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A New England Capacity Market That Works

Two authors beg to differ with Goldman Sachs’ Larry Kellerman on what needs mending in the Northeast.

Fortnightly Magazine - August 2006

and can be rewarded or penalized like central-station generation. These resources soon should satisfy a growing proportion of capacity requirements, and the FCM permits seamless integration as viable competitors that will help dampen cost increases.

Second, more than other capacity-payment schemes, the FCM promotes bilateral contracting and self-supply. This market should produce stable, predictable pricing over the long term, making bilateral contracts attractive for both parties. To the extent that municipal utilities or other load-serving entities wish to self-supply, that option fully is available without disrupting the competitive market. Within limits, states even may exercise self-help by contracting for capacity resources to alleviate localized constraints that would otherwise drive up the auction price. The FCM provides an inherent flexibility that permits load to satisfy its reliability obligations through a variety of means.

Third, unlike any other capacity procurement approach, the FCM provides a logical transition to an energy-only market. Such a market is not feasible so long as the demand curve remains inelastic and political realities make uncapped price spikes unacceptable. Just as Insull developed two-tiered pricing in the 1890s using Arthur Wright’s demand meter, however, innovators inevitably will refashion technology to permit real-time metering on a broad scale. By injecting elasticity into the demand curve, real-time metering should make all capacity markets atrophy and eventually wither away. When demand can respond instantly to price spikes, customers will be able to express with their dollars exactly how much an additional increment of reliability is worth, and suppliers will be rewarded through the energy market for satisfying that demand. As the demand curve becomes more elastic and more generators can thrive on energy revenues alone, capacity prices in the FCM auction will fall until they approach zero. The FCM provides a straightforward bridge to an even more optimal energy-only market.

Not Your Father’s Capacity Market

A broad consensus of New England stakeholders has designed a capacity market that fully addresses the universally acknowledged objectives for such markets: (1) a reliable electric grid; (2) lowest-cost reliability; and (3) an efficient mix of resources. To the extent that earlier markets were broken, they have been mended in New England, and the FCM solution is superior to any other approach now being touted. Other regions would be well served to consider New England’s FCM model as a means to ensure reliable capacity within a market-based, competitive environment.