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New Math: Capacity Market No Longer Designed to Clear at Lowest Cost! If tariff revisions are approved at FERC, ISO New England's forward capacity market will no longer be designed to clear the market to minimize total costs.
Instead, the clearing mechanism will be designed to maximize social surplus.
The change is largely prompted by elimination of the price floor in the auction, and the impact on the clearing mechanism from such elimination.
"While the descending-clock auction ably performs its role in winnowing the relevant resources and prices to the right neighborhood, in the specific area where supply and demand intersect, there are (because of the lumpiness of the supply curve and multiple zones) in general a number of potential solutions regarding which resources should clear and at what prices," the ISO said.
Moreover, given this reality, the ISO conceded that picking the precise clearing points amounts to "subjective" decisions about the proper outcome.
With the elimination of the price floor, which barring the ISO's changes would prompt the use of the cost-minimization approach to clear the market for the first time, the ISO said that the FCM rules contain provisions, "that will significantly limit the ability of the market clearing engine to effectively select a cost-minimizing solution."
Notably, the ISO said that one technique that would be used by the market clearing engine in seeking to minimize total consumer costs would be to clear smaller, but more expensive, quantities of capacity to get closer to the needed amount of capacity at a lower overall cost. In doing so, it may be necessary to increase the cost in a particular capacity zone in the service of lowering total system-wide costs. However, increasing the cost in that particular capacity zone may be effectively prohibited by other FCM provisions, such as: (i) the requirement to clear, generally, any new offer below the capacity clearing price, which would largely preclude the market clearing engine from avoiding large "lumpy" offers in seeking to lower total consumer costs; and (ii) the requirement that the market clearing engine ignore, in an import-constrained capacity zone, capacity that is not needed to meet the zone's Local Sourcing Requirement, which would make it much more difficult to raise the price in an import-constrained zone.
This, alone, however is not the ISO's sole justification for abandoning the cost minimization clearing metric. "[G]iven these restrictions [noted above], the total consumer cost minimization approach is needlessly complex," the ISO added. "Minimizing total costs requires the market clearing engine to solve for both the capacity clearing price and for the cleared quantities simultaneously. This is a non-linear mixed integer problem with equilibrium constraints that is very difficult to solve. Moreover, the techniques used to solve the problem are not standard and rely on heuristics."
The ISO said that to address these problems, it has proposed rule changes replace the market clearing engine's goal of minimizing total consumer costs with the goal of maximizing social surplus. Social surplus (sometimes called social welfare) is in this case the sum of consumer surplus and supplier surplus, and this value is at its maximum when demand equals supply.
The ISO said that the solution to maximize social surplus will first determine the cleared quantity of each bid in a well-defined optimization problem that maximizes the social surplus, with the clearing price being determined ex post in a separate pricing problem.
"[T]he ISO does not expect that this change will result in auction results that are appreciably different than those that would have resulted from the existing market clearing engine," the ISO said.
While the accuracy of this expectation will be borne out in future auctions, the ISO's filing further reinforces that capacity markets are not "markets" in any meaningful sense of the word, and amount to computer programs running administrative tariffs and rules, with unregulated prices.
Docket ER13-1880
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July 2, 2013
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Reporting by Paul Ring • ring@energychoicematters.com
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