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The Nation's Grid Chiefs: On The Future of Markets

Exclusive interviews with the CEOs of five regional transmission systems.

Fortnightly Magazine - October 2006

has been historically socialized—let’s say the cost of congestion. It was formerly spread out like peanut butter, not only across the wholesale price, but across the entire region. Now, however, that price is concentrated onto the area causing the problem, which is typically the area that can do something about it. Well, this type of price signal is unpopular. It’s the same problem in getting demand response to work properly at the retail level. There’s the tendency to want to have uniform, or flat pricing in retail rates, because conventional wisdom makes it unacceptable to have any kind of price volatility at the retail level.

Fortnightly: What about other criticisms of RTO markets—about the bid caps that limit prices, and the band-aids to encourage investment in capacity, such as ICAP, UCAP, or LICAP, when an energy-only market would be simpler?

Van Welie: This is somewhat of a religious argument in the industry. And like most religious arguments, I don’t believe we’ll ever see this fully resolved. From a pragmatic point of view, there is a way to address the issue of ensuring resource adequacy within markets.

To begin, from an economic point of view, energy-only markets are the purest way of doing things. The problem—and here the pragmatist in me comes out—is that experience has shown here in New England that, from a policy perspective, there is no support for the very high prices and the volatility that would have to persist in the energy market in order to make it work. To ensure resource adequacy in an uncapped energy market, it’s been shown that you would need to have prices in the range of $10,000/MWh to $20,000/MWh for 20, 30, or 40 hours a year, in order to recover the capital costs of a peaker, or a quick-start unit. One or two hours is not going to do it. When you look at the overall issue of how to generate enough revenue in a very short number of hours, very high prices in the market needs to exist and reliability has to be close to being threatened. That is just not a comfortable position for people to be in.

In New England, when we originally started with an uncapped energy market, prices roared up to $6,000/MWh in May of 2000. There was a huge outcry, and the result was the $1,000/MWh bid cap that now persists. That, of course, created a problem in the sense that a generator could no longer get full cost recovery in the energy market, and this in turn created the need for a capacity market.

There are really only three ways to solve this problem.

The first approach is to uncap energy markets. The second is an “obligation to serve.” With that, there would be an obligation, created at the state level, for the load-serving entity (LSE) to contract for the needed capacity for the long-term. Most restructured utilities vigorously resist that approach, however, because it creates a liability on their balance sheet in the form of a contract without a corresponding asset. And Wall Street