Battle lines form over market solutions to electricity needs

Source: Hannah Northey and Peter Behr, E&E reporters • Posted: Thursday, June 19, 2014

As regulators ponder fundamental changes in electricity market rules to cope with the grid’s clouded future, the industry is dividing along its old battle lines to debate the changes.

The Federal Energy Regulatory Commission continues to wrestle with the policies governing “capacity” markets operated by regional transmission organizations (RTOs) — markets that are counted on to deliver future generation resources and conservation measures. Many grid experts question whether the prices merchant generators are receiving in capacity markets under current rules are high enough to assure adequate supplies several years from now, as retirements of coal-fired power plants grow.

Meanwhile, the commission is under pressure from some leading Republicans in Congress who want FERC to assess the impact on future generation capacity and grid reliability of U.S. EPA’s regulations of power plant greenhouse gas and toxic emissions, which are hitting hardest on older coal boilers.

The sharp stresses on electricity supplies during the extreme winter weather at the beginning of this year has added to worries and arguments over the capacity issue, particularly over the gas-fired generation with uncertain gas pipeline deliveries that figures to replace most of the shut-down coal units.

In an interview with EnergyWire about the capacity market issue yesterday, FERC Commissioner John Norris said, “I think it is a problem that is only going to increase.

“I don’t think the current constructs are going to address the problem long-term, which means it will likely get worse unless we take some action to make adjustments,” Norris said.

“There’s no timeline, and I’m not sure there’s any consensus,” Norris added. While he said he is still formulating his views, he is considering rule changes that would enable more market alternatives, such as long-term energy supply contracts or state decisions to meet a portion of future supply requirements.

A key issue, Norris said, is whether officials and the public will accept the short-term energy price increases that may be necessary to encourage investment in the additional generation capacity that will be required.

Today, RTOs set price caps to deal with market power issues by dominant suppliers — and to limit political backlash.

“Theoretically, if capacity markets are going to truly reflect a scarcity and attract investment, but then for political reasons we put on price caps and limit actual truly free market solutions, you’re not going to have a successful outcome,” Norris said.

He said he is also open to considering long-term bilateral energy supply contracts or state-sponsored incentives for distribution utilities to build generation outside of markets to cover future supply gaps.

Addressing long-term needs

The capacity issue is reviving old divisions in the industry, mirroring the debate over interstate transmission policies six years ago.

An organization of traditional electric utilities has sent FERC commissioners a new study contending that market-based strategies for assuring adequate future supplies of electricity cannot be relied upon.

The Electric Markets Research Foundation funded the study by Christensen Associates Energy Consulting, released yesterday, which concludes that utilities in competitive markets must be allowed to sign long-term supply contracts or build their own generation.

With the study, the foundation — representing traditional state-regulated utilities — takes aim at the utilities’ historic rival, the merchant generators and the RTOs that operate the electricity markets that the merchants serve.

“There have been many proposals made to reform capacity markets or to design new methods to ensure resource adequacy in the structured markets,” the Christensen study said, referring to the RTO domain, “but most of these proposals assume that tweaks to the restructured market model will be sufficient.”

The RTO markets, which serve about two-thirds of U.S. electricity customers, are designed to handle short-term supplies of electricity, but they “do not and cannot address long-term capacity needs,” the study contended.

“We think these [capacity] markets are not going to be up to the task, and may be severely tested, I think, if the EPA clean power plan, in any variation of the current proposal, were to go into effect in the next two years,” said Mathew Morey, a co-author of the Christensen Associates report.

“The major concerns that we have about these centralized capital market structures meeting resource adequacy goals stems from the facts that these markets are short-term,” Morley said. “That doesn’t coincide with the life of investment,” which can reach out 20 or even 40 years.

Encouraging new investment

“The markets do not recognize fuel diversity” and its contribution to reliability, he added. The EPA greenhouse gas rules give compliance option to states, but the capacity markets aren’t able to direct investment to address climate issues or other public policy goals that states may have, he said.

That view got support from another direction yesterday, as the American Public Power Association adopted a resolution at its annual convention in Denver repeating its call for a phase-out of the RTO capacity markets and the use of bilateral energy contracts as the primary means for buying and selling energy resources. It blamed FERC for mounting an “unsubstantiated” attack on these options.

John Shelk, president of the Electric Power Supply Association, representing the competitive electricity suppliers, said FERC has made progress improving rules for capacity markets, and that process continues. “We don’t think the rules are fatally flawed, but they could stand improvements.”

To deal with coal plant retirements, the markets have to offer adequate investment signals that encourage resources to come online, he said. But allowing regulated utilities to own generation plants and then bid them into competitive markets at unfair prices isn’t going to encourage more generation investment, he said.

The challenge of providing adequate incentives doesn’t rest with capacity markets alone — the payments RTOs make to generation owners and demand-response providers goes to meet future power needs, he said.

FERC also needs to consider changes in energy markets, the hourly prices for the immediate wholesale electric power flows in RTOs, Shelk said. “Not everything the RTOs do gets priced into energy markets that generators see,” Shelk said.

That was particularly true during the stresses of the past winter, when some power plants responded but weren’t fully compensated by market prices. “To their credit, the RTOs recognize this is a problem,” Shelk said.

The capacity markets are moving in the right directions, said George Katsigiannakis, a principal with the ICF International consulting firm. “I hope the capacity market experiment is not going to stop.

“Don’t forget: The capacity markets haven’t been there that long, just since 2007, 2008. There is lot of learning still to do and experience to be gained,” he added.

Shelk said if there are too many market rule exceptions, if too many hopes are punched in market structures, they won’t work, and then the future supply problem becomes truly frightening.

But regardless of the debate within the industry, the grid map isn’t changing, he predicted. No one is going to force traditional monopoly utilities into RTOs, and nobody is going to break up the competitive markets, he said.