The great capacity market debate: Which model can best handle the energy transition?
Recent upheavals in wholesale electricity markets are giving new life to a years-old debate about market structure as the nation shifts to a cleaner energy mix.
“The big debate out there,” said Gordon van Welie, CEO of ISO-New England, “is can you do it the way Texas is doing, which is an energy-only market? Or do you need a capacity market?”
Capacity markets aim to ensure grid reliability by paying participants to commit generation for delivery years into the future. Energy-only markets, by contrast, pay generators only when they provide power on a day-to-day basis.
Of the wholesale electricity markets that serve two-thirds of the U.S. population, only two — the Electricity Reliability Council of Texas (ERCOT) and the Southwest Power Pool (SPP) — do not have capacity markets.
Supporters of the energy-only construct say it is the most efficient — preventing consumers from paying for generation that may never even be called on to provide power.
“I think what Texas has done is like an antitrust concept,” Commissioner Donna Nelson of the Public Utilities Commission of Texas (PUCT) recently told an audience at the Energy Thought Summit in Austin. “You protect competition; you don’t protect individual competitors.”
But others worry energy-only markets could become increasingly unstable in coming years because low electricity prices could discourage generators from building new power plants without the guaranteed revenue of a capacity market.
“I think the Texas model, in the long-run, is very vulnerable,” van Welie told Utility Dive on the sidelines of the conference after Nelson spoke. “It’ll work for a while; it’ll work as long as you’ve got demand growth in Texas.”
The capacity market debate is not a new one — Texas stakeholders chewed the issue over from 2011 to 2013 — but the persistently low price of natural gas and the spread of generation subsidies means both market models will face stiff tests in the coming years to preserve reliability and ensure fair prices for consumers.
The problem of low prices
At the Energy Thought Summit last month, Commissioner Nelson said the ERCOT market, which covers 90% of Texas, is performing nicely: Prices to consumers are the lowest on record, reserve margins are healthy, and the power mix continues to get cleaner.
In fact, everything would be hunky-dory if it weren’t for the pesky federal government.
“If you could design a wholesale market that wasn’t influenced by outside factors, obviously you wouldn’t have the kind of issues we’ve been dealing with,” she said, “but you do have those environmental policies like the production tax credit.”
Those “issues” stem from low prices. Along with the fracking boom of the past decade, which lowered the cost of natural gas generation, Nelson blamed the $23/MWh federal production tax credit for wind resources for depressing prices in the ERCOT energy market, reducing revenue for other plants.
“You can see if your average summer price is $24/MWh and you’re paying one of the segments of the market $23/MWh, that’s going to distort the market and drive prices down,” she said.
In Texas, regulators ensure reliability through a mechanism called scarcity pricing, which allows real-time electricity prices to reach as high as $9000/MWh on days of peak demand. Instead of guaranteeing generation revenue through a capacity market, the promise of high prices is supposed to incentivize generators to build new plants and keep them ready to operate.
That mechanism works best when the grid’s reserve margin is at about 11%, Nelson said, allowing for “enough instances of scarcity that prices will go up and allow generators to recover their capital costs.”
But in recent years, Texas has become the nation’s wind energy leader, with more than 18 GW of capacity installed. Nelson said that build-out, facilitated by the PTC, has helped bump reserve margins up close to 17%, and the influx of cheap generation has cut down on the number of scarcity pricing episodes.
“Last summer, for the first time, we saw days with high demand where we saw about 4,000 MW of wind online,” she said. “Now, that’s not enough where you can count on wind to always be there, but it is enough to remove the scarcity pricing, so that’s another way scarcity pricing has been affected by renewables.”
The worry for markets like ERCOT is that even when the PTC phases out in the early 2020s, better energy efficiency and continued renewable energy additions will combine with cheap natural gas to keep electricity prices low, thereby reducing the incentive for generators to build new plants.
