FERC’s new rule on compensation for demand resources tips the market balance toward negawatts. Arguably the commission’s economic analysis is flawed, and the rule represents a covert policy...
Prime Time for Efficiency
filed requests to retire with the ISO-NE. The conclusion that these plants still were needed to maintain system reliability led to a number of reliability-must-run (RMR) contracts—FERC-approved contracts that pay a considerable premium to keep a facility available for operation.
Each retirement application led to a hotly contested FERC proceeding, resulting in a non-market RMR agreement, contracts that both FERC and ISO-NE believed undermined the wholesale market but were needed as a temporary backstop. Eventually, in a key RMR proceeding, FERC mandated creating a more systematic approach of paying for capacity to avoid this ad-hoc and non-market approach.
The FERC mandate resulted in a process that produced a mechanism for making locational installed capacity (LICAP) payments to generators. As with RMR contracts, the LICAP requirements would result in paying a premium to generation facilities to stay in operation—however the payments would be made to all generators, not just those that had applied to retire, creating a general incentive with a locational premium to develop capacity on the New England wholesale electric system. The cost of LICAP for consumers was estimated at roughly $12 billion. This proved a tough pill for regulators, consumers and some utilities. Lengthy and painful legal and political challenges to LICAP followed.
As FERC considered an administrative law judge report advising approval of a highly contested settlement implementing LICAP, Congress included a section in the Energy Policy Act of 2005 (EPAct 2005) directing FERC to reconsider the LICAP requirements. FERC subsequently entertained presentations and testimony on LICAP and its alternatives, eventually convening marathon and arduous settlement negotiations.
The challenge, as it has been since the beginning, is how to keep the lights on while continuing to provide New England with affordable power. A break in what seemed like never-ending gridlock came with a proposal to put in place a new FCM that would replace LICAP as a vehicle for inducing the creation and retention of capacity resources. A noteworthy provision of this settlement is that for the first time, energy efficiency and other demand resources would be allowed to compete with generation to meet reliability needs, provisions championed by key state regulators, major utilities and the representatives of efficiency providers like the Conservation Services Group. Recognizing that demand resources had the potential to provide cleaner and lower-cost alternatives to new and existing generation, groups representing consumer interests and most of the region’s regulators supported this compromise. 2
Key provisions in the LICAP settlement provided a level playing field for demand resources. This offered an opportunity to lower capacity costs and to reduce pollution. Instead of meeting capacity and reliability needs by simply paying generators additional money, there was to be an auction for all capacity, and demand resources were to be eligible to compete and participate in the auction.
First, under the settlement, the LICAP requirements were replaced with an FCM. This is a locational market where all capacity needs and prices are determined by auction. Resources that could meet power needs are bid into the auction. The bids determine the price for capacity in the region.