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Learning from California's QF Auction

Fortnightly Magazine - April 15 1995

full avoided cost . . . is also a uniform price system . . . [T]he second-price auction is the logical extension of full avoided cost."3

THE QF SETTING

The CPUC, QFs, and utilities worked to extend the steps in the simple second-price auction to the QF setting. This task was accomplished through a series of design steps and CPUC decisions.

The QFs who bid differed in terms of unit size, capacity cost, energy cost, availability, transmission losses and costs, expected dispatch by the utility, and contract length. The winning QFs would supply two items of value to the utility: energy (in all periods of the year) and capacity (in peak-demand periods). But the California procedure combined all QF operating characteristics and any related benefits accruing to the utility into a single cents per kilowatt-hour (›/Kwh) figure. In this way, the QF auction treated all kilowatt-hours as equal, even though the bidders were trying to win two different things:

(a) the right to displace capacity of designated resources from the utility's resource plan (the Identified Deferrable Resources or IDRs)

(b) the right to use the utility's transmission capacity.

This duality led to a sequential bid scoring and selection procedure. In each step, only one winning bidder was selected. The IDR capacity and transmission capacity awarded to that winning bidder were removed from the auction. At the start of each step, the remaining bidders were rescored using the remaining unassigned transmission capacity. The CPUC specified the blocks of capacity (the IDRs) that would be auctioned by each utility. It compared the QFs on a cost-per-Kwh basis and assigned each QF a single ›/Kwh score that reflected the costs and capacity factors bid by the QF. The CPUC selected winners until it filled the effective capacities of the IDRs. The auction price (per kilowatt-year) was pegged at the "second price," giving a premium to the winning bidders.

Each winning QF would receive a contract to sell energy and capacity over several years. Thus, total payments to a winning QF during a given year would depend upon factors not known at the time of the auction. These factors would include the QF's actual availability and energy production, plus external factors such as inflation rates.

DISTORTIONS AND GAMING

The QF auction looked like a true second-price auction. Most parties simply assumed that the QFs would bid their true costs of supplying capacity and energy. But some parties testified that QFs would not want to reveal their true costs. For example, after winning the auction, QFs would have to negotiate with their suppliers and regulatory agencies. They would naturally want to conceal their precise amount of profit. The CPUC discounted these arguments.4

In addition to these factors, several features internal to the QF auction could have caused it to lose its true-cost-revealing property. Here are two examples. The first shows how QFs could increase payments by cutting capacity factor; the second shows how a large QF can increase its payments by bidding above its true costs.

Example 1 (em

Earning More With Less

A 15-megawatt (MW) wind-powered