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Capacity Markets, The Reality: Paying for Resources That Don't Respond When Needed A recent filing by ISO New England at FERC should give Texas regulators pause in consideration of a capacity market because the filing details how, despite paying billions of dollars for capacity, resources receiving capacity payments don't respond when needed, leaving customers to ask what exactly they are paying for.
"In sum, at times of greatest need, many resources did not deliver based on their offered parameters"
Specifically, ISO New England has filed changes at FERC (ER13-1733) to the Forward Reserve Market, which, as part of a series of tariff filings, are meant to provide a solution for, "fairly significant reliability concerns for the 2013-2014 winter season."
Right there, red flags should be raised. Because ISO New England has a three-year forward centralized capacity market. How can the ISO have any reliability concerns if capacity markets assure customers of reliability (as Texas supporters say)?
ISO-NE's concerns are two fold. One of the concerns is related to increased reliance on natural gas for power generation and gas supply issues in New England.
However, of note to the capacity market is the ISO's second concern, which is, "generation resource operations during periods of stressed system conditions revealed that many resources did not perform at the levels of their offered parameters." [emphasis added]
Although the ISO's filing relates to the reserves market, given the presence of a capacity market in ISO-NE (and argument that resources won't survive without a capacity market), it's logical to presume that these resources which did not perform at the levels of their offered parameters were receiving capacity payments. ISO-NE confirmed to Matters that, indeed, this was the case, that there were resources which received capacity payments under the Forward Capacity Market, and which did not perform at the levels of their offered parameters. The ISO could not provide an aggregate amount of capacity of such resources, nor could it quantify the total capacity payments such units received.
To be clear, this non-performance by capacity resources was not in violation of the rules, which we think makes it even worse. Cleared capacity resources in ISO-NE have obligations triggered during shortage events, and the non-performance described by ISO-NE did not occur during a shortage event (under the strict ISO definition), and thus no obligations were broken and no capacity payments were reduced or withheld to capacity suppliers. Under current ISO-NE rules, a Shortage Event is triggered when there has been a deficiency in ten-minute operating reserve for 30 or more minutes.
However, as ISO-NE makes clear, the non-performance of resources (some of which are receiving capacity payments) does indeed threaten reliability, regardless of whether conditions meet the definition of "shortage event."
"The ISO's analysis of operational performance of existing resources during stressed system conditions - times when resources' performance is essential to reliability - indicates that older units that are relied upon for peaking service, ramping or reserves are sometimes not performing to the full extent of their offered parameters. These shortcomings became manifest in operational events on June 24, 2010, September 2, 2010, and January 24, 2011 (including a NERC violation related to inadequate generation contingency response on September 2, 2010)," the ISO said.
Matters would note that, generally, these older units are the very units whose lives are extended by a capacity market, because the capacity market favors their low going-forward fixed costs over new (higher fixed cost) units, despite these older units' inefficiency and reliability risk.
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ADVERTISEMENT "More generally, an examination, conducted in early 2012, of dispatch response performance following the 36 largest system contingency events over the last three years indicates that, on average, the response rate for New England's non-hydro generation resources was less than 60% of the amount requested during the events. The non-hydro generators that were dispatched to address these contingencies were largely fast-start resources and spinning reserve resources, and the dispatch performance during these events is a low response rate for resources that are tasked with providing reserves in New England," the ISO said.
"In sum, at times of greatest need, many resources did not deliver based on their offered parameters," ISO-NE told FERC (emphasis added)
The fact that customers are paying billions of dollars in capacity payments, but still face reliability challenges during non-shortage events (which could even be true shortages in the sense of a lack of resource adequacy but simply do not meet the strict ISO-NE shortage definition, apart from more transient events) challenges any notion that customers receive value from paying for a mandated reserve margin. It's a bit like buying health insurance only to find out that your insurance covers care for chronic conditions (e.g. covering a known condition, similar to meeting a known condition like a mandated reserve margin), but won't pay a dime if you suddenly develop chest pains and need a bypass (transient events).
To ISO-NE's credit, it recognizes the current deficiencies in the capacity product, and is pursuing changes to the structure of the incentives and consequences that apply when the system is short of reserves. Specifically, under one proposal, all resources would be subject to a performance standard, eliminating all exceptions from performance now contained in the Forward Capacity Market rules. ISO-NE is also working to tighten to definition of shortage event, in order to trigger capacity suppliers' obligations more often.
However, with the ISO's biggest proposed change (pay-for-performance in the capacity market) not proposed to be implemented until some eight years after the introduction of the capacity market (delivery year 2018/19), we have to wonder if it's a bit like closing the barn door after the horses have left. It might be an improvement to the existing capacity market (and will still suffer more global flaws with any regulated capacity mandate), but customers will still have paid, for eight years, for a weak, unreliable capacity product. They can't get that money back.
The performance of resources has been a key concern of Texas regulators with respect to a capacity market, with Commissioners generally agreeing previously, when the current resource adequacy review began, that the energy-only market is superior for maximizing the performance of generators, because generators are losing money if they're not running. In contrast, under the ISO-NE capacity market, these resources which did not perform, and risked reliability, still received their capacity payment despite not responding (while they forewent an energy payment, at a much lower price cap than ERCOT, the ability to earn capacity revenues more than compensates for this).
Over the past year, however, it seems that individuals at the Texas Commission have acquired target fixation on meeting a mandated reserve margin, which due to limited options, almost necessitates a centralized capacity market. As noted above, simply meeting a mandated reserve margin may not guarantee all the purchased capacity is available, and may still result in reliability violations even though the reserve margin is met (and not because demand spiked above the forecast, but rather because paid-for resources are not available).
While we've heard the arguments for a mandated reserve margin, we haven't heard any rebuttal or refutation of the Texas Commissioners' original concerns about incentivizing proper performance of generators under a capacity market versus energy-only. The ISO-NE experience validates that these are real-world concerns, not merely academic exercises.
At the very least, ISO-NE's reliability risk, and its need to go back to the drawing board on the capacity market, rebuts the argument that Texas can simply graft a "working" capacity market from the East into ERCOT, with little effort or controversy. Indeed, even though Texas doesn't have FERC jurisdiction complicating things, the design of any capacity market will be just as administratively complex and contested, and prolonged. Aside from the common questions of forward commitment period, demand creation (vertical or sloping demand curve), and opt-out/self-supply options, it is clear Texas will have to address performance rules for capacity suppliers, which simply adds yet another layer of administrative determinations to an already bureaucratic construct. Texas regulators will have to make a determination of how resources should respond, and when, and penalties for non-response.
Taking the ISO-NE experience as a whole, it's another cautionary experience against the capacity market route, and illustrates the superiority of the energy-only market in efficiently matching supply and demand.
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June 24, 2013
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Copyright 2010-13 EnergyChoiceMatters.com
Reporting by Paul Ring • ring@energychoicematters.com
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