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Mending Our Broken Capacity Markets

The ability to provide reliable capacity is becoming both riskier and more costly to society and investors alike.

Fortnightly Magazine - June 2006

to be a “capacity market,” it needs to achieve reliability, cost-effectiveness, and resource diversification. That type of capacity is possible if we assign clear and unambiguous responsibility for getting the capacity, combine it with a fair and transparent long-term system for acquiring or rate-basing the capacity, and cap it with a durable approach for spreading the costs across the entire applicable customer base.

Functional Marketplace

Reduced risks for generators can translate into reduced costs for customers. In unorganized or short-term oriented capacity markets, owners of generation can demand high prices for keeping available otherwise uneconomic, but needed, generation. Much of the UCAP and reliability must run (RMR) payments are flowing to old, insufficient, largely capital-starved units, whose management is not incentivized to think in the long term about capital improvements because they have no certainty about their futures. If these generators were offered the opportunity to bid on long-term capacity commitments, the typical winning bid would be well below recent RMR contract levels or UCAP values in constrained zones. Long-dated, secure contracts then would motivate these generation owners—now contractually committed to keeping their projects in service over the long haul—to make the necessary capital, environmental, and operational improvements for a more productive and profitable energy marketplace.

Long-dated capacity contracts additionally enable leveraged, lower-risk, and lower-cost financing options than those available to at-risk merchant generators. Secure and predictable capacity revenue streams facilitate long-dated, low-cost project or corporate financings which, in turn, translate into the ability to bid and accept materially lower rates for both existing and new generation options.

The assurance of reliable capacity and resource adequacy revolves around very long-dated capital-asset deployment and investment decisions. To ensure that the right amount of capacity is made available at the right time and the right place, at the lowest practical cost to society, a planned, organized, long-term capacity acquisition model can create superior results relative to the short-term or non-existent capacity market variants that have emerged over the last decade.