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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

increments being constructed are the result of utility term contracting and self-build initiatives, as a short-dated energy-only market clearly isn’t capable of supporting new long-dated capacity investments. The ongoing UCAP food fight in the New England Power Pool isn’t resulting in one more needed megawatt being built where and when it is needed. It is focused on dividing up an existing pie rather than driving toward the end point of creating the right level of future reliability at the right cost to society.

A System That Works

There is a simple, three-pronged approach that has worked structurally for decades, and which, with incremental modifications, still can work today. The basics are as follows:

1. Someone has to be responsible for planning to meet capacity reliability commitments in each defined geographic area;

2. A transparent and open system needs to be put in place to acquire and retain capacity over long-term planning periods at the lowest practical cost; and

3. One needs a fair calculus to be established to allocate all of the costs of acquiring and retaining this capacity across the applicable loads.

On the first leg of the stool, when one assigns the responsibility to provide adequate capacity for customers to “the market”—that is, to everyone—no one is responsible. Ever since electricity was defined, in a political and regulatory context, as a public necessity, a single entity within each geographic jurisdiction has been assigned to determine how best to provide reliability. In the blind rush to embrace the motherhood-and-apple-pie principles of competition and markets, the overarching and clear delineation of who is responsible for capacity reliability and who they are responsible to has been sacrificed.

Second, capacity acquisition should be performed in a transparent, open, and sustainable methodology, geared to achieving least cost. The currently applied structures fail not only because they are short-term oriented, but because their Dutch auction format damages societal interests. That is, the current auction processes reward all bidders with the highest price selected in the auction for the last increment of capacity offered. I may have bid $5.00/kW/month and obviously would have been satisfied to receive the price I bid. But just because the last increment of capacity needed was bid at $10, under most current capacity marked protocols, I get this full $10 price, too. Arguably, this makes sense in energy markets, but not in longer-dated, capital-based capacity markets. Auctions for long-term capacity should award capacity contracts to parties based on least-cost parameters and negotiated deals designed to provide the lowest aggregate cost to consumers.

Finally, there must be a sustainable way to figure out who pays for the capacity being bought and built. Utilities in jurisdictions affording retail competition rightfully argue that there is no certainty of a load-serving entity retaining their current customer base over time. The simple answer is to ensure that all costs of acquiring new capacity and contractually retaining existing capacity, when procured in a fair and visible manner per the second step above, are allocated across all applicable loads within a given zone on jurisdiction.

If there is going