FERC: Capacity Suppliers' Obligation Under Capacity Market Not Real Obligation; Waived if Unable to Procure Fuel, Transportation

Capacity suppliers in ISO New England need not meet their capacity supply obligations as required under their commitment, established in the capacity market, to supply capacity during shortage hours if such capacity suppliers can demonstrate an, "inability to procure fuel or transportation," FERC ruled yesterday.

This exemption, along with existing exemptions to the capacity supply obligations under which consumers are paying billions of dollars, eviscerates any notion that current capacity market designs assure reliability or can keep the lights on.

FERC noted that although the ISO-NE tariff imposes what FERC termed "strict" performance obligations on capacity resources, the tariff, "also recognizes that certain events may cause a capacity resource to be unable to follow dispatch instructions."

In particular, FERC noted that Forced Outages, Force Majeure events and other events that result in a capacity resource not being physically available, "may excuse a capacity resource from following dispatch instructions."

This is of extreme import to Texas where the last rolling outages seen in ERCOT in February 2011 were not due to a lack of installed capacity, but rather the forced outages of a large amount of such installed capacity. Paying billions of dollars to capacity resources to meet a minimum reserve margin would not have prevented these rolling outages if Texas simply adopted, as proposed, existing capacity market designs which excuse performance for a variety of reasons, such as forced outages.

FERC did rule that an "economic determination not to procure fuel or transportation" does not excuse a capacity supplier from its capacity supply obligation.

However, FERC's order does not clearly define what constitutes an "economic decision."

Notably, with respect to fuel and transportation, economic decisions taken weeks, months, or even years in advance could, in the future, lead to a, "demonstrated inability to procure fuel or transportation," which FERC says excuses the capacity supply obligation.

For example, a capacity resource may eschew a firm service fuel or transportation agreement for economic reasons. When the capacity supplier is then interrupted during emergency conditions (such as an operational flow order) and unable to procure gas, is this considered a, "demonstrated inability to procure fuel or transportation," which excuses the obligation, because the capacity supplier was prepared to pay, in real-time, for the fuel/transportation but for the OFO, or will FERC find that the decision to forgo a firm service agreement was an economic one, and therefore, the excusal from performance is not granted. This is not clear from FERC's order.

Indeed, any decision regarding fuel or transportation could ultimately be considered economic. Taken to its extreme, it can be argued that constrained natural gas transportation into and in New England is well-known to generators. However, generators who do not make alternative arrangements to not rely on this constrained system (such as building a new pipeline) and relieve any potential for interruption are making an "economic" decision regarding their procurement of fuel and transportation.

The FERC order obviously doesn't impose an obligation on capacity suppliers to build out the natural gas transportation infrastructure, but we highlight this logical extension of the "economic" decision regarding fuel and transportation capacity to highlight how the distinction between an "economic" decision to not procure fuel or transportation, and a "physical" inability to procure fuel or transportation, is meaningless. Natural gas-fired generators know they need transportation and supply of gas. If they are unable to procure it during emergency conditions, when such emergency conditions are well-known and increasingly commonplace in New England, can a "physical" inability to procure gas during these emergency conditions really excuse a capacity supply obligation, when the generator made an economic decision not to make alternative arrangements to assure fuel delivery? As we read FERC's order (and we stress FERC does not clearly define what is a physical inability to procure fuel versus an economic decision so this is our interpretation), the answer is "yes" -- so long as a capacity supplier can demonstrate it was unable (and not just unwilling) to procure fuel or transportation when dispatched (not previously), it will be relieved of its capacity supply obligation.

This should dispel any notion that capacity markets, at least as designed in ISO New England (and similar eastern RTOs), "keep the lights on" -- because resources don't have to perform when they don't have fuel. Not only does this threaten reliability, but generators are excused from their capacity supply obligation, meaning not only are they not penalized for non-performance -- they are still paid their monthly capacity payment for being "available" -- even when they weren't!

Yes, capacity suppliers that are unavailable give up energy market revenues -- but the fixed capacity payment, which they retain, make this decision palatable. Indeed, when considering the cost of firm fuel and transportation, giving up short periods of scarcity pricing probably has very low opportunity costs (if any at all), because the fixed capacity payment is still being received by the resource.

Compare this to the February 2011 event in Texas. Resources which were offline due to fuel or transportation procurement issues recovered ZERO costs for the time they were offline -- missing one of the few scarcity pricing events in the market, and the opportunity to recover fixed costs and earn margin on top of that. This lost opportunity to earn scarcity revenues incents Texas resources to be online when needed most, and incents those resources which were offline to not repeat the same mistake.

In contrast, had Texas been operating under the ISO New England capacity market design, those Texas resources which were offline due to a demonstrated inability to procure fuel or transportation would have still received capacity payments from Texas customers, even though they produced no power, and made no contribution in an attempt to avoid rolling outages. Because resources still received a capacity payment, their incentive to contract for costly firm fuel or transportation, to assure their availability, is severely reduced.

Notably, FERC does say that, "If a capacity resource cannot procure fuel or transportation in real time in order to run at dispatch levels beyond its day-ahead commitment (or when not scheduled in the day-ahead market), then the resource is not physically available to perform for a reason beyond the resource's control for those additional hours and/or incremental MWs; thus the resource may be excused for non-performance" (emphasis added).

While not explicit, this emphasis on the "real time" ability of the capacity resource to procure fuel or transportation does suggest a complete evisceration of any semblance of the capacity payments from load creating a true capacity obligation. By stating that capacity suppliers unable to procure fuel or transportation in "real time" may be excused from their obligation, it suggests that there is no firm service requirement for fuel or transportation, and even though capacity suppliers previously made an economic decision to forego such prudent arrangements to assure performance, their "real time" inability to procure fuel or transportation will not be considered an economic decision, and they will be excused from their capacity supply obligation.

It bears noting that most instances in which generating resources have an inability to procure fuel or transportation will coincide with strained conditions on the electric grid -- meaning capacity suppliers, who are being paid billions of dollars, are being excused from performing and providing capacity to the grid during the times it is most needed.

More from FERC's order:

"There is, however, an important distinction between being unable to procure fuel or transportation and making an economic determination not to procure fuel or transportation. Contrary to ISO-NE's position, the Commission finds that, under the Tariff, a demonstrated inability to procure fuel or transportation for a resource to run beyond (in terms of hours and/or incremental MWs) its day-ahead commitment, or when not scheduled in the day-ahead market, may legitimately affect whether a resource is physically available. If a capacity resource cannot procure fuel or transportation in real time in order to run at dispatch levels beyond its day-ahead commitment (or when not scheduled in the day-ahead market), then the resource is not physically available to perform for a reason beyond the resource's control for those additional hours and/or incremental MWs; thus the resource may be excused for non-performance."

"Determining whether a capacity resource was unable to obtain fuel and/or transportation will, of necessity, be a fact-specific inquiry," FERC said. "The IMM will need to make such determinations on a case-specific basis in the first instance and will refer the cases to the Commission thereafter if the IMM has reason to believe that the resource's action is a Tariff violation. Given the complexities involved in determining whether a particular resource has demonstrated that it was unable to procure fuel in order to satisfy its performance obligations, the Commission will require ISO-NE, through its IMM, to provide a written explanation regarding factors the IMM typically expects to examine to determine whether there is a reason to believe that a violation has occurred."

Again, while FERC does find that a capacity supplier's "economic" decision to not procure fuel or transportation does not excuse a capacity supply obligation, FERC's definition of what constitutes an economic decision is so narrow it renders the distinction toothless:

"The Commission finds that economic considerations are irrelevant to determining whether a unit is 'physically available,' based upon a natural interpretation of the term 'physical,' as pertaining to that which is material or mechanical. Only a strained reading of that term would include consideration of price. Thus, the price of fuel may not affect a unit's physical availability, nor does an unwillingness to procure fuel at the prevailing price qualify as a “Forced Outage” or “Force Majeure” event based upon a reasonable interpretation of those terms," FERC said (emphasis added).

"As discussed above, a resource with a Capacity Supply Obligation must offer a MW amount equal to or greater than its Capacity Supply Obligation into the day-ahead and real-time energy markets when that resource is physically available, and those offers must remain open through the operating day for which the supply offer is submitted. Given that the exceptions to performance for physical unavailability, Forced Outage or Force Majeure are not applicable when a resource owner declines to purchase fuel due to price considerations, the Commission finds that a capacity resource that fails to comply with dispatch instructions when it is physically available but has determined not to procure fuel or transportation due to economic considerations is in violation of the Tariff," FERC said (emphasis added).

Again, Matters stresses here the emphasis on "prevailing price" and "operating day" as meaning FERC is limiting its economic versus physical distinction to real-time (or near real-time) conditions. While it is clear from the discussion above that a resource, in real time, cannot claim fuel is unavailable simply because of high prices during emergency conditions, it does not appear FERC is elongating this decision metric to include prior decisions, such as whether to contract for firm service. Again, we find no support in FERC's order that would require a capacity supplier to, ahead of time, contract for firm fuel or transportation service to assure that the capacity supplier meets its capacity supply obligation. So long as the capacity supplier can demonstrate an inability to procure fuel or transportation when called to be dispatched on a specific operating day (regardless of whether this inability is due to an economic consideration to not elect firm service), the capacity supplier is excused from its capacity supply obligation, and customers pay the resource for not performing when so obligated.

Docket EL13-66