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Seven Years Later, Capacity Market Conceded by RTO To Be A "Failure"
"[R]eliability in New England is deteriorating as a result," of the "failure" of the current capacity market to reflect some of the most basic principles of a market -- higher-valued, higher quality goods should receive greater compensation than goods offering poor quality and poor service, ISO New England said in a filing at FERC on Friday.
As noted by the ISO further below, not only does the capacity market not incentivize performance, but by clearing units with the lowest going-forward fixed costs and not penalizing these units for non-performance, the capacity market incentivizes these poor-performing units to remain in the market instead of exiting, displacing more reliable units
"Resources with lower going-forward costs and relatively poor performance clear in the Forward Capacity Auction instead of those with higher going-forward costs but better performance, even where the latter are more cost-effective. This structural bias towards clearing of less reliable resources in the FCM can only lead to serious reliability problems on the system" -- ISO-NE
This is what you get when the government writes thousands of pages of tariffs, eliminates consumer choice, and proclaims it a "market."
Unfortunately, rather than recognize this failure as a fatal flaw of the capacity market, ISO-NE believes that the market can be resuscitated with yet another administrative fix, even as it concedes seven years of market fixes and changes have not rectified the failure. ISO-NE is specifically proposing the previously drafted and anticipated performance incentives for capacity suppliers.
But the ISO's filing is more instructive in the utter admission of a broken system. While it's laudable that the ISO now recognizes consumers are getting poor service and un-assured reliability in return for their billions of dollars in capacity payments, it took seven years for the ISO to concede this fact which is patently obvious to anyone paying an electric bill in these ostensibly "choice" markets. Such is the glacial pace of regulation.
"When sellers can depend on payment regardless of the quality of the product delivered, quality tends to suffer. When payments reward higher quality, quality tends to improve. While there have been many efforts to refine the FCM over the years, its design has always failed to reflect these most basic principles, and reliability in New England is deteriorating as a result," ISO-NE told FERC.
"Much of the reason for the FCM's failure in this regard is its complexity. The product is poorly defined; while the region requires resources that reliably provide energy and reserves when supply is scarce, the FCM instead buys something only vaguely related to that, called 'availability.' The FCM applies different rules and different standards to different types of resources (even though it seeks to buy the same product from all of them), and includes numerous one-off provisions and exceptions. And at the end of the day, capacity 'obligations' mean little because there are rarely financial consequences for failing to perform," the ISO said.
"Each of these elements of the current FCM is contrary to sound market design. This is not surprising, however, because the core FCM design was not based on any standard market model. Rather, the FCM was built from the ground up, without a blueprint, through a long series of negotiations and compromises. The result is an idiosyncratic design that is failing to meet its most basic objectives -- ensuring reliability in a cost-effective manner," the ISO conceded.
"In the current FCM design, capacity payments are poorly linked to resource performance. In many cases, capacity resources are being paid for simply existing, rather than for actually performing when they are needed. With the linkage between payments and performance broken, there is little incentive for resource owners to make investments to ensure that their resources will be ready and able to provide energy and reserves when needed. The lack of such investment is posing serious threats to the reliable operation of the system," the ISO said.
"[T]he ISO has observed and documented pervasive and worsening performance problems among the existing generation fleet in New England."
Non-performance is chronicled in our two related stories today:
SHOCK: Unplanned Generation Outages DOUBLE After Introduction of Capacity Market; 13% of Total Capacity Supply Obligation Offline During Heatwave
What Billions in Capacity Payments Buy: Shoestring-Operated Capacity Suppliers Unable to Dispatch Because No Staff is Present
"In the current FCM, the consequences for non-performance are negligible," the ISO continued. "As an initial matter, even with recent revisions to the definition, Shortage Events are extremely rare. A supplier that is confident that the performance of its resource will rarely be measured is unlikely to feel a strong incentive to take steps to ensure the resource's ability to perform. Furthermore, the current rules include numerous exemptions, under which resources are considered 'available' during a Shortage Event even when they do not provide any energy or reserves whatsoever. A supplier that receives its full capacity payment while providing no energy or reserves is unlikely to see the need to invest in the ability of its resource to perform. Finally, even where a capacity resource is exposed to penalties under the current design, those penalties are capped such that there can be no net loss on FCM obligations, no matter how poorly the resource performs; participation in the current FCM essentially constitutes a free option. A supplier that cannot lose money for failure to perform as obligated is poorly incented to meet its obligations."
"The 'money for nothing' nature of the current FCM design results in adverse selection of capacity resources. It encourages resources that are likely to be poor performers to participate in the market when they should exit. Resources with lower going-forward costs and relatively poor performance clear in the Forward Capacity Auction instead of those with higher going-forward costs but better performance, even where the latter are more cost-effective. This structural bias towards clearing of less reliable resources in the FCM can only lead to serious reliability problems on the system, and is of course contrary to the goals of good capacity market design," the ISO said.
The ISO noted that while the oft-quoted raison-d'etre of capacity markets is to provide "missing" money, "it is not enough to simply calculate the amount of the missing revenue and give that amount to suppliers."
"In a fully functioning and uncapped energy market, the 'missing' revenue would be paid only to resources that are actually providing energy or reserves during periods of scarcity. It would not simply pay out that revenue to all resources that exist or that are conceptually 'available,'" the ISO said.
"Having that money paid for actual performance during periods of scarcity is precisely what incents resource owners to make investments to ensure that their resources will be ready and able to provide energy or reserves," the ISO said.
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January 21, 2014
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Reporting by Paul Ring • ring@energychoicematters.com
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