Occidental Power Marketing Suggests Hybrid of Backstop Procurement, Incentivized Voluntary Contracting for ERCOT Resource Adequacy

Occidental Power Marketing, L.P. has proposed in comments to the Public Utility Commission of Texas a limited backstop procurement mechanism to assure resource adequacy, that would provide incentives for voluntary forward contracting by load serving entities, and would have minimal impact on the energy-only market.

OPC described its limited backstop service (LBS) proposal as a hybrid of two alternatives noted by the Brattle report -- the "ERCOT Backstop Procurement at Minimum Level" mechanism and "Mandatory Resource Adequacy Requirement for LSEs" mechanism.

Essentially an insurance policy, the limited backstop service would authorize ERCOT to procure the limited resources needed to bridge any shortfall, for the next year only, through a reverse auction.

"As a limited procurement, LBS is intended to operate as an insurance policy without overly distorting the energy-only market. LBS is modeled on an established ERCOT process and past Commission precedents. Modeling on existing processes will minimize uncertainty and implementation risk. OPM's proposal should also have the advantage of costing dramatically less and having far fewer credit implications than a centralized capacity market," OPM said.

And unlike a centralized capacity market, LBS can be implemented within the timeframe necessary to make a meaningful difference on 2014 reserves, OPM said.

The limited backstop procurement process would operate as follows:

1. Designation of self-arranged resources
Prior to initiation of each year's ERCOT limited backstop procurement process, any LSE would be permitted to submit to the Commission and to ERCOT (under oath) a list of its owned or controlled resources' to cover all or part of its what it projects its load will be during peak times, plus the reserve margin percentage adopted by the Commission. This step would be voluntary for any LSE, but as noted below, it would reduce that LSE's risk of having any ERCOT LBS costs allocated to it. "This would significantly incentivize LSEs to own or contract for resources ahead of time, and would also appropriately direct the collection of any ERCOT limited procurement costs to LSEs that are short in the market," OPM said.

2. Determination of Additional Resource Need
In the current year, but only after LSEs have had an opportunity to voluntarily designate their self-arranged resources, ERCOT will identify any capacity shortfall projected for the summer period of the following reliability year relative to the target reserve margin set by the Commission. ERCOT will acquire resources through a limited procurement only if the CDR shows that not enough resources are projected to be available for the next year. If the CDR shows that enough resources are projected to be available for the next year, then ERCOT will not conduct any limited procurement, even if the self-arranged resources registered by LSEs do not meet the entire projected need. "This keeps ERCOT from over-procuring resources," OPM said.

3. Reverse Auction for Limited Backstop Resources
If ERCOT identifies a need for additional resources for the summer period in the next reliability year, ERCOT will then open a reverse auction to solicit bids from new, dispatchable resources for the capacity necessary to bridge any gap between the projected reserve margin and the desired reserve margin for the next reliability year. The auction would be opened in the fall to procure additional resources for the summer period in the next reliability year (and only that reliability year). Bids could be submitted by any new resource; however, it would have to be a new resource. New resources could include, "new generation, previously mothballed generation that is reactivated, new demand response, new energy efficiency, specifically identifiable firm imports in excess of historical levels or other new dispatchable resource in the market." A new resource would not include existing generation, existing demand response, existing energy efficiency, existing import capacity, or other resource that have previously participated in the ERCOT market at peak time, OPM said.

Necessary new resources would be selected in the limited backstop procurement on a lowest-cost basis. Once selected, the resource would be obligated to be deployed by ERCOT for the summer period of the upcoming reliability year in the limited way outlined below. After the summer period, the resource is free to remain in the energy-only market for subsequent periods (without restriction) or, if prices do not support its continued market participation, it can withdraw from the market.

4. Deployment of LBS Resources and Price-Setting
LBS would be deployed at a specific strike price at or near the system-wide offer cap ("SWOC") as a part of a revised Power Balance Penalty Curve to reflect the value of reserves (and the corresponding scarcity conditions on the system). That price will remain in effect until the LBS is recalled to avoid any price reversals. This will minimize the use of this capacity and the potential for market interference.

5. Payment Structure
Resources that are selected to provide LBS would receive a fixed capacity payment at the market clearing price for LBS, and would be allowed to retain all energy revenues or load imbalance payments (if any) when deployed.

6. Allocation of Capacity Payments
Capacity payments made to LBS resources by ERCOT would be allocated to market participants in a manner similar to RUC payments. Costs would first be paid by short LSEs (short LSEs being those LSEs who did not voluntarily submit a list of owned or controlled resources to the Commission and ERCOT sufficient to cover all of their proportional capacity plus reserve needs prior to the start of the LBS procurement cycle), up to a multiple of the average per kW cost of the LBS resources procured by ERCOT. This allocation of LBS costs would create a meaningful incentive for LSEs to obtain their own capacity in some manner to avoid the substantial risk of receiving an LBS cost allocation, OPM said. LBS is intended to be a limited backstop procurement and is not intended to be an alternative resource procurement mechanism for LSEs, and it is therefore important to have a cost allocation cap that is high enough to dissuade any LSE that might consider using LBS as its default resource procurement mechanism, OPM added. After allocating LBS costs to short LSEs in this manner, any remaining costs would be uplifted to all LSEs based on their load ratio share of the market at the time of peak.

OPM also rebutted claims that capacity obligations need to be cleared several years ahead in order to "allow time for new generation plants to be constructed."

"[E]ntities do not fund the major capital investment in building a new generation plant based on a single year's capacity price. Whether that single year's capacity price is for next year or for four years from now, it is still only a single year's capacity price, that in itself, will not support capital investment in new resources. What does support capital investment in new resources is a liquid market from which a forward curve can be built by those who develop, invest in and fund new resources as well as by those who trade in capacity attributes. A 'next year' resource obligation with a strong bilateral component is a much more liquid market from which a forward capacity curve can be built by interested parties. A 'four years from now' capacity obligation is likely to have much less new resource participation and is likely to be much less liquid due to the very significant credit requirements arising from the need for potential market participants to make commitments so far out into the future. For example, it could be much harder and would take much more credit for a rental generation supplier to make a commitment for four years from now than it would be for it to make a commitment for next year. As another example, it is much harder (due to future business uncertainties) and also takes much more credit for a demand resource to make a commitment to be interruptible four years from now than it does to make a commitment to be interruptible next year. Overall, OPM would assert that a more liquid, more certain 'next year' resource obligation will better integrate with ERCOT's energy-only market design, and will provide market participants with a better starting point from which to build the forward curves upon which investment decisions are based," OPM said.

"[A] review of other capacity markets with extended forward obligations shows that the large majority of all installed capacity claimed to have been incentivized by those extended forward obligations consists of resources that would likely have been available without the forward obligation being an extended obligation. For example, the large majority of new capacity resources claimed to have come from PJM's extended forward obligation consists of demand response and energy efficiency, increased firm imports, withdrawn and cancelled generation retirements, mothballed generation reactivations and generator upgrades, most of which are relatively short gestation projects compared to construction of new generation," OPM said [emphasis added].

OPM called the energy-only market the, "most efficient and least-complicated market design."

"It relies on natural market incentives rather than administrative interventions and mandates The energy-only market rewards participants that are quicker, more efficient, and provide better quality service than their competitors. It also empowers all technologies, both emerging and established, to compete on an even playing field," OPM said.