Capacity Market Primer
Prepared by NERA for the IESO Capacity
Market Information Session
8th April, 2014
Agenda
1. Introduction to Capacity Markets
2. Why have capacity markets been incorporated into
the market structure of regional power markets?
3. What have capacity markets helped accomplish in
other jurisdictions?
4. How could a capacity market complement the
industry structure in Ontario?
5. What specific types of benefits would a capacity
market achieve in the Ontario market?
2
Introduction
What is a capacity market and how
does it work?
3
What Is a Capacity Market?
 It is a centralized market operator-administered
framework for qualifying, tracking and
compensating resources for providing capacity
 Capacity is the ability to provide energy
 Typically each control area establishes a minimum
amount of required capacity that it needs to
optimize the probability of involuntary curtailment
 Capacity markets help ensure that such neither
too much nor too little capacity is provided to the
market, alleviating the “boom-and-bust” problem
4
Capacity Markets Share Basic
Common Features
 Resource providers must demonstrate their ability to provide
capacity at the level they will be compensated for by attaining a
production level
 Obligations will be placed on capacity resource providers – e.g.,
an obligation to offer energy in the market for each hour
 Payments will be adjusted by the availability/performance of the
provider
 The market operator will make payments to capacity providers
and recover the amount of those payments through charges to
loads
 The capacity market establishes a clearing price that indicates
the cost/value of capacity at the margin and provides an efficient
price signal to guide the provision of and the consumption of
capacity
5
Example Capacity Auction
Market Equilibrium
(Clearing P&Q)
6
While Capacity Markets Have Basic Similarities,
There Are Also Differences – Some of Which Are
Briefly Reviewed Below
 These are all important issues that Ontario would need to
consider should it decide to implement a capacity market
– However, an initial evaluation of the costs and benefits of a capacity
market can be performed without diving to this level of detail
Design Choice
Explanation
Capacity / Procurement
Target
Some buy to a minimum requirement while others
employ a “demand curve”
Forward Period
Some are cleared with sufficient time to allow new
resources to compete and set the price while others
are spot markets open only to units that are
operating
Purpose of Market
Some use the market to procure the minimum level
of supply while others use the market as a price
signal to provide incentives for supply
Commitment Period
Some are seasonal and others are annual
Payments / Penalties
There are differences in how payments are adjusted
for availability/performance
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Topic 1
Why have capacity markets been
incorporated into the market structure
of regional power markets?
8
The Ideal View of a Capacity
Market
Rationales for a capacity market
Find the “missing money”: the gap between
revenue needed to attract efficient entry and
revenue available from the energy market
Dampen volatility: The reduction in
uncertainty through steady capacity payments
may make investment more attractive
Efficiently Expanding Capacity by Providing
the Correct Price Signal.
Explanation
Primary reasoning and most often discussed
The gap exists because energy market prices
are limited for a variety of reasons
Some may consider this necessary without
any limit on energy prices
Prices in an “energy-only” market are too
volatile and too close to sacrificing system
reliability to be acceptable.
Discipline of a market process will add new
supply more efficiently and with greater
transparency.
 With an “ideal” capacity market, entry and continued operation and
investment decisions are left to market forces
 The focus is often on major investment decisions, but a capacity value can
also affect a variety of smaller decisions
9
Topic 2
What have capacity markets helped
accomplish in other jurisdictions?
10
NERA Economic Consulting
11
U.S. Capacity Markets Are Designed
To Achieve Several Objectives
 Provide price signals that will:
1
Result in sufficient available capacity to maintain supply adequacy –
these markets were an outgrowth of power pool installed reserve
requirements
2
Encourage the efficient entry and exit of generation resources
3
Encourage the efficient deployment of demand side resources and
alternative resources such as distributed generation
4
Equitably compensate owners of existing generation capacity and
mitigate the impacts of price and bid caps on generator revenue
 ISO-NE, NYISO and PJM capacity markets were approved by FERC
based on the finding that the market structure without such capacity
constructs did not provide generators just and reasonable compensation
12
US Capacity Markets Have Generally Been
Successful in Achieving the Objectives for
Which they Were implemented
 Capacity adequacy has been achieved through new
capacity additions, uprates and demand response–
see IESO backgrounder (pages 4 and 5) for
information on capacity additions in the US markets
 Demand response resources have been deployed at
higher levels and most likely more efficiently than if
developed only through utility programs
 FERC has found on an ongoing basis that the US
markets (capacity, energy and ancillary services)
taken together provide pricing that is just and
reasonable
13
US Capacity Markets Have Also
Assisted in Shifting Long Term
Investment Risks Away from Ratepayers
 Risk shifting was not one of the rationales in mind when US
capacity markets were developed
 The decision to not have ratepayers bear long term resource
investment risk is a policy decision that was made by many states
before capacity markets were developed
– Rationale is to shift risk to market participants, which are in a
better position to identify and mitigate risk
 Capacity markets have helped enable the shifting of risk away
from ratepayers while maintaining supply adequacy
 Capacity markets have provided price signals to attract entry
without long term ratepayer support
14
Topic 3
How could a capacity market
complement the industry structure in
Ontario?
15
The Elephant in the Room
Q: Can a Capacity Market usefully co-exist with an industry structure that
provides for a Long Term Plan that:
(1) specifies resource objectives by type and amount; and
(2) anticipates that the OPA will offer long term contracts as required to
achieve those objectives?
 Yes, as will be demonstrated as we progress through the primer many of the
benefits of a capacity market and establishing a price/value for capacity are as
valuable in a “planned” environment as they are in a wholly “market” environment
 A capacity market can exist with long term contracts that are implemented by an
entity such as the OPA without increasing costs to customers
 In New York for example, the capacity market is used to provide an incentive for
the market to meet reliability needs, but a formalized Comprehensive Reliability
Planning Process and Reliability Needs Assessment is conducted and if the
market is not providing sufficient capacity there are regulatory backstops
 Give the expectation of significant contracting by a central authority it is not
realistic to assume that a capacity market could be used, as it is some
jurisdictions, to entirely shift long term risk from customers to resource providers,
but many benefits can be attained without such a risk shift
16
High Level Understanding of the
Ontario Market and Institutions
 Hybrid market structure is well entrenched in practice
– IESO energy and ancillary markets are well suited to encouraging efficient resource
utilization
– Long-term planning for both capacity and transmission is the responsibility of the OPA,
which relies on IESO markets as part of its procurement structure
– Planning is neither solely based on economics nor entrusted to market forces, but is
heavily influenced by many concerns ranging from sustainability to local impacts – the
2013 LTEP is indicative of the many concerns which influence energy policy
 Like other ISO energy markets, the IESO energy market does not and will not
provide sufficient margins to support entry or significant reinvestment in older
facilities
 Merchant entry is not prohibited
– However, it not attractive given energy price levels that would prevail even when new
capacity is needed
– There is no stated desire to have market forces alone support new entry
– Precedent of issuing contracts has tempered entrepreneurial investment
17
A Capacity Market Can Help Achieve
Many Benefits in the Context of a Hybrid
Market Structure
 US markets with capacity markets seek to place most all of the burden of
entry on markets, though this need not be the case
 A capacity market can also help inform planning decisions in Ontario’s
hybrid market structure without replacing the planning role
 A capacity market price signal could stimulate alternate technologies
such as demand response and storage as well as repowering /
repurposing of retired assets or assets at the end of their useful life
 A well understood capacity market structure could lead to a reduced
need for contractual support of new investment and lower contract prices
as developers would have a clearer view of post contract revenue
opportunities
 In the next few slides we will discuss the potential benefits identified in
the IESO backgrounder
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Topic 4
What specific types of benefits would a
capacity market achieve in the Ontario
market?
19
10 Specific Potential Benefits of a
Capacity Market in Ontario
1
2
3
4
5
6
7
8
9
10
Potential Benefit
More efficient allocation of resources
Lower costs of service
Attract new entrants from a diverse range of resources
Defer investment in new conventional resources
Risk sharing
Transparent price signal for all resources
Enhanced forecasting and planning
Reliability
Investment Certainty
Innovation
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1
2
More efficient allocation of resources;
and Lower costs of service
 In Ontario a capacity market could lessen the need for
centrally planned decisions on resource entry
– Allow the most efficient and least expensive resources on
the supply or demand-side to be developed to meet
reliability needs, at the right price and over the right
timeframe
 As supply and demand conditions change or deviate
from forecasts a capacity market would naturally
adjust, allowing resources to enter or exit the market
 This flexibility would ensure adequate capacity is
available at all times but also avoid overbuilding to
meet an unexpected challenge, or overpaying to have
excess capacity sitting idle and unproductive
21
3
4
Attract new entrants; and
Defer the need for investment in new
conventional generation
 Attract new entrants from a diverse range of resources - a
capacity market could be a sustainable mechanism to facilitate
the entry of new, efficient resources into the Ontario market and
enable innovative technologies such as energy storage and
demand response service providers to compete alongside
conventional resources.
 Deferring the need for investment in new conventional
generation resources - capacity markets have proven
successful in unlocking the latent demand response potential
from industrial and commercial and low volume consumers, as
well as incentivizing investment in refurbishing and extending the
life of existing assets. Combined, these low cost resources have
deferred or avoided the need to build new facilities.
22
5
Risk sharing
 By appropriately compensating existing resource
providers, a capacity market that provides uniform
compensation for the provision of capacity could
facilitate entry of resources without long term
contracts and shift a portion of the long term
market-based risks away from ratepayers.
 This could also reduce and potentially eliminate
the need for extensions or renewals of expiring
long-term contracts and increase efficiency by
having facilities with expiring contracts participate
in the capacity market and be paid the market
price for their services.
23
6
7
Transparent price signals; and
Enhanced forecasting and planning
 Transparent price signal for all resources - a capacity market
would identify the costs of capacity and enable Ontario to provide
a clear price signal for capacity as opposed to bundling capacity
costs in the Global Adjustment. This would enable a more
accurate price signal to be sent to customers, improving the
efficiency of the market.
 Enhanced forecasting and planning - a capacity market could
complement the forward looking reliability assessments made by
the IESO and the long-term plans developed by the OPA. It could
formalize responsibility for assessment and coordinate action to
maintain reliability at the lowest possible costs that reflect market
conditions and policy objectives. This could work in conjunction
with the Ontario Energy Report as contemplated in the recent
LTEP, issued annually to update Ontario on the energy supply
and demand picture for the province.
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8
9
Reliability; and
Investment Certainty
 Reliability - a capacity market could standardize and
formalize the obligations associated with providing
capacity cost-effectively. However, ensuring a reliable
supply mix to meet operational requirements must be
a central tenet of any capacity market design.
 Investment Certainty - by providing an enduring
mechanism for investors, producers and consumers to
procure and manage capacity in the Ontario market, a
capacity market would provide an independent, longterm sustainable platform available to all resources,
technologies and service providers.
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1
0
Innovation
 Capacity markets strive to be technology neutral and
have proven successful in attracting a diverse range of
potential providers helping innovation across multiple
sectors including Demand Response, imports, storage
and conventional generation.
 Regular auctions would attract the best available
resources, many of which will rely on technology
advancements to be competitive.
 Over time as more modern facilities are added, and
less efficient facilities exit the market, the supply mix
will reflect the best available technologies.
26
In summary
Topic
Summary
Capacity
Market
Purpose
To ensure an adequate level of capacity is built by (1) toping up
“missing” energy market revenue; and (2) smoothing volatility of
revenues.
Capacity
Markets in
Northeastern
U.S.
U.S. capacity markets are designed to coordinate investment:
specifically to ensure resource adequacy, deploy demand and
distributed resources, coordinate entry and exit, and compensate
existing capacity owners.
Capacity
Markets in
the Ontario
Context
In a hybrid market structure, a capacity market can aid planning
decisions, incentivize innovation, and (potentially) provide an
alternative contracting mechanism.
Specific
Benefits for
Ontario
Efficiency and cost savings; Attract new entrants from a diverse
range of resources; Deferring investment in new conventional
resources; Risk sharing; Transparent price signal for all resources;
Enhanced forecasting and planning; Reliability; Investment
Certainty; and Innovation.
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Questions?
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Contact Us
Eugene Meehan
Jonathan Falk
Senior Vice President
NERA—DC
+1 202 466 9287
[email protected]
Vice President
NERA—NYC
+1 212 345 5315
[email protected]
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National Economic Research Associates, Inc.
All rights reserved.