Playing Safe with Capacity Markets

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PJM would minimize risk, but so did regulation.

PJM would minimize risk, but so did regulation.

Fortnightly Magazine - February 2015

As we learn from the great Roman historian Tacitus, "The desire for safety stands against every great and noble enterprise." And so today, some 20 centuries on, we see a trend in many power markets to add "safety" measures as a result of perceived market failures.

PJM, a regional transmission organization (RTO) covering a large part of the Midwest and Eastern U.S., filed a proposal last December with the Federal Energy Regulatory Commission (FERC) to modify its current capacity market structure. PJM's proposal is similar to the one that FERC had approved for ISO-New England some six months earlier. The changes envisioned in these two efforts call for ever more structured markets, further reducing the scope of the competitive landscape from which RTOs arose, and to which they presumably remain dedicated. These changes evoke a desire to create a competitive market place in the generation sector of the power market, while preserving the safety that the regulated market brought. However, this desire may produce a system that is actually more costly and less innovative than regulation. Free markets by their very nature are evolutionary, requiring trial and error. But the RTOs are preventing evolution to the point that we might best go back to regulation.

Where Are We Today?

By the time you pay your bill, there are several components for which you are paying. If you reside in a deregulated region, the only portion representing the competitive market is the energy piece. Your Retail Electric Provider (REP) can offer you savings only on the energy piece of your bill. All the other pieces are essentially fixed, so that any attempt to shop for a lower price on other categories of service will not drive further savings.

Figure 1 - Fewer Dollars in Play

In order to prevent a price shock in the move to deregulation many markets placed a price cap on the power price. This very move creates a hole in the movement to a true deregulated framework. Do we limit cell phone prices or even gasoline prices? The PJM price cap is currently $1000/MWh.

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Unlike other goods and services sold, power requires a perfect balance between supply and demand, or else all parties can lose access to power through a brownout or blackout. In the regulatory construct, an excess buffer of generation was built and paid for by the ratepayer to avoid this potential outcome. This generation may never run for many years. This "free" market model with a price cap results in economic losses for the generator supplying this buffer. Case in point: if a simple-cycle gas unit cost about $85 million dollars for 85 MW and runs only 40 hours in the year, in order to have a payback in 3 years