Finding the 'Sweet Spot'

Fortnightly Magazine - May 2008

As president and CEO of ISO New England, Gordon van Welie has his feet planted firmly on each of two sides of a cultural divide. First, as a transmission system operator, van Welie must keep the lights on and the wires humming—a conservative agenda dictated by long-established engineering concepts where even a moment’s failure can and does lead to political repercussions.

At the same time, however, he must run a regional market—an ongoing experiment in freewheeling capitalism in an industry fraught with more long-term uncertainty than perhaps any other.

Fortnightly: I’m hearing through the grapevine that your recent auction in the forward capacity market was “hijacked” by a huge wave of demand-side bidding. My sources tell me these bids pushed the price so low that some power producers—hard asset owners—are left asking, “What’s in it for me?”

van Welie: There was a very large show of interest. We whittled the amount down through our qualification process and then ran the auction. Ultimately, we ended up with approximately 1,200 MW of demand-side resource and about 600 MW of new supply-side resource. And yes, while it is correct that a large amount of demand-side resources was procured, we’re actually quite pleased about it. Our instinct has been that—at least in the early years of the auction—there ought to be some low-hanging fruit in the form of demand-side resources that could be picked in New England.

Fortnightly: Do you have any safeguards to make sure that these demand-side resources will show up when they’re needed, say, in summer, during a peak demand period?

van Welie: If a university, for example, said it was going to install a large-scale energy efficiency project by 2010, it would have to send us a report every quarter on its progress, including dates the new equipment was ordered, when it arrived, and when it was installed. Or, as another example, consider an aggregator promising to pull together retail customers to cut load. It would have to provide documentation on its progress, including lists of the retail customers under contract, how much each customer is expected to reduce load, and the results of any testing done with each customer.

Fortnightly: What about environmental mandates and renewable portfolio standards?

van Welie: New England has been at the leading edge in this area. Five out of the six states have formally adopted renewable portfolio standards (RPS) and I believe the sixth is now evaluating it. Also, all six have signed on to the Regional Greenhouse Gas Initiative (RGGI). RGGI requirements are the same for the entire region, but with RPS, the definition of the renewable requirement varies a little from state to state. However, both of these initiatives set a requirement at the state level. The cost of resources then will be priced into our markets, through the market bidding process.

Fortnightly: Do you anticipate any conflict between your FCM model and these state environmental mandates?

van Welie: No. Our wholesale markets are designed to be agnostic when it comes to environmental requirements. They treat all resources the same because markets only evaluate a resource for one thing, and that’s price. And of course we check to make sure that whatever is bid into the markets will satisfy our reliability criteria. But we don’t do anything to discriminate from one resource to the next from an environmental point of view.

For example, let’s say that a state decides to tax carbon or put in place a cap-and-trade system, such as RGGI. That will tend to make fossil-fired resources, such as coal, gas or oil, become relatively more expensive over time. If these resources aren’t competitive from a price standpoint, most likely they won’t be selected to run.

Fortnightly: Have you been an activist on climate change? Has the ISO participated regarding legislation or the debate on carbon taxes versus emissions allowances?

van Welie: We are neutral on which is the better method. The method doesn’t concern us because we can accommodate either one.

We have spent a lot of time trying to analyze the consequences of environmental regulation for the region, and inform policymakers. Annually, we publish the regional system plan. Through this plan, there has been a practice over the past several years of trying to quantify the environmental implications of the resources we have on the system. We took it a step further last year, which I thought was quite innovative. We conducted a process called scenario analysis. We convened a stakeholder working group comprised of market participants and state environmental and economic regulators, and we analyzed the potential impact of different resource choices on New England’s power system. Essentially, we benchmarked different resource choices from the perspective of reliability, economics, and environmental outcomes. Of course, what we were looking for was the “sweet spot” where you find the intersection of all three.

Clearly, there are tradeoffs between cost, for example, and environmental requirements. What you are looking for is to try to see what the lowest-cost resource would be that would satisfy both reliability and economic requirements.

Fortnightly: What do you do with that information when you get it? Do you share that with power producers and utilities?

van Welie: We published it and made it available to all our stakeholders last year. We shared it with policymakers as well as market participants. [Editor’s Note: See, www.iso-ne.com/committees/comm_wkgrps/othr/sas/mtrls/elec_report/scenari...

There were some really interesting results for New England. It showed that energy efficiency was one of the clear winners in terms of a resource type that would solve that “sweet spot” intersection that I described. Given the situation that we have in New England, a number of constraints are placed upon us. We are at the end of the pipeline. We import all our fossil fuels. We are densely populated, with 14 million people in a relatively small area. So our resources are somewhat limited.

It was interesting that, given our RPS policies and our commitment to RGGI, there are several resource types that will help us meet those requirements. These include greater interconnection with renewable resources, such as wind and hydro, and imports of power generated by those types of resources through our neighbors to the north.

Fortnightly: And that doesn’t inject you right into the middle of the fuel-choice debate?

van Welie: It’s educating policymakers about the implications regarding certain resource choices.

For example, one of the things that came out of this analysis for New England was that if we want a lot of renewable resources in our system, we’re going to have to build more transmission to get to it. That’s because, for the most part, our renewable-resource potential is distant from the demand centers... in places where we do not have robust transmission infrastructure.

So the scenario analysis discussion helped reveal that and, in fact, triggered a discussion we’re having this year. The discussion is focused on transmission investment to enable development of renewables, not only to meet environmental requirements, but also to allow us to address some of the economic implications of the resource mix that we have at the moment.

Fortnightly: It sounds like the concept of an ISO as a neutral manager of markets is a difficult one to hold to.

van Welie: Our role is to provide the information to market participants, and to the states. Part of our role is to give everyone the same information so there’s a level playing field. And wholesale markets in my view represent the preferred model going forward to tackle climate change and the other environmental imperatives at both the state and national levels.

In the old world, where the technology was relatively stable, a cost-of-service, regulated model was appropriate, though there were some efficiency problems with that model. But if you think about the world we face in the future, it’s very clear to me, and to many in the industry, that it’s going to be very difficult to predict which resource is going to be the winner 30 years from now.

If you had a crystal ball, you could make the decision today to go ahead and build lots of that certain resource—and you would have solved the problem. And you could do so using a cost-of-service model. But if you don’t know what the right resource choice will be for the next 30 to 40 years, the industry is better off leaving that risk to the market. Consumers will end up having to pay the efficient cost of investment, but they will not be on the hook for the mistakes that are made. That’s one of the real powers of the wholesale market approach.

We would be fooling ourselves to think that any single company has the answer to these problems.