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Texas Market Monitor: "Not Sure" Any Capacity Market a "Good Facilitator" of Decision to Invest
"I'm not sure any capacity market is really a good facilitator of the actual decision to invest [in new capacity]," Dr. David Patton, President of Potomac Economics, ERCOT's Independent Market Monitor, said during a Texas workshop on resource adequacy yesterday.
Patton, who supports a capacity market if a mandated reserve margin is adopted, was explaining his view that forward procurement of capacity is not necessarily required if a capacity market is instituted.
However, his conclusion that capacity markets are not good drivers of investment decisions immediately implicates pricing decisions for capacity, even as Patton said that, "you have to pay everybody," and there should not be "price discrimination" (whatever that means in the context of a government-defined product).
Specifically, we can only see two reasons for adoption of a uniform clearing price for capacity resources which are procured to meet the mandated reserve margin.
1. Price discrimination arguments
2. The need for inframarginal capacity revenues to support new entry (investment)
The first argument can be dismissed out of hand. Price discrimination arguments only arise because the government-designed capacity product has been administratively determined to be perfectly fungible. In designing the capacity market, the government can just as easily recognize the inherent difference in value provided by different capacity resources, which is how customers actually view individual capacity resources. Especially since the intent of the capacity market is to provide "missing money" to capacity owners, in the absence of government-mandated procurements, customers are only going to provide support, via capacity procurements, to those resources expected to be missing money in the delivery year. Since the capacity market is a construct entirely designed by government fiat, worries about "price discrimination" distorting the "market" are spurious; but for government edict, capacity resources would not be fungible.
That leaves the need to support inframarginal revenues as compelling a uniform clearing price for capacity.
However, if Patton is correct that capacity markets are not good facilitators of the actual decision to invest (due to, among other reasons noted below, providing only 1 year of capacity payments), then paying all capacity resources, other than the marginal unit, inframarginal revenues is just providing a windfall to capacity owners, without incentivizing new investment. By providing a uniform clearing price, the capacity market is intended to attract new investment by new units with going forward fixed costs below that clearing price, since these new units would be able to earn margin. The entry of these units would then decrease the price paid by consumers, displacing higher-cost units.
But if capacity markets don't drive investment decisions, and don't drive new entry resulting in a lower clearing price, paying all units above-cost inframarginal revenues does nothing except raise the total cost paid by load, and guarantees capacity resources will earn more than simply their "missing money."
Patton noted even with those capacity markets with forward procurement, the capacity payment is generally only guaranteed for a single year, while the investor is building a 30-year asset.
"It's far from clear to me that they're going to make their decision to enter based on that one year," Patton said.
"What in all likelihood they're going to do is bank that year and then either forward contract or simply forecast what the capacity revenues are likely to be over the remaining 29 years," Patton said.
"If that's all they're going to do, then they can do that in a short look-ahead," such as NYISO's seasonal capacity auctions, Patton said.
If a short look-ahead capacity market is well functioning, and market participants can therefore forecast prices, "then it will facilitate the sort of forward contracting that actually does get plants financed," Patton said.
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October 9, 2013
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Reporting by Paul Ring • ring@energychoicematters.com
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