Resource Adequacy: Theory and Markets Presented to: Joint SPARC and Markets Committee David B. Patton, Ph.D. President, Potomac Economics April 23, 2014
Introduction Potomac Economics is the Independent Market Monitor ( IMM ) for MISO, monitoring the conduct/actions of both participants and MISO to identify: Flaws in market rules that create inefficiencies or gaming opportunities; Efficiency improvements; Market power abuses and manipulation; In addition to this primary scope, we also: Review and evaluate new market rules and design changes; and Support MISO s implementation of its market power mitigation measures. This presentation will focus to two essential market design issues: Resource Adequacy; Interchange with adjacent markets; and External interface pricing.
Resource Adequacy Threshold Question: Is the purpose of the MISO markets to provide price signals to facilitate efficient investment, retirement, and maintenance decisions that will satisfy MISO s resource adequacy needs? I believe the answer should be yes because efficient market signals: Will not impede the States planning processes or ability to oversee or facilitate investment by their regulated utilities; Provide valuable economic signals that can assist States and their regulated utilities make the most cost-effective choices; Facilitate efficient capacity imports and low-cost merchant investment; Prevent inefficient exports out of the MISO region; Facilitate a vibrant forward (bilateral contract market); Allow wholesale market revenues to cover a much larger share of utilities capital costs (rather than retail ratepayers); and Ultimately generate substantial savings for the region s consumers due to the effects described above. -3-
Market-Based Investment/Retirement Market-based investment in wholesale electricity markets is ultimately facilitated by the markets economic signals, including: Energy and ancillary service net revenues during non-shortages; Energy and ancillary service net revenues during shortages; and Capacity market net revenues; Long-run equilibrium is achieved when the combination of these expected revenues cover entry costs of the marginal resource. Energy-only markets include the first two revenue streams and will generally not satisfy RTOs planning reserve needs. In other words, there is missing money. Capacity markets exist primarily to provide the missing money. -4-
Why is There Missing Money in Electricity Markets? Planning reserve requirements exceed levels that an energy-only market would provide, assuming the energy market prices shortages efficiently. Why? The 1 day in 10 year reliability standard implies a value of lost load of $100,000 to $200,000 per MWh Therefore, additional revenues are needed to prompt the higher level of investment needed to satisfy these targets. The higher planning margins result in more supply, which reduces the frequency of shortages (and associated shortage revenues). Real-time prices may not always fully reflect the value of energy because of the effects of the ISO s reliability actions: Committing peaking resources or other generating resources; Curtailing load; and Curtailing exports; -5-
Essential Attribute: Capacity Demand Curve Demand for Capacity. Based on the reliability value provided by the capacity. Vertical demand curve indicates that the last MW needed to meet the capacity requirement has extreme value and the first MW of surplus has no value. In reality, each MW of surplus capacity increases reliability, although these reliability increases diminish as the surplus grows. Supply of Capacity. The competitive offer for capacity (i.e., the marginal cost of selling capacity) is generally close to zero because the costs of satisfying the capacity obligations are usually very low. These characteristics cause: Clearing prices to almost always be close to zero. Poor investment signals produced only from shortages that are unpredictable and unstable. -6- P P* Q* Quantity Cleared = Minimum Requirement Capacity Requirement (Vertical Demand Curve) Competitive Supply Stack Q
Essential Attribute: Capacity Demand Curve A sloped demand curve reflects that additional capacity above the minimum does have reliability value (which decreases as the excess increases). The price (P*) would be determined by the marginal value of additional capacity as represented by the sloped demand curve, rather than by a supply offer. A sloped demand curve: Provides more efficient prices that reflect the prevailing surplus. Improves price stability, which should facilitate investment by reducing price risk. Reduces incentives to withhold capacity by raising the opportunity costs of withholding (foregone revenues) and decreasing its price effects. -7- P Clearing Price P* Minimum Capacity Requirement Capacity Requirement (Sloped Demand Curve) Q* Quantity Cleared Q
Locational Requirements and Zones Transmission constraints cause RTOs planning needs to vary locationally to satisfy: Resource adequacy needs; and Transmission security needs. In order to efficiently facilitate investment (and retirement) decisions, these local needs must by accurately reflected in the capacity market. Prices should dynamically adjust based on the supply and demand that exists in local areas. -8-
Questionable Attribute: Forward Procurement Capacity markets vary regarding when capacity must by procured: NYISO (and MISO): Shortly before the operating year or month. New England and PJM: Roughly 3 years in advance. Primary role for the capacity markets, regardless of the procurement timeframe, is to establish a transparent, efficient price for capacity. Such prices facilitate efficient forward contracting and long-term decisions (investment, retirement, and maintenance). Many in the industry confuse RTOs mandatory forward procurement with longer-term forward contracting. They are not substitutes; Bilateral forward contracting remains key under any market design for locking in revenues and facilitating financing of new resources. Mandatory forward procurement has significant potential drawbacks and it premature to determine whether this is desirable attribute. -9-