The amount of capacity a system
needs in a given period is a function of the maximum expected demand
and capacity markets have traditionally been designed on that basis.
But customer expectations about reliability require that these
resources perform not just when demand is at its highest but also under
other extreme conditions. That was not the case in the Northeast and
Mid-Atlantic during the 2013/2014 Polar Vortex when reliability was
placed at risk because a great deal of committed capacity failed to show up.
In large part, this resource flakiness was caused by weather-related
plant outages coupled with fuel delivery problems, failures that the
existing capacity markets largely do not address. System operators have
proposed revisions to existing markets to drive improvements in the
resource mix in hopes that it will result in better reliability. But it
remains to be seen which if any of these reforms will keep up with the
needs of a system in transition while promoting affordable, clean
electricity.
Pay-for-Performance
System
operators in regions affected by the Polar Vortex—PJM, NYISO and ISO-NE
—have each proposed market reforms to address resource performance.
While NYISO, which has a capacity market, has concentrated on
improvements in energy market pricing, PJM and ISO-NE have concentrated
on revising their capacity markets, adding “pay-for-performance”
mechanisms that increase capacity payments for resources that perform
during all peak and emergency hours, rather than just the
annual peak, and penalize the resources that fail to show up. After
these changes, the risk of non-performance will fall more heavily on
capacity resources and less on system operators and consumers.
The
Federal Energy Regulatory Commission (FERC) approved ISO-NE’s capacity
market revision in 2014 and is currently considering PJM’s proposal.
ISO-NE split its capacity payments into two parts: an initial payment
followed by a performance payment or penalty. As before, the marginal
offer sets the clearing price for the base capacity at the time of the
auction and higher offers are rejected. The difference is that when
these resources enter the system three years later their total payment
is adjusted for performance via an additional payment or penalty.
The
performance payment or penalty is a function of how well a resource
actually performs during emergency, summer-, and winter-peak conditions
(“scarcity events”) relative to its original capacity offer. The
penalties paid by under-performing resources cover the higher costs paid
to over-performing resources to maintain system balance. The table
below (from ICF) shows the numbers for ISO-NE:
How Will This Change the Resource Mix?
Under
the old market structure, resource owners offered capacity into the
market based on the difference between all-in costs and expected
revenues from energy and ancillary service markets, with the risk of
“normal” operating problems borne largely by consumers. Under this new
structure generators must account for a substantially higher risk of
penalties for non-performance during scarcity events, which themselves
will grow more frequent and less predictable as more variable generation
is added to the system and as “extreme” weather events become more
commonplace in a changing climate. Additionally, resources not directly
involved in the capacity market (either because they do not offer in
their resource or because their offers are too high to be selected) can
still be rewarded for providing electricity during scarcity events.
As
a result, the new structure becomes an unattractive prospect for
resources that are seasonal or at risk during scarcity events. At the
same time, resources that can expect to be available year-round and in
extreme conditions get a shot in the arm under the “pay for performance”
structure, with a renewed incentive to lock down their fuel supplies,
add dual-fuel capabilities, and protect plant operations from extreme
weather events like deep freezes or drought. ICF predicts this
will raise capacity prices for ISO-NE but ultimately drive down
wholesale energy prices and increase overall system efficiency and
reliability.
While it seems certain that these changes will
improve resource availability during scarcity events, it is less clear
whether they will deliver greater system flexibility since there is no
explicit reward for responding quickly (rather than simply being up and
running in advance). The Analysis Group concluded that
the most significant response in ISO-NE would be to add dual-fuel
capability to existing gas plants, which would do little to increase the
flexibility of the system. In fact, driving down wholesale energy
prices (by replacing them with fixed capacity payments) reduces
incentives for flexible resources—particularly demand response and
energy storage—whose values rely heavily on short-term price volatility.
PJM’s Pending Proposal
The new PJM Capacity Performance proposal adopts
a similar framework to the one used in ISO-NE but introduces “resource
coupling” to help level the playing field for all resources. “Resource
coupling” in the capacity market allows
more seasonal or variable resources like some forms of demand response,
variable generation and energy efficiency to “couple” their offers with
one or more resources that complement their generation profiles. For
example, wind turbines (which often produce more in the winter and at
night) can combine with solar plants (which produce more in the summer),
energy storage, or demand response to comprise a single offer into the
capacity market in PJM.
Some public interest organizations in the
PJM proceeding would prefer to see FERC reject the proposal, however,
asserting in their comments to FERC that
the deck may be unfairly stacked against renewable resources, and that
this is a broad, costly solution for a relatively small problem. The
ability for seasonal or variable resources to couple their offers with
other resources mitigates the inherent disadvantage they face to some
extent, but the benefits of coupling will be dampened by the
restrictiveness of combining smaller sets of resources instead of taking
advantage of the diversity in the full portfolio of resources on the
system.
If the system’s primary unmet need is dependable capacity,
the proposed capacity market reforms may well do the trick. A broader
challenge remains, however: these markets have long-term flexibility
needs as well, and even these revised administrative capacity mechanisms
may prove too rigid to adapt efficiently to the coming system evolution.
Placing greater emphasis on improved energy market price formation,
such as the NYISO proposals approved in early 2015, may be an
alternative that addresses the wider set of challenges more efficiently.
Implications for Grid Flexibility and Resource Adequacy across the Country
It’s
difficult to say what impact these capacity market reforms will have on
the rest of the country. By no means are pay-for-performance capacity
markets the only way to ensure resource adequacy, and they do not
directly favor a significantly more flexible resource mix. Energy and
capacity markets can—and should—be reformed to drive efficient
investment in more flexible, reliable resources. For example, Mike
Hogan, author of Aligning Power Markets to Deliver Value, described in a recent paper how
we could value flexibility in energy and ancillary service markets by
more fully pricing scarcity and further opening markets to
non-traditional providers. NYISO focused their reforms on
improvements in energy market pricing, and even in PJM and ISO-NE the
capacity market reforms have been accompanied by multiple proposals to
improve shortage pricing in energy markets. The Electricity Reliability
Council of Texas (ERCOT) has proposed reforms to
its energy and ancillary service markets to value the properties that
flexible resources can provide. Outside of restructured market areas,
planning will continue to play an important role in ensuring adequate
system flexibility.
There are, of course, tradeoffs between
different market solutions. Capacity market approaches may be simpler
to administer but they focus on meeting peak when we know we also need
more system-wide flexibility. Likewise, allowing energy market
prices to fluctuate more freely or refining ancillary service market
products may support flexible resources but may prove too complex or too
politically unpalatable. Energy decision-makers will want to watch
closely to see which of the responses to the Polar Vortex - or which
other approaches we’ve yet to see proposed - best facilitates the
transition to an affordable, reliable, clean electricity system.
However
it’s supported, it is clear that a more flexible, resilient resource
mix is needed. As weather patterns change and variable resources become
a greater share of our electricity supply, an efficient market should
deliver flexible resources to complement low-marginal-cost energy from
variable resources at the lowest possible cost.
http://theenergycollective.com/americaspowerplan/2222361/do-pay-performance-capacity-markets-deliver-outcomes-we-need
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