Texas Mulls Capacity Market

Proposal closely watched

Published In: EnergyBiz Magazine Mar/Apr 2014

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A capacity market may be the greatest thing since sliced bread, but it’s not an easy sell.  Even PJM Interconnection, the world’s largest competitive electricity market, which is very happy with its shift to a capacity market, found that the hardest part was to get regulators and stakeholders to buy into the concept.  “The biggest hurdle was getting the regulatory approvals,” Terry Boston, PJM CEO, said.  “But just getting stakeholder agreement was also an obstacle.”

However, the system has functioned well in reducing the rate of economic retirements, Boston said, and now that cheaper shale gas and new EPA regulations are having an effect, it is contributing to a highly efficient capacity.  “It has attracted 28,000 megawatts of new capacity, largely combined-cycle”, he said.

As the Electric Reliability Council of Texas mulls adoption of a capacity market model, the pros and cons of such a shift are being carefully scrutinized.

PJM has consulted with ERCOT on the advisability of implementing such a system, and the current situation in Texas where underinvestment in capacity has threatened shortages is an argument in favor of adopting it, Boston said.  “You couldn’t have a better time”, especially in view of cheaper fuels and tougher emission restrictions.  The reaction among policymakers in Texas has been “fairly positive,” he said.

“If you construct it properly, it is better than the alternative,” Adam James, an energy expert at GTM Research, said.  In a capacity market, James explained, a reverse auction several years in advance has power plants bidding their total cost of operation (capital costs plus operating costs) and obligating themselves to have a certain capacity available.  The last unit accepted in the bid sets the clearing price.

An energy-only market like ERCOT gives a very short term price signal, which can lead to potential capacity shortages such as that faced by Texas under current forecasting.  A medium-term price signal provides some breathing room for capital investment in new capacity.

The risk on the other side is that forecasts for electricity demand that overshoot actual demand can result in thousands of megawatts of excess capacity being priced into the rates consumers pay.

Proponents of the capacity markets argue that the premium above energy-only pricing is still less than what consumers pay when shortages are met by much higher-priced energy or blackouts.  “When you do a cost comparison, you have to include the high marginal power prices when there is a capacity shortage,” James said.

Boston said that PJM’s experience has been that their all-in cost was lower.  “Prices are much lower when you have adequate capacity,” he said.

An important component in a well-designed capacity market is demand response flexibility – customers also play a role in the market, James said.

For instance, Boston explained, in the PJM market a chemical company may reduce or shut down operations during peak hours in order to get a capacity payment, reducing its overall energy costs.

A capacity market can also help development of alternative energy sources, James notes.  Wind or solar may have zero fuel costs down the road, but have high capital investment before generating any electricity.

“Capacity payments would give them another revenue stream,” he said, which could be vital given the decline in government support.

Although two out of three members of the Public Utility Commission of Texas in October indicated their support for a mandatory capacity reserve margin, essentially creating a capacity market, Commissioner Kenneth Anderson opposed it.

In a November presentation submitted to the Texas legislature, Anderson argued, “A mandatory capacity reserve margin will result in billions of unnecessary, unavoidable and largely un-hedgeable costs to customers, without guaranteeing rolling blackouts will not occur.”

GTM Research’s James agrees that some caveats are in order.  “If you don’t design it properly, it can become a life-support system for unused capacity,” he said.  Western Australia, where mistaken forecasts ran up excessive capacity costs, is an example of how a capacity market can backfire.

But measures such as demand response flexibility can mitigate these risks.  “Essentially, the capacity market model threats ancillary services market functions as one of the attributes of the resource,” James said.

Although getting a capacity market up and running is the main challenge, PJM is still tinkering with its model to make improvements.  “There is a little more volatility than we would like,” Boston said.

Also, the operator’s focus has been on peak loads in the summer, and some products are only available then.  This winter’s wave of cold weather has increased PJM’s focus on that season as well.

 

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