During the hot summer months in Texas, participants in the energy markets, including the independent system operator known as the Electric Reliability Council of Texas (ERCOT), turn their attention to making sure that there is sufficient generation available to meet power demand. While ERCOT is unlikely to have significant reliability challenges during the balance of 2013’s summer, there are concerns about whether this will hold true in the future. In order to address these concerns, some market participants, such as NRG, have argued that Texas should consider implementation of a capacity market, and preferably one similar to the capacity market in the Mid-Atlantic region of the country.
Understanding capacity markets
The Pennsylvania, New Jersey, Maryland, (PJM) interconnection operates the largest energy power market in the world. An integral part of the PJM model is the inclusion of a capacity market, which provides a steady stream of revenue to generation owners regardless of any electricity produced and sold in the market. The theory behind the capacity market is that revenues from energy production alone may not be sufficient to cover the operating costs for generation needed to ensure reliability. In 2005, PJM redesigned its capacity markets to include a “locational” component, meaning that generators receive different capacity payments depending on their location, which also factors in to the societal benefits that they provide in terms of supporting reliability of the electric grid. (For information on PJM’s capacity market, click big red box below).
In a recent article, the CEO of a company that owns generation assets in PJM criticized the capacity market, saying that it is fundamentally flawed and equating it to socialism. Another CEO said that flaws in the PJM Capacity market will not only impede investments in competitive generation resources and the development of a robust competitive market, but will also, ultimately, impact reliability. Critics of Capacity markets have also argued that most of the payments are distributed to existing generators.
What this means for Texas
As previously discussed in this space, the Texas market potentially faces future concerns regarding reliability as demand for power will continue to increase as a result of population growth and Exploration and Production activities in the West, yet little additional generation is being built. Between 2014 and 2015, projects totaling approximately 3,000MW of additional capacity are expected to be completed. Some market participants have been advocating for implementation of a capacity market similar to the design in PJM. The advocates of this approach note that PJM has seen increased investment in generation as a result of implementation of the capacity market. In advocating for the importation of the PJM capacity market, proponents rely on two key points:
1) The energy only market in Texas is not supporting future investment in generation. ERCOT’s Independent Market Monitor (Potomac Economics) has noted in each of the past 5 years that, adjusted for weather anomalies, revenues from energy available to generation owners have been insufficient to support investment of new power plants. This lack of adequate revenue creates a hurdle to investment and could eventually lead to shortfalls of energy in the Texas market. In other words, the argument is that the energy only market design will result in boom/bust generation investment cycles and will not provide the stable revenue stream necessary to insure long term reliability.
2) Fewer implementation challenges. The design and implementation of capacity markets can be a lengthy and complicated process as market participants jockey for position and attempt to create a market design which most favors their economic interests. This can lead to prolonged time frames for implementation and multiple court challenges, further delaying implementation of any proposed solution. Replicating the PJM market design on to the existing market structures in Texas, would arguably reduce implementation time. Getting a capacity market design implemented quickly will help Texas address near term reliability challenges, mitigating the risk of blackouts.
While both of these arguments hold an intuitive appeal, they are unlikely to carry the day in the Texas market. The Texas PUCT has consistently rejected the idea of a traditional capacity market in favor of the energy only market design and has taken steps to enhance the Texas energy market to create incentives for new generation without a capacity market. For example, the decision to increase the price cap in the wholesale power market up to $9,000/MWh in June 2015 was designed to encourage investment in new generation by providing additional revenues to generators when power demand spikes; however with mild 2012 and 2013 summers this has not been the case as Real-Time prices have been very soft (low). In addition, the Texas PUCT is considering a change in the operating reserve (an ancillary service provided by generators to make sure that sufficient power is available in the event of a loss of one generation unit or a major component of the high voltage transmission system) markets to encourage generation investment in Texas.
The capacity debate
While the discussion of capacity markets is probably obscure to most consumers in the Texas marketplace, it is clear that capacity costs would be covered by load. Although it is unlikely that at this time Texas will implement a traditional capacity market, the current debate about how best to meet future resource challenges is arguably bringing the day closer when the Texas PUCT will have to do something or otherwise face the possibility of insufficient generation available to meet future power demand. The Texas PUCT and all stakeholders should evaluate the pros and cons of various options before committing to a long term solution, for example:
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Participation from Demand Side Management providers has proven to work in PJM, as it has helped in bidding capacity prices down
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Define what generators would be included in the capacity market design. Targeted capacity markets could maintain competitive electricity costs. This concept is being tested in Europe as a limited Capacity market
Regardless of what model is selected, it will take between 3 to 5 years for the market to develop and function as an efficient market. Contact your energy advisor to discuss how this market design could affect you.
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