Capacity Markets: Money for Nothing

The American Public Power Association has published its latest biennial report on the impacts of mandatory capacity markets.  This report is not a theoretical analysis.  It looks at individual projects built in 2013 and how they were financed.  Most of the 24 page report is appendices with tables describing the new generation plants built in 2013.  As in their 2012 report, APPA concludes that, particularly in terms of stimulating new generation in areas where it is needed, capacity markets run by RTOs have almost no impact on creating new generation.

As was found in the analysis of 2011 generation, almost all new capacity was constructed under a long-term contract or ownership. Just 2.4 percent of the new capacity was built for sale into a market, a number that includes new facilities for which no information could be found about the contracts. Moreover, when broken down geographically, only 6 percent of all capacity constructed in 2013 was built within the footprint of the RTOs with mandatory capacity markets.
APPA thus found that all of the electric industry’s claims about capacity markets stimulating new investment are just wrong.  Who are the members that control the RTOs?  The big boys in an RTO are the holding companies that own a lot of existing generation capacity.  They have designed the capacity markets not to help new competitors enter their markets.  The incumbent generators design the markets to line their own pockets.
Are the capacity markets the least-cost means to achieve reliability?
These constructs are costing consumers billions of dollars for little in return, for the following reasons:
Different resources have different costs.
In these markets, a 50-year old coal plant is paid the same amount per MW and for the same duration as is a brand new highly efficient combined-cycle natural gas plant as is an agreement by a factory to curtail load when needed. As a result, excess windfall revenue is paid to the older depreciated plants and the revenue stream is not stable enough to attract investors in new resources.  The bulk of revenue has been paid to existing plants.  In the PJM Interconnection (primarily covering Maryland, New Jersey, Pennsylvania, Virginia, West Virginia, Ohio, northern Illinois, and Delaware), $72 billion has been paid or will be paid by consumers to generators and other capacity providers. Yet over 90 percent of this revenue has gone to existing generation, although many older plants have paid off much of their fixed costs. Moreover, most of the new generation capacity that has been built was done so under utility ownership and long-term contracts, not as a result of capacity market payments.
Capacity markets do not ensure an appropriate mix of resource types.
Because the capacity markets do not distinguish between technology types or specific locations on the grid, critical needs are not addressed, including adequate flexible ramping capability to match the variability of renewable resources, reliability gaps created by retiring coal plants, the coordination of natural gas infrastructure and delivery with the significant expansion of natural gas generation. As a result, the RTOs often create systems of side payments to ensure reliability, such as direct payments through what are known as reliability-must-run agreements to coal plants to remain in place to ensure reliability.
Price signals are not effective.
If transmission congestion limits the ability of capacity in one area to deliver lower cost power to another zone, the more congested zones may have a higher price. The theory behind zonal price differentials is that higher prices will act as a “signal” for the development of new generation or transmission. But such higher prices are not effective signals because owners of generation have no financial interest in building new resources and lowering prices for their existing units; investors seek steady and predictable revenue flows, not fluctuating prices; and many other factors influence the decision to build, including land and transmission availability, local acceptance, and environmental rules. Transmission construction may alleviate these price differentials, meaning that consumer paid both for higher prices and for the cost of the transmission.
So APPA concludes that good old fashioned contracts between a seller and a buyer (bilateral contracts) and internal investment by power companies provide the long term financial stability that investors need to build power plants.  Capacity markets can never provide that kind of stability and assurance of cash flow.  All capacity markets do is provide a smokescreen for power companies to pick rate payer pockets, to the tune of $72 billion in PJM alone, according to the report.
Of course, generation capacity is largely a problem because of peaks in demand in most US RTOs.  The US electrical load is characterized by wide swings from normal base load to very short periods of very high load.  There are winter peaks, caused mainly by heating, and summer peaks, caused mainly by cooling.  But what if we tackled the capacity problem by tackling what causes it – the demand problem.  What if we did what the Danes did, and eliminated electric heating almost entirely by using gas combustion and “waste” heat form power plants and manufacturing businesses?  Then the winter peak goes away.
Summer peak is a little different, because that is caused by cooling, which is tied pretty tightly to electricity by air conditioning technology.  Winter peak could be eliminated entirely by shifting all electric heating systems to other heating sources.
Heating with electricity is also phenomenally inefficient.  Eliminating electric heat would eliminate the need for rate payers to pay for thousands of megawatts of generating capacity and transmission lines during times of even normal load.
But in the US, there is no planning across industries.  There is no attempt to reduce electrical use by shifting technologies from the electrical sector to the natural gas sector by expanding heating.  Using natural gas or biomass combustion for direct heating is much more efficient than burning gas or biomass in a power plant, even a highly efficient one, sending that electricity hundreds of miles and running it through a resistance coil in a furnace.  This lack of planning across sectors has also led to the absurd situation last winter in which large parts of the US were left with shortages of both electricity and natural gas for heating because so much electricity is now generated by natural gas power plants.
So capacity markets aren’t even the best way of planning capacity for peak load.  Here too, capacity markets are money for nothing.

2 thoughts on “Capacity Markets: Money for Nothing

  1. Bill: Yet another great analysis laying bare the machinations of the old line utilities. Although they span state boundaries, RTOs function as monopolies through their collusion in the capacity markets. This is why it is important that FERC and DOE distance themselves from their utility buddies and step up their oversight of RTOs and their monopoly minded members. It is past time for ratepayers to stop feeding the big guys with their hard-earned money and time for state, regional and federal regulators to step up and plan for the long term changes ahead for the energy sector. They need to include local PV solar in their mix and foment policies that encourage its adoption throughout the country. This will go a long way towards solving some of the peak power problems, stop the utilities’ financial shenanigans against local solar generators, put solutions back in the hands of consumers and encourage a vigorous open market of solar providers.

    • Don, I agree that changing electric generation is an important part of the picture, but it is only part. Load management would result in huge energy savings and efficiency gains, as well as eliminating the need to create a lot of excess winter generating capacity for winter peak. That is the other conversation we need to be having. Here in WV, the PSC and the power companies are only concerned (minimally) about increasing the efficiency of electricity use, not shifting it away from electricity entirely. Without this kind of load shifting, gains from efficiency are relatively limited. Only when you include the broad range of alternatives to electricity use can you begin to make the kinds of radical reductions in electricity use that we are seeing in Denmark and other parts of Europe. The shift in heating in particular opens the door to expanding the efficient use of biomass combustion, because you can use the heat directly without losing a lot of it in generating electricity.

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