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Dynamic Pricing Solutions

How to account for lack of strong price signals. A hard year puts deregulation to the test.

Fortnightly Magazine - January 2009

quite small, in large part due to the lack of strong price signals at the time of the system peak. 3

Day-Ahead Prices

The most obvious explanation for muted price signals at the time of the system peak is a surplus of electric generating capacity. This makes sense, since under deregulation, policy makers have maintained the same generation adequacy standard (one day of outage every 10 years) that existed under regulation. To implement this standard in New York, all load-serving entities (LSEs) are required to purchase enough unforced capacity to cover their forecast peak load plus a minimum margin. Capacity payments are designed to help generators cover the fixed costs they don’t recover through the energy market. To receive capacity payments, generators also must agree to bid into the day-ahead market for energy. Because more generation than actually is needed bids into the day-ahead market, the possibility of scarcity prices is sharply reduced.

The amount of excess generating capacity that bids into the day-ahead market has increased over the past five years. The minimum reserve margin for unforced capacity (UCAP), set in November 2002 at 12 percent, was raised in May 2003 to 14 percent. However, the amount of capacity in excess of the forecast peak expanded well beyond this level in the middle of 2003 when the administrative demand curve (demand curve) for spot capacity was implemented by the New York Independent System Operator (NYISO). The minimum reserve margin has been lowered over time and was set at 8.4 percent through October 2008. But, the amount of capacity in excess of the forecast peak still is close to 20 percent, primarily due to the increased demand fostered by the administrative demand curve (see Figure 2) .

The tendency for energy prices to spike at the time of the system peak has mirrored changes in the amount of excess capacity. When the margin of excess unforced capacity was quite low, between 2000 and 2002, hourly day-ahead prices even in upstate New York were much more prone to price spikes in the summer. For example, the day-ahead hourly price in the Albany capital region spiked to more than $1.40 a kWh in the summer of 2000 and rose near the newly imposed $1/kWh price cap during the summer of 2001. The hourly day-ahead price also was quite volatile during the summer of 2002. The more muted behavior since 2003 by hourly prices during summer peak hours coincides with the jump in excess unforced capacity to the 20-percent level. The excess in generating capacity state-wide has had a smaller damping impact on the hourly day-ahead price for electricity in New York City and on Long Island, because those markets have location restrictions that reduce the number of generators qualified to participate. This increases the potential for scarcity prices in those markets.

Scarcity Prices

Ultimately the most straightforward way to solve the problem of missing price signals is to eliminate the generation adequacy standard, capacity payments and the administrative demand curve for capacity. But policy makers are reluctant to abandon these mechanisms until they are