News Analysis

 

New England puts a price on electric reliability, but some say the charge looks more like a tax.

Does ICAP qualify as a true commercial product, traded on its own merit with a tangible value for customers?

Or does it exist as artifice - a fiction contrived by regulators to revive and monetize the traditional duty to serve, itself an idea that may have lived past its time?

ICAP denotes "installed capability" - not the electric energy that users consume, but the capacity to produce it. ICAP represents the right to receive power that utilities (also called "load-serving entities," or LSEs) must buy from generators to make sure they have enough supply to cover the demands of their customers, including a margin to allow for contingencies.

Regulators want to make a market in ICAP. They say ICAP offers an essential incentive for power producers to build new plants, since without it, generators could never recover their fixed costs. To create that incentive, regulators impose an ICAP deficiency charge, based on some administrative estimate of the value of installed generating capacity, and payable if your ICAP runs short. Utilities never buy ICAP, the theory goes, if they find it cheaper to go without and pay the penalty. So most everyone concedes that the deficiency charge will set the price of ICAP traded in a bilateral market. Yet the regulators are having trouble setting the deficiency charge, and hence setting the price.

Is the price $8.75 (expressed in terms of a kilowatt-month), as it was in the New England Power Pool (NEPOOL) throughout the decade of the 1990s? Or is it 17 cents per kW-month, which is the current price, supported by many in NEPOOL. Or is it $2, $3, $4.87, or as little as zero? Any such range of prices could apply under the entirely revamped interim ICAP regime proposed on June 4 by ISO New England (ISO-NE). Sithe Energies and FPL Energy brand this peculiar result as "a concession to the 'anti-ICAP parties,' who persist in arguing that ICAP is valueless." All the same, the ISO' s interim ICAP plan would take effect August 1 and run through December, when the ISO would move to a new, permanent plan. By contrast, the base ICAP price in the PJM market is $5.38. The ICAP price runs considerably higher in in the New York ISO.

Some of NEPOOL' s anti-ICAP faction would set the deficiency charge at the price of ICAP traded in bilateral markets, turning on its head the common assumption that the deficiency charge sets the price. That would beg the question of whether ICAP has any value at all. They argue that real-time spot energy markets already recover all generator costs, operating and fixed, and that any ICAP charge in reality is a tax on consumption, since power producers and utilities alike should need no further incentive to build a capacity cushion.

Welcome, then, to dockets EL00-62-015 and EL00-62-026, the two cases in which the Federal Energy Regulatory Commission (FERC) must respond to a federal court remand order (). It also must review the ISO plan, which arguably does not represent the real parties in interest. Those players - the 200-odd "participants" in the New England Power Pool (NEPOOL) - earlier had voted 65 percent in favor of a completely different plan, but had failed to win the required two-thirds majority required for passage.

Mirant and PG&E put the matter bluntly: "As the [FERC] is well aware," they noted, "most NEPOOL Participants supported a 17-cent/kW-month deficiency charge."

In other words, the ISO' s plan is really nobody' s plan. It fails to say how it would dovetail with the comprehensive standard market design proposed recently in New England for congestion management and wholesale settlements. ()

"It' s a curious mix of interim provisions, proposed future rule changes and various ideas-in-the-process-of-development," writes Frederic Klein, assistant general counsel for Northeast Utilities Service Co., of the ISO plan.

All this uncertainty has taken a toll on New England. "The high level of effort involved on all sides continues to drain resources away from other, more productive work," adds Carlos Gavilondo, of New England Power, a subsidiary of National Grid.

And if that wasn' t enough, the ISO showed signs of backtracking in "working session" held on June 22 to present the idea to NEPOOL. At that meeting ISO representatives "acknowledged that their proposal had a number of holes in it" and asked for input on "how to flesh out significant details," say Debra Bolton, house counsel for certain Mirant generators in New England, and Steve Herman, at for PG&E Generating.

Scott Siverstein and Roberto Denis, house counsel for Sithe Energies and FPL Energy, want the FERC to step in and impose the old charge of $8.75. "The FERC should stand by its convictions," they say. "The design of electricity markets is far too complex," they add, "and the stakes far too high, to be dealt with in this piecemeal fashion."

Top Ten Disputed Proposals New England' s ICAP plan has something for everyone - but more, it seems, for consumers.

1. MARKET MITIGATION. ISO could knock ICAP price down to $2 (with further 40-cent cuts) if ISO finds too-few players (three) controlling the net surplus of capacity not pledged as ICAP, during a mid-month market review. But some generators (e.g., Sithe) see greater concentration among ICAP buyers than sellers. They say buyers could trigger the $2 mitigation price almost at will, simply by choosing not to buy ICAP from the sellers with the largest volumes. (Pro consumers.) 2. FORCED DISCLOSURE. ISO could force traders to disclose positions during the mid- month market review. (Anti-producers.) 3. GOOD BEHAVIOR DISCOUNT. Utilities and LSEs get 20-percent discount off deficiency charge after covering their ICAP obligations in the prior month. (Pro consumers.) 4. CURE PERIOD. They also can avoid ("cure") up to 5 percent of the deficiency charge by buying ICAP retroactively up to two weeks past the monthly supply period. NRG Power Marketing complains that this rule lets ICAP buyers move after the fact to arbitrage the difference between the bilateral market and the deficiency charge. Utilities like National Grid say its too difficult for buyers to forecast load and ICAP requirements in advance. Others, like Aquila Energy Marketing, say the 5 percent cure allowance is too low, and will encourage buyers to hoard. That "will create a false scarcity in the ICAP Market," say Maine state regulators, "artificially inflating the bilateral contract price." (Pro consumers, but they don' t see it that way.) 5. DELISTING RIGHT. Generators may choose not to sell capacity in bilateral ICAP market, but export it instead (to New York, for instance) with no recall right for ISO-NE. (Pro generators.) 6. UNIT COMMITMENT. Generators selling ICAP in New England must submit a supply bid in real-time energy market, but capped at the equivalent of $1,000 per MW. Calpine complains that gives the ISO a virtual call option on energy, but without giving the generator the right to negotiate either the strike price (the $1,000 cap) or the option premium (the ICAP deficiency charge). "If the strike price is manipulated by regulatory fiat, it is most certainly going to affect the option premium." (Pro consumers.) 7. MARKET STANDARDIZATION. ISO touts its plan as based on PJM' s ICAP charge, but it differs on many particulars (monthly, instead of seasonal, and with no "bad behavior" penalty, as in PJM), and seems not to achieve a standard design. (Displeases many on all sides.) 8. REGIONAL COORDINATION. ISO aims plan at reducing "seams" issues with PJM, yet many argue that New York is the more natural trading partner. (Mainly of academic interest.) 9. INSTALLED CAPACITY VALUE. ISO sets $4.87 "default" deficiency charge simply by taking PJM' s charge ($177/MWh, or $5.48 per kW-month), based on PJM' s per three-year-old estimates of value of installed peaking capacity ($368/kW), and adjusting for different treatment of outates, but fails to update figures to current cost profile in New England. (Angers producers/consumers alike, who believe true current capacity value in New England is now higher/lower.) 10. BILATERAL PRICE CAP. ISO drops hints that later it will impose a price cap on ICAP traded in bilateral markets. It suggests a price cap based on the 95th percentile of energy clearing prices during OP-4 conditions, averaged over a rolling period, plus 20 percent. (Pro consumers, alarms generators.) - B.W.R. Source: FERC Docket Nos. EL00-62-015, EL00-62-026, proposals, comments and protests filed through July 8, 2001.

Regional Coordination: PJM vs. New York

The New England ISO makes it clear from the start that it wants to pattern its ICAP market after PJM' s ICAP plan, but opponents cry foul.

First, the details of New England' s ICAP plan vary widely from PJM' s. Second, if New England believes it so important to standardize markets so as to minimize "seams" between regions, then why not select New York as the model to emulate?

NEPOOL generators Mirant and PG&E sum up some of the differences between PJM and the scheme proposed by ISO-NE: "ISO-NE' s proposal É only selectively adopts portions of the PJM installed capacity approach as a jumping off point for ISO-NE' s own approach."

Duke Energy highlights differences over ratcheted discounts and penalties: "PJM has no similar program of discounts for 'good behavior.' Rather, PJM retains 'bad behavior' penalties, which increase the ICAP deficiency charge when a participant misses its capacity obligation by greater than 5 percent."

Various generators affiliated with PPL Energy add that in PJM, generators enjoy a safe harbor right to obtain ICAP compensation pegged at an "alternate valuation point," if bilateral prices fall too low.

"Thus," says PPL, "ICAP suppliers theoretically would receive compensation ... To the contrary, ISO-NE purports to guarantee nothing, explicitly stating that ICAP suppliers may receive a payment of zero regardless of the sale revenue they could garner from selling ICAP elsewhere."

Mirant and PG&E add that if regional convergence is the desired goal, then New England should focus on New York - not PJM:

"At this time," say the two generators, "it is almost impossible to sell ICAP from the NY ISO into PJM because NY ISO does not provide (and PJM requires) external ICAP resources to have firm physical transmission service into PJM. ... Adopting a watered down version of PJM' s capacity deficiency rate will not create any real convergence between PJM and NEPOOL, nor should NEPOOL/PJM convergence be the first goal.

"If ISO-NE is truly concerned with promoting convergence with external markets, its short-term solution should be to look to the external installed capacity market that is now, and for the foreseeable future will be, the most physically and economically linked with NEPOOL - the NY ISO ... where the deficiency charge É will increase to no less than $10.40/kW-month ... during the next two years [except in New York City - where the charge is currently $12.50]."

Pricing Issues

Testifying for Sithe Energies, the well-known consultant William Hieronymus, vice president of Charles River Associates, suggests that ISO-NE should set the ICAP deficiency charge at least as high as $6.70/kW-month. That would assume a deficiency charge that fully recovered the value of installed capacity, with no penalty component added on. (NEPOOL' s historical charge of $8.75 is widely seen as implying a capacity charge of between $5 and $6, plus a penalty component for the balance.)

Hieronymus notes that PJM' s $5.48 baseline charge reflected a 1998 estimate of $348/kW for the value of installed peaking capacity (equivalent to $64.56/kW-year, or $177/MW-day). He then calculated the current installed cost of New England peaker capacity at $475/kW, which he says implied a capacity value of $82.11/kW-year, including $7.50/kW for fixed O&M and administrative and general expenses. (He cited other data showing that mid-priced peakers in PJM were selling in April at costs that implied total turnkey installed costs of about $525/kW.)

By contrast, the Rhode Island Attorney General Sheldon Whitehouse argues that spot energy markets alone may prove high enough to compensate generators for reliability (capacity) value. Whitehouse proceeds by comparing the ISO' s proposed $4.87 default charge (derived from dated PJM data), with PJM' s analysis of its own energy markets, as conducted in a report issued last year.

"On page 6 of the report," says Whitehouse, "PJM estimates that a new peaker with a marginal variable cost of $30 per MWh would have earned about $77,000 per MW in the PJM energy market during 1999 in fixed margins. This is equivalent, to $77/kW-year, or $6.42/kW-month. The important point is that this is enough to pay all of the annual fixed costs for a new peaker in a year."

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