Power Lines Blog

New England shows need for electric market reform

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Electricity rates paid by customers in New England are already among the highest in the nation. And those rates are in danger of climbing even more, owing to lack of transmission and pipeline infrastructure and the ineffective capacity markets (in which resources for future electricity markets are estimated and purchased ahead of need).

The Independent System Operator for New England (ISO-NE), the entity that manages electricity markets and access to interstate transmission lines in the New England region, went down a rabbit hole of centralized mandatory capacity requirements years ago. Many market participants have expressed great unhappiness with centralized mandatory capacity constructs, albeit for different reasons and at different times. Now the consequences of a faulty market structure are about to erupt.

Reliability concerns in New England have been growing. A major cause is the region’s increasing reliance on natural gas without the corresponding expansion of natural gas pipeline capacity. Demand for natural gas has gone up as a result of an increase in natural-gas fired generation and local distribution companies’ conversion of a large portion of their customers to natural gas heating. Compounding this problem is the pending retirement of large baseload resources, including the Vermont Yankee nuclear power plant.

ISO-NE has taken steps to improve reliability over the past few years, including increased operating reserves, stricter financial penalties for generators that fail to perform, more stringent generator audits, and programs directed at mitigating the non-performance of generators on account of unavailability of natural gas. But these programs come at a steep cost. For example, a program to avoid major outages by paying for on-site oil storage and demand response during the extreme winter of 2013-14 cost almost $80 million.

Clearly, the region’s power markets need to attract new generation resources to increase reliability. And reliability is closely tied to how capacity markets operate.

Before we get into the issues, let’s take a minute to understand how a wholesale electric capacity market works. Capacity markets are “forward markets,” in which a commitment to have generation in place is made a few years ahead of when electricity needs to be delivered. In contrast to energy markets where current electricity needs are traded, capacity markets provide revenue to recover the capital costs of the physical generation asset to ensure that there is sufficient generation capacity to provide power in future. Capacity payments are also paid to the providers of demand response, which is an agreement by a customer to cut back on demand for power when needed.

ISO-NE operates what is known as a centralized mandatory capacity market, which procures capacity three years in advance of when it is needed. A clearing price is determined at an auction and then paid to all resources, regardless of technology, age, cost, or other characteristics. This absence of any long-term planning and reliance on the market is a major factor for an excess building of natural gas-fired generation in New England. This market is mandatory, meaning that all capacity must “clear” the auction before being eligible to meet the reliability requirement of a load-serving entity, such as a public power utility. Entities cannot opt out of the market construct. In New England, 3,100 megawatts of potential future power supply were recently retired from the forward capacity market, compounding the reliability concerns and driving up the annual capacity cost from $1 billion to $3 billion.

Capacity market transactions do not ensure that capacity will provide power when needed. ISO-NE found that a significant portion of the capacity receiving payments from the markets was not generating power when called upon during times of system stress. As a result, the ISO recently presented to the Federal Energy Regulatory Commission (FERC) — the regulatory body with oversight of markets — a Forward Capacity Market Performance Incentive (FCM PI) proposal.

The FCM PI looks to incent generators to increase availability and performance through an incentive structure that would charge under-performing and pay over-performing resources when the bulk power system is stressed. Resources that are not producing energy or reserves when there is a shortage of power — for any reason — would be subject to penalties.

The FCM PI proposal is fraught with problems and was opposed by 90 percent of the region’s stakeholders. A key objection is that plants would be subject to high penalties even if they were unable to generate power because of events outside of their control, such as transmission outages. The threat of stringent financial penalties might even hasten the retirement of generation units, further diminishing already inadequate resources.

In view of the problems with ISO NE’s proposal, the New England Power Pool (NEPOOL) Participants Committee  has submitted an alternative proposal for FERC to consider. NEPOOL’s alternative is a more incremental and less costly proposal and widely supported by the region’s public power utilities. Like the FCM PI proposal, it also involves financial rewards and penalties, but at a more moderate level and based on deviations from the individual units’ average performance over the past five years. The NEPOOL proposal also incorporates proposed market changes to improve price formation and incentives in the energy and ancillary services markets.

In early May 2014, nine senators sent a letter to FERC leadership requesting careful consideration of the NEPOOL alternative. Senators Jeanne Shaheen, Patrick Leahy, Edward Markey, Kelly Ayotte, Richard Blumenthal, Christopher Murphy, Sheldon Whitehouse, Elizabeth Warren, and Jack Reed have pleaded with FERC to consider the impact of both ISO NE and NEPOOL proposals on long-term reliability and consumer costs. They called for collaboration among market participants. “New England faces major long-term electric and energy challenges that can only be adequately addressed if regional stakeholders work collaboratively to identify solutions,” the senators pointed out.

The New England situation reflects a serious concern in all U.S. electricity markets operated by regional transmission organizations (RTOs), such as ISO NE. At a recent Department of Energy public meeting on infrastructure constraints in New England, many of the presenters concluded that the markets are unable to address reliability problems, and that alternative solutions are needed. It’s time for FERC to think outside the box of the RTO-operated wholesale markets and explore solutions that call for a significant overhaul of the current electric market structure.

Sue Kelly

Sue Kelly

President and CEO

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