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Competitive Wholesale Power Market: Capacity Market
By Raj Addepalli, Ph.D., CFA
Presented at
USEA-USAID Executive Business Meeting
Bogota, Colombia
July, 2006
New York Action Regulatory Restructuring – Flexibility Divesture of utility generation assets to eliminate vertical
market power concerns Creation of the New York ISO Mid 1999 Wholesale and Retail Competition in the State Presently over 40% of customer load is supplied by competitive
suppliers; remaining load is still supplied by host utilities as default service providers
Utilities use a supply portfolio approach - includes certain long-term legacy contracts with divested generators, short-term purchases from generators and wholesale suppliers through bilateral contracts, purchases from the NYISO spot market, and financial derivatives to mitigate risk
3
New York State: 19,157,532 people
Peak Load Forecast of 33,295 MW
38, 340 MW Native Generation
Over 335 generating units modeledRequired Installed Capacity 39,288 MW
The NYISO Control Area
1700 MW in Demand Response
10,775 miles of High Voltage Transmission
4
2006 Capacity (MW) by Fuel Type
17%
9%
35%
9%
15%
13%
1%
1%
Gas 6508
Oil 3659
Gas & Oil 13831
Coal 3505
Hydro 5700
Nuclear 5169
Other 341
Wind 245
New York ISONew York ISONew York ISO"Hub of the Northeast"
* = Peak Load in Megawatts
IMO23,857 MW*
HydroQuebec19,410 MW*
ISO -New England25,158 MW*
New York ISO31,983 MW*
PJM54,176 MW*
Area Covered by Northeast
Major Cities coveredwould include:• Montreal• Ottawa• Toronto• Augusta• Portland• Montpelier• Concord• Boston• Providence• Hartford• Albany• Syracuse• Buffalo• New York City• Philadelphia• Harrisburg• Baltimore• Washington, DC
• Serves a combined load onthe order of 155,000 MW
• Involves over 50,000 milesof transmission lines
• Serve a population on theorder of 70,000,000 people
• Includes a combinedcustomer load greater thanthe entire WesternInterconnection
• Includes major worldpolitical, financial andcultural centers
2400 MW
2500
MW1000 M
W1500 M
W
1600
MW
1500 MW
350 MW
- Washington D.C.
- New York City
- Ottawa
New York Market91% Merchant Generation
Regulated and Merchant Transmission
Regulated Monopoly Distribution
Competitive Retail Sales
New York Wholesale Markets Energy - Day-Ahead and Real Time Markets Installed Capacity Market Ancillary Services Markets
Market based: Reserves (10 min spinning, 10 min non-spin and 30 minute reserves) Regulation
Cost based: Voltage Support Blackstart Scheduling
Demand Response Virtual Markets Transmission Congestion Contracts
Bilateral(forward)Contracts
50%
RealTime <5%
NYISODay-Ahead
Market45 – 50%
Bilateral Contracts outside the NYISO 50%NYISO Day-Ahead Market 45 - 50%NYISO Real-Time Market <5%
100%
New York Wholesale Markets- EnergyCentral Dispatch System
10
Why Capacity Market?
There is a continuing debate regarding whether there is a need for a separate capacity market or competitive markets should rely solely on energy markets to provide sufficient inducement for new entry.
If reliability is not a criterion that needs to be satisfied, or if there is sufficient demand price elasticity, or if there is sufficient tolerance for very high energy prices, then perhaps one could consider reliance solely on energy markets - BUT we are not there yet.
11
ICAP Market Purpose
Capacity markets were created to insure that a sufficient supply reserve margin would exist to assure the reliability of the electric system.
A combination of bid/price cap energy market mitigation measures and the desired capacity reserve margin result in energy revenues that are insufficient, by themselves, to support new entry.
Capacity market revenues provide the additional revenue stream that is needed to facilitate new entry.
Installed Capacity Market Reliability criterion of a one day in ten years loss of load expectation is
established by the NERC’s Northeast Power Coordinating Council
(NPCC). To meet the reliability rules, utilities and other load serving entities in New York are required to purchase capacity to meet forecast peak load plus 18% reserve margin
Three Capacity Markets in NY New York City Long Island Rest Of State
Six month strip auctions (summer and winter), monthly auctions and spot auctions are conducted by the NYISO
The six-month and monthly auctions are voluntary Spot auction (deficiency auction) is mandatory If loads do not have sufficient bilateral capacity contracts, they are
assigned the capacity cost based on the spot auction results
13
Original ICAP Market Design Demand Curve was vertical in nature Loads were required to purchase Minimum Requirement- bilateral
or through NYISO market Deficiencies charged a high penalty Market proved dysfunctional
Erratic ICAP prices When capacity is tight, ICAP prices spike When capacity levels exceed the minimum requirement, however, ICAP prices plunge Loads had no incentive to purchase ICAP above minimum Excess capacity beyond minimum not valued although it may help reliability
Susceptible to market power abuse Suppliers had incentive to withhold to create deficiency
14
ICAP Demand Curve
Original design used “vertical” demand curve Fixed minimum requirement Fixed deficiency charge
New design uses “sloped” demand curve Price decreases gradually as supply increases Loads buy excess supply cleared in the auction
Market function improved Prices less erratic Prices vary predictably with ICAP supply
15
Demand Curve
Original ICAP Market Design vs. Sloped Demand Curve
0
5
10
15
20
25
96 98 100 102 104 106 108 110 112
% of Minimum Requirement
$ p
er
kW
-mo
nth
Original market design
Sloped DemandCurve
16
Demand Curve
$10.88
$6.78
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
$20
$22
80 82 84 86 88 90 92 94 96 98 100 102 104 106 108 110 112 114 116 118
17
NYS UCAP Prices Under DC
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
Jun-
03
Aug
-03
Oct
-03
Dec
-03
Feb
-04
Apr
-04
Jun-
04
Aug
-04
Oct
-04
Dec
-04
Feb
-05
Apr
-05
Jun-
05
Aug
-05
Oct
-05
Dec
-05
Feb
-06
Apr
-06
Jun-
06
Aug
-06
Oct
-06
$/kW
-mo
nth
Strip
Monthly
Spot
18
Sloped Demand Curve
The purposes of the sloped demand curve include (compared to a vertical one):
stabilize revenue streams for generators reduce potential market power of generators provide for more predictable prices for sellers and
buyers value capacity beyond the minimum level as having
reliability value
19
Derivation of the Sloped Demand Curve
The Sloped Demand Curve is specified in the tariff, and approved by FERC. The parameters are updated every three years.
DC is a simple straight line defined by two points. The reference point is (X1,Y1)
X1: The installed capacity requirement: 118% of peak load Y1: The cost of new entry for a peaker less anticipated energy and
ancillary service market revenues X2: The capacity level where its value is zero: 132% of peak; Y2=0 The maximum price is capped at 1.5x the cost of new entry
20
Reference Point The analysis to help determine the reference point
update last year was performed by a consultant, Levitan Associates, with the help of market participants.
Key Assumptions include: Installed cost of a new peaker- Frame 7FA gas turbine for the ROS
market Equipment (Power Island, Balance of Plant, Spare Parts Construction Owner’s costs (Development, Engineering during construction etc) Startup and Testing
21
Key Assumptions (contd)
Size, Heat Rate Debt/Equity ratio: 50%/50% Cost of Money: 20 year debt @7.5% interest rate, equity (after tax)
@12.5% Fixed O&M (property taxes, site lease, contract services, staffing,
insurance, general and administrative costs) Depreciation life, Income Tax Rate etc From the above, compute annualized carrying cost of peaker
22
Key Assumptions (contd)
Expected Energy Revenues Apriori Estimation
Historic Based Expectations
Deterministic Stochastic
OR Post-fact hypothetical peaker based estimate
Expected AS Revenues The annualized reference value is then adjusted for
summer/winter periods
23
Items Debated Is there a need for introducing a sloped demand curve? Will the change induce new merchant entry - the ability to generate cash
flows to cover cost of new entry over long-term Will it help keep needed existing economicgeneration from retirement? Should there be a forward market (beyond one year) component to the
capacity market? What are the customer impacts - including quantity of ICAP to be
purchased and the new market clearing price? Is there authority for NYISO or regulators to impose such a purchase
obligation on the loads? How does regulatory uncertainty affect investor risk assessment?
24
Items Debated What should be the frequency for updating parameters? Derivation of each element in the reference price Y1 Levels of X1 and X2: should X1 be exactly at the minimum requirement or
somewhat to the right of it? What should be the price to the left of X1? The slope of the demand curve
stability vs volatility of prices customer impact impact on generator market power
Monopsony power - the ability of large loads to enter into contracts ‘out of market’ with new suppliers to suppress market clearing prices
25
Resource Planning ISO Reliability Planning Process
Pre restructuring, vertically integrated utilities built (or contracted for) needed resources to ensure reliability of the system
In a restructured market, it is envisioned the market should address resource needs to ensure reliability
Planning process is primarily designed to provide information to the market participants
While market is expected to address resource needs, there could be instances of “market failure” and the market may not satisfy the resource needs
In that case, there is a need for a back-stop solution to procure adequate resources to ensure reliability
26
Resource Planning
Annual Comprehensive Reliability Plan NYISO does a 5-10 year Reliability Needs Assessment
annually as a first step and identifies reliability based resource needs
It seeks market based responses (transmission, generation, demand response) to meet the needs
In addition, it seeks from the responsible utilities a “backstop regulated solution” in case market solutions do not materialize in a timely fashion; other entities can also offer an “alternate regulated solution”
NYISO certifies projects that would technically meet the identified need without identifying a preferred solution
Cost Allocation based on beneficiaries-pay methodology
27
Resource Planning
“Economic” Planning process:Primarily intended to address congestionNYISO posts information on a historical basis on
several quantitative metrics of congestion - to assist the market place
Under what conditions should regulatory solutions be considered to alleviate congestion? Work in progress
28
Checklist
Any time we consider changing the market design, we try to address the following: What is the affect on existing wholesale or retail competitive markets? Would it provide sufficient incentives for new generators to enter the market - lead to the entry of
appropriate techonology and size generators? Would it provide sufficient incentives for existing generators to stay in the market, if economically
appopriate? Will it lead to cost minimization to customers? Will it work as intended? Is it simple to implement? Is it a minor change or major change? What are the risks of implementing? Will it have unitended consequences? How are potential market power concerns addressed? Will it be transparent and clear to market participants and accepted by them? Is it easy to police and to ensure there is no abuse by market participants? Would it receive regulatory support?