Texas Should be Skeptical of Capacity Market as Demand Response Incubator Given Obstacles Introduced to Negate Generator Competition in Eastern RTOs

As Texas considers resource adequacy, and specifically demand response, it should view skeptically claims, especially from capacity owners, that the fastest and most effective way to develop demand response resources is to introduce a centralized capacity market.

Several capacity owners in ERCOT have told the PUCT that a centralized capacity market is the best way to facilitate demand response. "[T]he single biggest incentive for increasing DR in the most equitable, transparent, and market-based approach is through the development of a centralized forward capacity market in which both Generation and DR can participate," Exelon Generation, LLC has said.

However, experience shows that while demand response is an active participant in the eastern capacity markets, generators in those markets continually attempt to stymie and restrain the participation of demand response in capacity markets, by advocating command and control rules regarding demand response's participation, in the name of comparable obligations with physical capacity, or reliability assurance.

It's yet another example of capacity market proponents embracing a less controversial design to get their foot in the door, then rushing to make the market as favorable as possible to incumbent asset owners once a capacity market has been adopted by regulators. As previously noted by Matters, in response to the disinclination of Texas regulators to certain capacity market features, most notably the price floor, proponents of a Texas capacity market initially said there would be no need for a minimum offer capacity price in Texas. Of course, these same capacity market proponents turned around and said that the lack of minimum offer price floor can be "revisited" as warranted by a maturing market (see prior story).

A similar experience can be expected with demand response. Once a capacity market is adopted, expect physical capacity owners to do everything to gain a competitive advantage over demand response by advocating unwieldy and unworkable rules for demand response, in the name of reliability assurance. Of course, a true market wouldn't have the plethora of command and control rules like a capacity market would, but we will not belabor that point here.

The latest example of barriers facing demand response in the eastern capacity markets is PJM's adoption of several new requirements for demand response capacity resources, under "DR Sell Offer Plans" which must be submitted by demand response resources.

The requirements are purportedly to assure demand response performance in the future during the capacity deliverability period, which, certainly, is something that is needed.

However, several of the mechanisms to assure performance are simply incompatible with the nature of bringing new capacity into the market, which is the claimed purpose of these capacity markets (supporting new capacity).

Most notably, the DR Sell Offer Plans require a customer "letter of support" in certain cases, in which the customer must attest to being "likely to execute a contract" obligating them to provide demand response three or more years in the future. If the customer declines to provide such a letter, or provides one to more than one demand response supplier, that capacity cannot be counted at all and will be removed by PJM from each demand response suppliers' plans that include that customer.

While Matters understands the need for capacity resources to perform, this should be assured by market mechanisms -- namely severe penalties -- rather than command and control eligibility-type rules.

Matters does not claim to know what, if any, similar metrics new physical capacity must complete prior to its eligibility. But certainly, under the very forward design of the market, there can never be assurance that new capacity will actually be available, regardless of its form. For example, a new power plant which is dependent on the capacity payment revenue stream for development is not going to start major construction until it clears the market and is assured of the capacity payment. While the generator may be required by rule to assure a commercial operations date, there is no guarantee of this, due to construction delays, materials shortages, etc.

Regardless of the form of capacity, it should be allowed to bid, as would occur in any market. While future delivery is a realistic concern, especially for demand response resources (see the Maryland Gap RFP contracts), establishing proper penalties for non-compliance, severe enough such that no capacity bidder would risk non-compliance, would properly address this problem, rather than regulator review of sell offers in the market.

Moreover, proponents of the single-clearing price capacity market (with new and existing capacity entitled to that price) love saying that capacity is a fungible product. If that is the case, so long as capacity sellers meet their obligations and no double counting is employed, PJM should be agnostic of where the capacity comes from. However, the DR Sell Offer Plan would appear to limit the creation of fungible capacity portfolios to meet sellers' obligations.

Various demand response providers have filed a complaint at FERC over the new PJM rules (Docket EL13-57).