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Capacity Markets: A Bridge to Recovery?

A review of the ongoing evolution of market design.

Fortnightly Magazine - May 2005

long-term market stability for the sake of avoiding a damaging summer newspaper headline.

This is especially true in NoCAP markets. Marginal generators in NoCAP markets are dependent on the few days when the intrinsically volatile energy markets deliver high-priced hours. The ability to capture revenues during these high-priced times gives marginal generators the ability to capture a sufficient level of revenues. But, with price caps in place, generators lose this revenue which tends to dampen the new build signal and undermine the ability of system-critical resources to capture adequate revenues.

Location. Many have begun to recognize that the regional diversity of the geographic footprint covered by power pools is such that they need to worry about where generators are encouraged to build. Given the constraints of the transmission system, it is critical that new generation be located as close to load as possible. For example, building new generation in western Massachusetts does not solve the supply situation in southwestern Connecticut.

In single-price capacity markets, there is no incentive or price signal provided by the capacity market that encourages new generation to build in an area that benefits the grid. Differences in locational marginal pricing (LMP) encourage generators to build closer to higher-priced locations, but this does not provide enough benefit to marginal generators.

The shortcoming of non-locationally based capacity markets can be witnessed in part by the need for many markets to continue to maintain reliability must run (RMR) programs. RMR payments are designed to compensate system-critical resources that are needed to maintain system reliability. These resources are often older units that run infrequently due to inefficient, out-moded equipment with high heat rates. In many cases, these units would not cover their going-forward costs and would be retired if they didn't receive additional monetary support from RMR payments.

For example, units like El Segundo on the beach in Los Angeles or Devon on the coast of Connecticut are needed to maintain system reliability. In those areas it is very difficult to site new transmission lines, and probably impossible to site a new power plant anywhere near El Segundo, so the system needs to ensure that these units earn sufficient revenues to keep them from retiring. Without a capacity market that provides additional compensation for these generators (or more modern substitutes), the power pool must continue to prop them up with administrative RMR payments.

Operating (and Fuel) Diversity. In addition to issues surrounding location, questions have been raised about the ability of capacity markets to address the operating profile of new equipment. The argument is that even if you get enough capacity at the right place, you still need to worry about the type of equipment that is built. The system needs resources that have operating flexibility and also contribute to the fuel diversity of the overall fleet.

The "dash-for-gas" witnessed in the recent past created a glut of homogenous units. One problem that has surfaced as a result of this monolithic block of capacity is that supply is very dependent on gas prices. Given the correlation of gas prices to heating needs