Capacity Market: Door to More Supplies or Pandora?s Box?

A capacity market appears to be on the state?s horizon?but how it might be shaped to address resource-adequacy requirements remains an open question. Getting input on existing East Coast capacity markets, which allow the advance sale of a generating unit?s capacity separately from its output, and assessing the benefits and pitfalls of creating such a market in the Golden State were the focus of a packed meeting October 4-5 hosted by the California Public Utilities Commission, the California Independent System Operator (CAISO), and the Energy Oversight Board. Resource adequacy is the administration?s top priority, and a capacity market is a means to that end, said Joe Desmond, the governor?s energy czar. The CPUC plans to vote later this month on whether to accelerate the 15-17 percent reserve mandate from 2008 to 2006 as urged by Governor Arnold Schwarzenegger. ?A capacity market is not the answer, it is part of the answer? for meeting that accelerated goal, Desmond said, adding that it could ?accommodate different market structures.? That presumably includes a revival of direct access. A properly designed capacity market is expected to allow generators to recover their costs because energy payments subject to price caps are supplemented with capacity payments. This forward market is also said to be a means to help utilities and other providers meet resource-adequacy needs by creating a place to buy and sell small amounts of capacity that could add up, and also exchange? negawatts? from demand response. It is also expected to keep aging power plants from being shut down. A looming question is whether capacity markets actually provide solid enough economic arrangements to finance new power projects. East Coast capacity markets have yet to lead to the addition of new generating units. Creating incentives for generators to build supplies near where they are needed, at the right time and price, is the biggest challenge, according to John Chandley, principal of consulting firm LECG. He and others advocated basing the price of supplies on their proximity to load, thus relieving transmission congestion, also known as locational marginal pricing. San Diego Gas & Electric senior vice president Jim Avery agreed. He added that a capacity market is a means of escaping expensive reliability-must-run contracts attached to aging power plants. A key feature of a capacity market is allowing supplies to migrate, thus disconnecting the availability of electricity from a utility or other energy provider. ?Where load ends up is the function of the market,? according to Desmond. Proponents contend that using a capacity market could facilitate direct access by eliminating its thorny side effects: stranded assets and cost shifting to a utility?s remaining customers. ?Simply assuming that there will be no stranded costs because there is a capacity market would be wrong and an unacceptable smoke screen to hide cost shifting,? countered The Utility Reform Network senior attorney Mike Florio. He reasoned that most capacity markets often do not yield enough to promote the building of new capacity, so this market could mitigate but not eliminate stranded costs. Also weighing in against capacity markets was Frank Wolak, Stanford economist and member of the CAISO market surveillance committee, who said such markets are ?very expensive? and ?largely untested.? The state can meet its resource needs by relying on long-term contracts and aggressive demand-response efforts, he said. High spot-market prices are not necessarily a bad thing because, according to Wolak, they can spur demand response. Thus, he added, power plants will get built where they are needed instead of being located far from load, which can create transmission problems. Grid operators from other parts of the nation were on hand to offer their experience. Capacity markets in New York and New England are overseen by their ISOs, but it remains unclear whether CAISO would pilot this state?s capacity market?if it gets off the ground. A capacity market also begs the question of market manipulation. In New England, a concentration of plant ownership?in areas of resource scarcity?makes it very difficult to control market power, said Mark Karl, ISO New England market design manager. There was also considerable debate over the right planning horizon. PJM, the East Coast?Midwest ISO, has a four-year advance procurement. Here, Desmond proposes a one-year forward capacity market, claiming that not enough of a track record yet exists to justify extending the time frame further. In addition, stretching out the time frame increases the potential for demand forecasting errors, noted Mark Younger, Slater Consulting vice president. If a market were to come to fruition, many would want it to include penalties for bogus capacity and to confine payments to capacity actually available at the time of need. Also among the long list of unresolved issues is how to create enough rules to protect customers in this highly complex market?but not so many that it sinks under that weight. The state?s three investor-owned utilities do not see eye to eye on the subject. Southern California Edison and Pacific Gas & Electric question whether a capacity market will ensure resource adequacy ( Circuit , October 1, 2004). SDG&E, on the other hand, is a big proponent of such a market, especially one that entails CAISO handling a centralized auction. The next steps to be taken by California agencies, which could include a white paper and/or CPUC workshops, are expected to be announced soon. Lisa Weinzimer also contributed to this report.

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Capacity Market: Door to More Supplies or Pandora?s Box?

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