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The Capacity Market Enigma
Why haven’t reliability markets developed?
Ask two economists to define electric reliability, and you may get three different answers. That’s bad, but better than asking two engineers, who may bombard you with technical acronyms. So, the first step in discussing markets for reliability is to agree on a workable definition. Only then does it make sense to discuss whether such markets are needed, and if so, why they haven’t already sprung up by themselves.
The Very Public Blackout
The genesis of providing reliability in wholesale (or bulk power) electric markets has been the evolving structure of the electric industry, including wholesale and retail deregulation efforts that have led to the creation of independent system operators (ISOs) and regional transmission organizations (RTOs), in conjunction with FERC’s so-called “standard market design” efforts. The 1965 Northeast blackout prompted the formation of the North American Electric Reliability Council (NERC) in 1968, and subsequently 10 regional reliability councils and power pools, whose mission is to coordinate the operations of the many independent electric utilities, and thus reduce the risk of future blackouts. A few of those power pools, such as in New England, fully coordinate and dispatch generation; the others operate more loosely, allowing individual utilities to determine how they dispatch their generating plants, but coordinating operations to ensure the overall system functions smoothly.
The need to coordinate generation in a region provides a crucial clue to defining reliability, as well as acknowledging the challenges of designing a reliability market. Reliability, which we define as the ability to meet the demand for electricity over time, whether during the next 10 minutes or the next 10 years, is a public good. What that means is, first, that reliability for one is reliability for all, something economists call non-exclusivity and non-rivalry in consumption. Second, it means that the operating decisions made for an individual generating unit may create spillovers, that is, effects on others, both good and bad. Third, as with all public goods, individual suppliers, left on their own, won’t provide enough system reliability, because they can’t reap the full economic benefits of doing so and would rather “free ride” on other suppliers’ investments. This is a typical characteristic of public goods: Non-exclusivity means that someone who doesn’t pay still can consume the public good just as much as someone who does. As a result, no one has an incentive to invest; after all, why invest when you can “free ride?”
How do these public-good characteristics manifest themselves in transmission markets? Consider New England, which has spawned vigorous debate before the Federal Energy Regulatory Commission (FERC) over development of an installed capacity market to be run by ISO-New England