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Commission Watch

LICAP and Its Lessons:
Fortnightly Magazine - January 2005

that, this LICAP regime comes "hard-wired" (this apt description comes from Peter Fox-Penner) to make it virtually impossible for power producers to withhold individual units from the market to create artificial shortages to boost prices. Even if a unit owner "de-lists" the plant, or takes it off line for maintenance, or simply chooses not to participate in the LICAP auction, the ISO employs a fiction that assumes that all such plants actually did submit a bid. The supply curve includes all installed "iron in the ground," short of actual retirement and dismantling. (But the ISO would subtract net exports.)

This strange rule allows the ISO to "oversee" and eliminate the withholding of capacity without having to examine or second-guess the behavior of suppliers. With its new approach, the ISO complies with FERC's directive in June that New England's LICAP market must be purely voluntary, with no coercion from the ISO. ()

This miracle market also would feature CTRs (Capacity Transfer Rights), a near-exact analog to the tradable financial transmission rights (FTRs) featured in the energy market. The CTRs would serve as financial instruments, so that utilities and other load-serving entities (LSEs) who participate in the LICAP market could hedge the risk of any inter-zonal imports and exports needed to satisfy cost of their minimum capacity obligations, as imposed by the ISO.

Nevertheless, over the past 21 years, New England, on average, has enjoyed a supply of generating capacity greater than what the industry has required. This period indicates an average capacity level of 105.4 percent of what is needed to match peak demand plus the required reserve of 12 percent.

Some parties urge the ISO to boost the LICAP incentives even higher. They want the ISO to move its demand curve to the right, so that it is designed to encourage even greater supply margins than the ISO's current proposal. But listen to James Daly, the director of electric and gas operations for Boston Edison (the NSTAR subsidiary), testifying on behalf of a coalition of consumers and state attorneys general on how much the LICAP market could cost.

Daly claims that if the ISO's LICAP market should succeed in maintaining the ISO's targeted equilibrium level of electric capacity (known as C-target), then electric rates for New England's 6.5 million retail customers would climb by nearly $2 billion per year. That would amount to an extra $303/yr. on average for every customer, or about 1.5 cents extra per kilowatt-hour.

Paradoxically, the cost is even greater if LICAP does a worse job on encouraging investment in generation.

Thus, according to Daly, if the LICAP market "incents" developers to build only enough plants to serve peak demand plus the mandated 12-percent reserve (the ISO defines this level as "Operational Capability," or OC), then the yearly cost of the LICAP auction would soar to about $5.4 billion. That means $838/yr. per customer, adding an incredible 4.2 cents/kWh to the average retail bill.

And consider what would happen if the plan should succeed too well.

Suppose the LICAP auction encourages developers to build plants until capacity levels