The state of wholesale power markets: What’s wrong with proposed changes in Eastern RTOs?
In part one of this series, we discussed why generators are struggling to make ends meet in wholesale power markets, summarizing the reason for low revenues in one word: overcapacity.
In many markets, oversupply is chasing after flat or decreasing demand. Coupled with very low natural gas prices, energy and capacity prices are at all-time lows, pinching generators. In response, several states have provided subsidies or out-of-market support for plants that would otherwise retire. This, in turn, exacerbates overcapacity.
Generators that have not benefited from these recent state policies are now asking market operators for new rules to increase revenue, making unsubstantiated claims about reliability risk from state policy support for certain resources. In response, three market operators — ISO-NE, PJM, and NYISO — have proposed new rules.
This article analyzes the proposed market reforms and evaluates each on policy merits. We consider how these reforms would address the near-term overcapacity issue, evaluate long-term market impacts, and assess how well they integrate market goals with state and customer goals.
How state policy interacts with capacity markets
Several market operators trade capacity (megawatts) in addition to energy (megawatt-hours). In forward capacity mechanisms (FCMs), market operators run an auction that selects plants to receive a payment for being available to generate electricity at a future date. Plants bid into FCMs based on the expected amount of revenue needed outside of the energy market and other sources (e.g. subsidies) to make them economic.
State policy can impact FCMs two ways. First, units receiving state subsidies can bid into the auction at a lower price because they have additional revenue. These subsidized units are therefore selected more often in the auctions than they otherwise would have been, given their lower bids. Consequently, the most-expensive unit selected in the auction, which sets payments for all units, is now a less-expensive unit, lowering prices for everyone.
Second, if state policies incent additional resources to be built beyond those selected in the FCM auction, the result is generation overcapacity, which exacerbates oversupply impacts, for example further depressing energy market prices.
In light of new state policies coupled with the above concerns, PJM and ISO-NE have each proposed changes to their capacity markets, moving each to a two-staged process.
The two-stage capacity market proposals
PJM and ISO-NE have proposed similar changes to address the low revenue challenge for generators not supported by recent state policies. Both proposals involve running the capacity market in two stages.
Under PJM’s proposal, the market operator solicits bids from generators the same way it does today: In the first stage, PJM runs the capacity market like it has in the past, keeping “subsidized” units in the market. In the second stage, PJM reruns the market but uses administratively determined prices that add back state subsidies, raising payments to all resources selected by the market.
ISO-NE’s proposal also uses a two-stage approach. In the first stage, ISO-NE runs the capacity market as usual, but uses administratively determined prices that add in state subsidies. In the second stage, ISO-NE runs a different auction to pair resources that were not selected in the first auction with resources that were selected, but are open to retiring. For example, if a coal plant cleared the first auction at $10/kW-month and cleared the second auction at $2/kW-month, it could make a profit of $8/kW-month from transferring its capacity obligation to a new unit and permanently exiting the market. That’s nearly $50 million for a 500-megawatt (MW) plant. The goal is to pair units that are willing to retire with other resources that are not selected in the first auction, in a pay-for-retirement scheme.
The reasonable intention of two-stage capacity markets
While neither of these proposals is likely to address current market concerns, the ISO-NE proposal rightly aims to correct the supply-demand imbalance by encouraging uneconomic units to exit. This highlights the merit of encouraging retirements in the short term in an effort to bring supply and demand back into equilibrium.
The cons of two-stage capacity markets
Both proposals introduce significant problems. First, the proposals require grid operators to calculate subsidies for different resources. Yet subsidies come in many forms – tax credits, land leases, sales tax exemption, and worker training, to name a few – and vary by region and over time. RTOs are not set up to handle this type of ongoing analysis.
Second, the proposals will likely over-procure resources and further depress energy market prices. In PJM, market operators use a demand curve when choosing the amount of resources procured. Lower resource offer prices mean more capacity is procured. However, because units know their prices will be inflated in the second stage of the auction when subsidies are added in, they are likely to lower their offer prices, resulting in even more capacity being procured. In ISO-NE, if resources don’t clear the second stage of the market but are built anyway due to state policy, too much capacity will be built.
Finally, the proposals artificially increase payments on the backs of customers. Higher payments are likely to exacerbate oversupply because uneconomic units will be able to stay around longer. With more units online, energy prices will be further depressed, furthering the stretch of low prices for generators.
The upshot: Two thumbs down for two-stage markets
Both proposals, by trying to accommodate state policy rather than simply acknowledge it, put forward clunky, discriminatory solutions that will likely continue driving overcapacity and exacerbate existing market conditions.
The carbon adder proposal
Both NYISO and PJM are considering a carbon adder (CA), which adds a price to generator offers in the energy market based on a price of carbon and the emissions intensity of each plant. Economists like the CA because it aligns the long-term carbon reduction policy goal with market signals.
In practice, though all polluters pay the CA, they also receive higher payments based on the emissions intensity of the last (marginal) unit selected by the market. Generators whose emissions intensity is lower than the marginal unit make more money, while dirtier generators are penalized. In aggregate, generators are likely to increase profit. The financial and emissions impact of the CA is significantly dependent on the level of the carbon price over time.