Single Buyer Model for Capacity

1
Single Buyer Model for Capacity

• Tom Welch
• March 26, 2004

2
Reflections on the Debate

• Character of electricity frustrates purists on
  both sides
• Binary nature of reliability creates cliffs in
  market prices
• Time differentiation of product creates capital
  cost differentiation relative to energy cost
• Market orthodoxy sees capacity auctions as IRP
• Regulatory orthodoxy sees market results as
  insufficiently directed
• May be time to recognize inevitability of hybrid
• Retreat from full risk shift to market may be
  required

3
Decision Criteria

• Can offer only political perspective
• (Currently) favored criteria
• Connect (explicitly) payment with product
• Allow politics to determine cost/benefit balance
  of persistent reserve margins
• Technology agnostic
• Allow markets to determine most efficient
  solution within defined needs

4
Objections to Demand Curve LICAP

• It doesn't connect payment with delivery
• People who build won't get the money
• People who get the money won't build
• Choices of slope are arbitrary
• Market can't set slope because of flatlands and
  cliffs
• History reflecting fully integrated period say
  little about needs in market context
• By choosing slope, regulators re-introduce
  administrative determination of "need" (so why
  not do it directly?)

5
Objections to Demand Curve LICAP Near Term

• Doesn't connect payment to problem
• Pays those who need support to run too little
• Pays those who don't need support too much
• Locational element identifies who should pay, but
  proposed LICAP approach does not provide
  politically palatable (or economically effective)
  answer to near term shortages

6
An Alternative

• Short term
• Find the money within the capacity constrained
  areas to keep necessary units running
• If politically necessary, provide minimal support
  level to existing units (minimally differentiated
  between short and long areas) pending
  implementation of long term solution
• Long term
• Develop model that satisfies decision criteria

7
The Single Buyer Auction Alternative

• Long term approach
• Links payments with delivery
• Allows RSC determination of need (beyond NERC
  requirements)
• Allows demand, DG, and all technology
  combinations to participate equally
• Provides "market" for identifying most efficient
  solutions

8
Need Assessment Process

• RTEP/PSPC (or equivalent) estimates baseline
  (meet NERC reliability guidelines)
• RSC provides overlay (diversity, environmental
  considerations, additional surplus to limit
  market power)
• RTO files, FERC approves

9
Need Assessment Granularity

• Estimate out far enough to permit greenfield
  projects to bid (3-5 years?)
• Need assessed by zone where import or export
  constraints are identified
• (Optional) Need established by type of product
  required (e.g. baseline, peaking)

10
Auction

• Held annually for period beginning T "x" years
  (e.g. 2005 auction for obligation beginning 2009)
• Existing and new can participate
• All currently in the market must bid (similar to
  current rules against withholding in energy
  market)
• RTO or another entity with tariff authority is
  counterparty

11
Product Description

• Obligation (for specified period of years)
• To increase distance between load and available
  generation at specific time and place
• Bid at or below strike price established in
  contract
• Example
• Increase distance between load and available
  generation by 50 MW
• Deliverable to NEMA
• Bid into market at 100/MWH

12
Product is technology agnostic

• Treat equally
• Local generation
• Local demand reduction
• Remote supply or demand resource plus ability to
  deliver
• Note -- As demand bids become more sophisticated
  and pervasive, need for physical peaking units is
  likely to decline

13
Capacity Payment

• Pay as bid (?)
• Payment made at time of delivery
• Payment is contractual obligation of RTO or other
  entity filing capacity tariff with the FERC-given
  right to collect from load
• Payment collected from load at time of delivery
  based on proportional peak demand

14
Energy Payments

• Owner of energy associated with the capacity
  payments
• Has sold a call option
• Must bid in at or below strike price
• If dispatched receives lesser of
• Market price of energy
• Strike price in contract

15
Treatment of bilateral contracts

• Load with bilateral contract for capacity has the
  right to bid the capacity into the auction. If
  the bid is made at the price paid for capacity,
  revenue neutrality is assured

16
Security for delivery

• Greenfield projects can bid but all must provide
  security
• Milestone obligations could be imposed for new
  construction