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Boom and Bust? Understanding the Power Plant Construction Cycle

Rising energy demand could spur investment in waves, but a fixed capacity charge might flatten the curve.
Fortnightly Magazine - July 15 2000

gas. The total PX price is 5 mills per kilowatt-hour above the energy price, so it follows the same upward trend.

Wholesale Impacts. The 5 mill per kilowatt-hour capacity payment is clearly evident in Figure 4 because the total price is always 5 mills per kilowatt-hour higher than the energy price. This may leave you with the impression that the "price of stability" is a constant 5 mill per kilowatt-hour penalty, year after year. But that would be a false impression. The real "price of stability" is to be found by comparing a simulation relying exclusively on energy prices with simulations that allow an additional payment for capacity. Such comparisons show that capacity payments lead to long-term price stability, and the eventual price converges to the levelized cost of a new CCCT. In other words, a constant capacity payment can convert an inherently unstable system into a stable one, and the "price of stability is limited to somewhat higher prices over an eight-year period.

One way to interpret this short-term price penalty is to estimate the increase in wholesale earnings by large utilities in California. The annual payments would be highest in the years immediately after capacity payments are adopted. They would then phase out automatically over time. The total impact could range from $1.6 to $4.0 billion depending on the simulated conditions.

Retail Impacts. A $4 billion penalty could be interpreted as the extra wholesale cost to serve the energy needs of the retail demand of the California utilities. If wholesale costs increase by $4 billion, one would normally expect that retail costs would increase in a similar manner. But retail ratemaking in California is governed by the state's key electric restructuring law, AB 1890. That law requires consumers to cover the stranded costs of the three utilities. The stranded costs have been estimated at $26 billion to $30 billion. The utilities are allowed to recover these costs by adding a competitive transition charge (CTC) to the retail bill.

Figure 5 places the CTC in perspective by showing charges on a typical bill in 1998. The largest component is distribution charges (36 mills per kilowatt-hour.) The CTC is the second-largest contributor at 34 mills per kilowatt-hour. The PX energy charge, the focus of this article, is the third-largest charge and is substantially smaller than the CTC. The PX energy charge and the CTC are the charges that would change due to the capacity payments. The PX energy charge would be replaced with the total PX charge (for both energy and capacity), and the wholesale impact might be around 5 mills per kilowatt-hour immediately after capacity payments are adopted. The CTC charges, on the other hand, would decline by a corresponding amount because the utilities would earn more from selling to the PX.

The compensating change in the CTC charge arises from the rules of AB 1890, which were written to protect the utilities from the adverse cash flow of a competitive market. If the market clears at lower prices, for example, the utilities may impose a larger CTC to meet their