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When Markets Fail

New England grapples with excess capacity and rock-bottom prices.

Fortnightly Magazine - May 2010

effect anyway for FCA auction number 4, to be held in August of this year, for which buyers and sellers already have made extensive plans, so as not to cause untoward disruption in the short run.

FERC also now has OK’d the ISO’s proposal to reconcile the probabilistic engineering test employed for measuring the capacity needs for individual geographic zones (the local sourcing requirement, or LSR), with the deterministic engineering test used for measuring whether local resources are needed to satisfy reliability standards.

Previously, the two tests had been inconsistent, leading to situations in the first and third capacity auctions where the capacity requirements for a given local area were easily met, requiring no special locational zonal price premium to entice capacity into the local area, but where the ISO had found itself obliged to reject de-list bids filed on behalf of local resources, since removing the resources from the auction would impair local reliability.

That result had undermined the very reason that FERC had required New England to adopt a new capacity market in the first place—to reflect locational differences in resource costs, just as regional energy markets reflect geographic nodal differences in energy dispatch costs through locational marginal pricing.

The incompatibility was partly to blame also for the fact that with three capacity auctions having been conducted, the market had yet to see any zonal price separation. Each auction had cleared at a single price applicable over the entire region.

Thus we are left with two key issues that still haunt New England’s forward capacity market, directly linked to the twin evils of surplus capacity and depressed prices:

CONE vs. Auction Price . First, should auction clearing prices track the value known as CONE, or cost of new entry, which represents a best guess at the price developers would likely demand to cover the long-term levelized average capital cost of their new power plant projects—projects assumed to be gas-fired turbines—or should the ISO take no special effort to ensure that CONE estimates and auction clearing prices remain closely linked, thus allowing prices to fall into a death spiral, if that is how the auction clears?

Out-of-Market Offers. Second, when an owner of capacity resources secures a revenue stream outside the parameters of the ISO’s capacity market such that the owner need no longer depend upon auction proceeds to cover its fixed costs, and so becomes indifferent to the rise or fall of the auction clearing price, how should the ISO review FCM low-ball price offers from such “out-of-market” (OOM) resources, to ensure that such offers don’t distort the market outcome, either by depressing the clearing price, or by injecting excess uneconomic capacity into the auction?

Robert Stoddard, vice president and leader of the Energy and Environment Practice at CRA International (formerly Charles River Associates), argues that whatever is being tried now to answer these questions is clearly not enough:

“At least 1,400 MW of new capacity, and perhaps twice that figure “has been injected into the new England market ahead of demonstrated need with the express or tacit