The Illusion of Reliability: NE-ISO’s Capacity Market
Feb 5, 2014

As much of the country continues to reel from Old Man Winter’s latest blow, something he likes to call the Polar Vortex, an alarming situation has unfolded in the New England ISO (NE ISO). That brutal cold, which has exasperated the need for electricity, has exposed reliability issues within the region’s electric grid.  Now we haven’t seen rolling blackouts, yet, but this is only due to extreme measures (jet fuel generation anyone) and good fortune. What makes this difficult to comprehend is that NE ISO has a forward capacity market.

The Illusion of Reliability: NE-ISO's Capacity Market

A forward capacity market basically allows grid operators to plan and organize generation resources to meet electricity demand three years in advance. The ISO carefully determines how much electricity the region will need at its peak, plus a reserve margin just in case. Then, through an auction, they collect assurances from generators who commit to producing needed electricity – and from demand resources for helping reduce the amount used. Generators and demand resources are compensated for their future commitments, with the hope being that this additional compensation mechanism will help encourage further investment in generation resources. In the end, the grid operators get what they want (and everyone else for that matter); a reliable grid. And generators get what they want; additional revenue for producing power. A real win-win situation.

So how, with all this pre-planning and assurance, has the NE-ISO been challenged with reliability concerns this winter? Well it comes down to supply and demand, and having a few too many eggs in an unreliable basket.

Location, Location, Location (And Subzero Temperatures)

Thanks to the shale revolution, about half of New England’s electricity is now being produced from generators that utilize natural gas as their fuel. Usually it’s cheap and abundant, so it makes perfect economic sense. However, New England has one issue when it comes to natural gas supply; the pipeline capacity coming into the region is still somewhat limited. And usually, this isn’t too big of a problem. That is, unless it gets really cold and demand shoots through the roof, which is exactly what happened. Subzero temperatures exponentially increased the need for natural gas, not only in New England, but throughout much of the Midwest and Mid-Atlantic regions. Given the capacity constrictions of New England, though, gas demand exceeded supply, and what supply there was became extremely expensive.

So how did all those natural gas generators react to this market place condition? Well, 75% of them decided to stop running. Either they were unable to run because they couldn’t get natural gas, or they simply decided that it was more cost effective to shut down than to pay the high price for their fuel. This forced NE-ISO to call upon little used turbines that consume oil or aviation fuel to avoid any devastating blackouts. Now many of those natural gas generators had received capacity payments from NE-ISO for being available during times like these, yet when push came to shove, those generators were not there.

Looming Issues Beyond the Winter

This winter has certainly challenged NE-ISO’s capacity market’s reliability promises in the here and now, but bigger issues loom over the region’s grid dependability in the coming years.

The elimination of the forward capacity auction price floor for the upcoming capacity auction (FCA #8, covering June 2017 to May 2018), coupled with administrative rules that favor new generation sources over existing sources, have led to an exodus of power plant retirements in the region.  Three times as much capacity has announced plans to retire prior to this upcoming auction as in the previous seven auctions combined! Plants don’t have to disclose exactly why they plan to shut down, but projections that new resources will earn as much as 500% more compared to existing resources for capacity may have played a large role in these decisions. NE-ISO hasn’t taken this news sitting down, and has rejected the closing of the Brayton Point power plant, which planned to close in 2017, because shutting it down would threaten reliability. That NE-ISO fought to prevent this closure should be very telling of the urgency of this situation.

Also factoring into these retirement decisions by generators has been a preference by NE-ISO for demand resources when securing capacity. Demand resources, such as demand response, are certainly preferable because they help reduce the overall demand for electricity and do so at very little cost, especially as compared to generation resources.  NE-ISO has made more use out of these types of resources than any other capacity market, with them often accounting for around 10% of the ISO’s peak demand. Because of their low cost, demand resources bring down the clearing price for capacity, which is why generators aren’t too fond of their inclusion.

These demand resources, though, are now becoming increasingly problematic to NE-ISO. The ISO has found that less than one third of the interruptible load cleared in current and upcoming capacity years has actually been available to the ISO to meet the regions demand. NE-ISO is now faced with a situation where the capacity market provided them incorrect signals on how much generation they needed, which will challenge reliability in the near term, but has also turned off would be generators by the lowering of capacity compensation, which will have long term effects.

Let’s Make This a Lesson

With ERCOT currently considering adopting their own capacity market and PJM already operating one, we should certainly learn from what is currently going on in NE-ISO and avoid repeat situations.

  • First, capacity markets need teeth, and lots of them. Both demand resources and generators in NE-ISO have found it more palatable to take non-performance penalties than to actually deliver on their promises, which undermines the planning of the ISO and the grids reliability. Stiffer penalties should deter this behavior.
  • Second, diversification of resources needs to be encouraged. NE-ISO found itself with much of its generation tied up in natural gas and when natural gas became scare, the grids reliability came into question. Capacity markets, as they exist now, try to promote reliability at the cheapest possible costs, but perhaps further incentives beyond the market need to be offered to broaden generation sources.
  • Next, existing and new generation resources need to be treated with more equity. One goal of capacity markets is to incentivize the development of new generation resources, so it makes sense that new generators should be compensated more.  However, reliability must also be achieved, and that won’t happen if existing generators feel overly under-appreciated. You can’t have discrepancies of 500% and expect to keep generators willingly online.
  • And lastly, demand resources shouldn’t be counted on so heavily. Stronger penalties would certainly help curtail the use of demand resources, but capacity markets themselves need to be restrained with these resources. Demand resources shouldn’t inhibit the development of generation to a large degree. In the end, we can’t meet our electricity needs by just shutting everything off, unless we want to live in the stone age, so we must encourage continued generation. PJM has already sought changes in this direction.

This winter may have caused a black eye for capacity markets, particularly in New England, but that shouldn’t mean we view them as a failed mechanism. When done right, they have proven to promote reliability and encourage continued generation investment. A few adjustments and soon Old Man Winter may need to find a new move to knock our lights out.

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