When FERC law judge Bobbie J. McCartney issued her initial decision back in June, weighing in at 280 pages, plus 2,435 footnotes, she already had accepted the basic structure of the ISO New England (ISO-NE) LICAP plan to create a location-specific market for installed electric generating capacity. That's because, in prior rulings, the Federal Energy Regulatory Commission (FERC) had told her to do so.
In its prior rulings, FERC had accepted the basic legitimacy of LICAP, with its twin concepts of: (A) a downward-sloping demand curve; and (B) some method to assure capacity availability in load pockets or constrained areas, such as a deliverability requirement or, as eventually proposed, a set of different obligations, auctions, and prices for each of five geographic market areas within New England.
As far as the commission was concerned, it wanted to limit further debate to the finer-grained details of LICAP. Such details would include, for example, the exact parameters of the sloping demand curve, the method(s) for defining plant availability, and measures for combating capacity withholding and minimizing market power.
By contrast, FERC, the ISO, and many other parties had seen no reason for further debate over the need for a location-specific capacity market. That's because power producers often tend to ignore transmission topography, and usually choose to build new plants in low-cost areas, putting a strain on the transmission grid. But why not, since transmission costs are socialized across the region? Thus, without a locational obligation to force utilities to gather capacity reserves in constrained areas, FERC and the ISO feared that plant-siting decisions would force high-cost solutions biased in favor of high-cost grid investment. Further, the ISO would find itself forced to award power producers with more cost guarantees through RMR (reliability must-run) contracts. In particular, the ISO had offered evidence to FERC that these costly RMR contracts had grown out of control, and threatened the regional market. ()
Nevertheless, by limiting debate, FERC had foreclosed a raft of competing ideas. In November 2004, for example, McCartney had struck from the record an alternative plan offered up by the Connecticut's consumer counsel, the state's public utility commission (PUC), and others, calling for a system of call options for energy (proposed as the "Reliability Options," or RO Market).
Under this plan, which sounds a little like the RUC idea (Residual Unit Commitment) under consideration in California as part of a pending new rate design (the MRTU) from the California ISO (Cal-ISO), capacity suppliers would sell options on energy contracts tied to specific, available generating units. The RO plan would set the strike price higher than typical average energy prices, but lower than expected peak price in the spot market. If the ISO calls the options, the supplier repays to the ISO the difference between the strike and spot prices. That payment is then redistributed ultimately to retail consumers. In this way, it is the power producers - and not the ratepayers - who bear the financial risk when a shortage of generating capacity forces the ISO to scramble to drum up power at the very moment that peak prices prevail.
Connecticut had touted its plan as a just-in-time solution. By creating options available for the ISO to call during emergencies, the plan kicks in only when needed. Utilities would not need to acquire extensive and costly capacity portfolios to be available 24/7, as would be required under the ISO's LICAP proposal. However, the Connecticut RO plan went beyond the scope of the issues stipulated by FERC, so judge McCartney had been forced to declare it out of bounds.
Of course, plenty of complicated issues remained on the record for resolution. Consider, for example, the nearly dozen different alternative LICAP demand curves proposed in the case, two of which are reproduced here, in Figures 1 and 2. Each curve represents a different view of how much capacity really is needed to satisfy reliability needs for the region. ()
All of this changed in late summer, however, when FERC on Aug. 25 announced a new set of ground rules for the upcoming oral argument. Suddenly, FERC had asked the attorneys to compare the costs and benefits of New England's LICAP proposal to other possible plans, and whether LICAP—or any—would provide for just and reasonable wholesale power prices, and adequate assurance of necessary generating capacity. After that, it was "Katy bar the door."
In the three-plus weeks remaining until oral argument on Sept. 20, opponents went back to the drawing board and filed a host of new proposals to compete with LICAP. They flooded the record with an alphabet soup of acronyms, denoting a raft of new and complicated constructs.
Consider NERAM (the New England Resource Adequacy Market), and its companion plan, known as NELRAM (the "L" stands for Locational), as proposed by anti-LICAP groups representing various coalitions of state PUCs and consumer representatives in New England.
Each plan stands as an offshoot to the generic CRAM model developed by National Economic Research Associates. NERA presented the plan in February 2003 (or perhaps 2004, there is some dispute about this), to PJM, New England and the New York ISO, for their consideration in developing capacity markets. ()
NERAM and NELRAM (and CRAM) each envisions an open-market, periodic, descending-clock auction, with the auction price binding throughout the expected three- to five-year time frame for new plant investment. Generators would submit actual supply bids in exchange for a commitment several years hence to provide capacity, with the promise to receive actual auction-clearing price upon eventual delivery. Proponents claimed that either NERAM or NELRAM would give developers a greater incentive to build, since they already would know today exactly how much the capacity market would pay them eventually, several years down the road, when plant construction was complete.
Contrast these plans to LICAP, where the "auction" is a fiction. The price is set administratively by the ISO's self-designed demand curve. Also, under LICAP, new generators who see incentives in this month's LICAP capacity price will not necessarily receive that same price when their new plant comes on line several years hence. The price, in fact, could be considerably lower. Thus, LICAP opponents see that risk as too great for today's power-plant developers.
Nevertheless, CRAM, NERAM, and NELRAM share a common weakness. As the question was posed at oral argument by attorney John Estes, representing capacity suppliers, "Who is the buyer?"
"Each proposal," says Estes, "talks about a central buyer. Is it ISO New England? Do they take title? Do we have a contract with them? … Is there some state entity like California's DWR that's set up, except we need six of them [one for each state] and they all need to pass legislation at the same time so they can all enter into contracts?" ()
When the moment finally arrived for the oral argument at FERC, Estes and the other attorneys and witnesses attempted valiantly in the precious few minutes allotted each speaker to flesh out these new ideas, and the commissioners struggled as well to keep up. Chaos reigned, however, since the evidence, analysis, and testimony needed to fully explain these newly presented alternative ideas was now irretrievably missing from the massive case record that had been painstakingly developed over the preceding 18 months. (By at least one count, that record had included presentations by some 46 witnesses, plus 4,000 pages of testimony and some 600 exhibits.)
This highly unusual situation made for a helter-skelter hearing, with new topics seeming to come out of the woodwork. At one point, FERC Chairman Joseph Kelliher appeared willing to go so far as put even the commission's hallowed price caps into play.
That issue arose because power-plant developers in New England invested like crazy five to seven years ago when the regional market opened without wholesale bid caps (the correct term), but then had retreated when FERC and the ISO had installed the caps and other mechanisms to restrain prices. So just about everyone now concedes that price controls are largely at fault-by discouraging merchants to risk more capital, thus giving rise to predictions of eventual power shortages in New England, and the concomitant need for LICAP.
Consider this exchange between FERC Chairman Kelliher and Joseph Rogers, chief of the utilities division of the office of Massachusetts Attorney General Thomas Riley, appearing on behalf of residential, commercial, and industrial ratepayers in the Bay State:
KELLIHER: Your recommendation is that we take no action and that somehow generation will start getting built in New England?
ROGERS: Well, if you believe in markets, then you should believe that when the price rises generators will be incentivized …
KELLIHER: You're arguing we should rely on markets. You're arguing we should lift the price caps?
ROGERS: I think that's an issue that should be addressed.
This exchange reveals the sheer outrageousness of some of the extra-record claims, assertions and arguments that spilled forth at the LICAP oral argument. Yet consider an even greater shock-one that came from across the country, some 3,000 miles away.
On Aug. 25, the same day FERC blew open the doors in the LICAP case, staff of the California PUC released its Capacity Markets White Paper, urging that the state's utility regulators go against the grain and consider a technical LICAP model styled after the New England proposal. Then came the Cal-ISO, the state's independent grid operator, responding to the report on Sept. 23 by saying, in effect, "not so fast."
Opposite from its counterpart in New England, the Cal-ISO chose to withhold any formal endorsement for a California LICAP plan. Moreover, it seized the opportunity to air a collection of studies to suggest that perhaps the best way out of the capacity market mess was to consider killing the price caps-the very remedy to which Kelliher alluded at FERC's LICAP hearing.
Without specifically advocating an end to price caps, the ISO nevertheless raised the issue by attaching to its formal response to the California Public Utilities Commission (CPUC) a copy of an article by Harvard Professor William Hogan that suggests just such a step. The response from the ISO, totaling more than 200 pages, included extensive reports on investigations underway at the Midwest ISO and in ERCOT to consider comparable systems to eliminate price caps and create stronger incentives for merchants to build plants. ()
In his article, Professor Hogan cites the problem of the "missing money"-how price caps prevent plant owners from recovering fixed costs through scarcity rents collected at those few magic moments when wholesale power prices in RTO-sponsored day-ahead markets otherwise might reach super-peak levels. By killing price caps and relying simply on energy prices to encourage developers to build capacity, Hogan says, regulators can avoid the evil of having to make administrative determinations of how much supply is needed. ()
Will the California PUC take the bait and bite on its staff's advice to consider an Eastern-style LICAP model for its state-mandated resource adequacy requirements (RAR), even though the likely LICAP market administrator, Cal-ISO, seems lukewarm to the idea?
In fact, the same market attributes that led New Englanders to consider a LICAP market may be present in California as well. Consider this conversation, taken again from the LICAP hearing at FERC on Sept. 20 between Commissioner Suedeen Kelly and John Estes, representing a coalition of suppliers of generating capacity:
KELLY: Mr. Estes, is it fair to say this proposal [New England's LICAP] would eliminate the possibility of what happened in California in 2000?
ESTES: It does as much as you can do right now to prevent that. And, you know …
What other region of the country besides New England has chronically bad deliverability of natural gas? What other region of the country? California has air emissions limits that are starting to tamp down on generation.
You know, what other region of the country relies on hydropower from Canada, that can dry up in a dry hydro year? California.
On Sept. 27, CPUC administrative law judge Wetzell vetted a draft opinion setting out a tentative RAR regime to begin in June 2006 that would ensure capacity by forcing load-serving entities (LSEs) to procure energy contracts tied to specific generating units. But the draft order remains cagey on the question of LICAP:
"While we have not determined that a centralized capacity market should be developed, … the question … should be studied in additional proceedings." ()
Moreover, the draft opinion seems to herald possible trouble down the road for a state-mandated LICAP scheme.
First, while the draft plan would impose obligations on LSEs, it makes no demands on generators: "While we generally approve the concept of a split RAR obligation that includes Cal-ISO enforcement of specific generator availability and performance duties, we cannot and will not adopt the Staff/Cal-ISO proposal here." ()
This issue-how to measure plant availability-has proven particularly troublesome in New England, and could well prove problematic in California.
In New England, the ISO chose to measure plant capacity in terms of its availability only during certain critical hours, on the theory that these periodic periods of peak demand and power shortage are the reason that LICAP is needed. Also, New England had proposed a method of calculating plant outages (which diminish availability) that was said to be incompatible with the traditional definition used in PJM and the New York ISO (and in New England under its current ICAP regime, which pre-dates LICAP). That more traditional measure is known as EFFORd, or the "equivalent forced outage rate." Of all the questions presented by New England's LICAP plan, these issues received the greatest degree of review and criticism by judge McCartney in her initial decision at FERC.
Second, it appears the CPUC might also delay beyond 2006 its promise to establish a local capacity (locational) component to its RAR regime to ensure deliverability in load pockets and congested areas. Indeed, will California see its LICAP dreams run aground on the same cost concerns that have dogged regulators in New England? Consider this excerpt from the draft decision, discussing Cal-ISO's straw proposal Jan. 25 for establishing local capacity requirements, designed to overcome problems imposed by transmission constraints:
"The record before us does not allow [us] to find that the reliability benefits of the Cal-ISO's straw proposal justify the costs and operational burdens that will be imposed on LSEs and their customers. … LSEs may need to procure 25,000 MW of local RAR in 2006. …
"The Cal-ISO proposal may result in higher capacity requirements than are currently available under contract through RMR contracts. Also, the analysis appears to have resulted in unexpectedly high levels of local capacity requirements because of some combination of transmission and generation contingencies and … peak loads that are collectively more extreme than the analyses justifying RMR contracts." ()
To anyone following the LICAP case in New England, California's "unexpected" discovery should come as no surprise.
Consider this last comment from John Estes, at FERC's oral argument on LICAP on Sept. 20:
"I can't help but point out that for something like five years now virtually every load-serving entity in virtually every state government has fought against any capacity market whatsoever."
As might be expected, however, ISO New England was ready for such criticisms, as shown by this deft rejoinder by its representative, Clinton Vince:
"Political bodies and consumer groups don't support LICAP, but I promise you they will not support blackouts either."
Yet, according to an analysis of the testimony in the LICAP case record, as conducted by a coalition that opposes LICAP and instead supports the NERAM alternative (including the Massachusetts, Connecticut, New Hampshire and Maine PUCs), the New England region for the past 40 years has not suffered a single blackout due to a lack of installed capacity.