Despite their many flaws, wholesale power capacity markets are likely to become increasingly crucial as the U.S. transitions to a cleaner energy mix, a panel of experts said May 11.
"Capacity markets, in the end, are supposed to be about the reliability of the grid, and as we move toward and through the energy transition, a lot of the focus is on the electrification of everything," Andrew Kleit, a professor of energy and environmental economics at Penn State University, said during a virtual panel hosted by independent research organization Resources for the Future.
"If that's going to be the case, electricity reliability is going to become increasingly important, and so I suspect that capacity markets or some substitute for them will become increasingly important," Kleit added.
Kleit co-authored the recently published book Electricity Capacity Markets with Todd Aagaard, a visiting fellow at Resources for the Future and law professor at Villanova University. The book offers a close examination of the nation's three mandatory capacity markets operated by the PJM Interconnection LLC, ISO New England and New York ISO, all overseen by the Federal Energy Regulatory Commission.
Aagaard said that in researching the book, he was struck by "how little thought" went into capacity markets when they were originally conceived in the mid-2000s.
"There's no clear underlying theory behind these markets," Kleit said during the May 11 discussion. At the same time, events such as the mid-February 2021 blackouts in Texas — a state that largely relies on $9,000/MWh scarcity pricing to ensure grid reliability — have demonstrated the value of mandatory capacity market constructs, Kleit said.
"I'm not sure what to replace them with," Kleit said.
'No natural demand'
Kleit likened mandatory capacity markets to paying a supermarket to stay open in addition to buying food from the store. "Capacity markets are really unique in this sense that you just get paid for being there," Kleit said.
Since their inception, capacity markets have become increasingly complex. PJM's market manual now totals about 4,000 pages, Aagaard noted.
One of the main challenges associated with capacity markets is setting an administrative demand curve that reflects the total amount of power supplies needed for a given year. PJM and ISO-NE run three-year forward capacity auctions, while NYISO holds its auctions on a spot, monthly and seasonal basis.
Unlike a product such as bread, for example, "there is no natural demand for reliability or for capacity," Kleit said. "No one wants to go out and buy 3 MW of capacity."
"So what the [grid operators] have to do is to create a demand curve for this product in what we call a policy market, and creating a demand curve for a product nobody wants is a very difficult task," Kleit said.
Use of mitigation rules seen as 'peculiar'
In more recent years, regulations known as minimum offer price rules, or MOPRs, have been used to address alleged price suppression in capacity markets caused by state subsidies for clean energy resources, the authors noted.
"What these minimum offer prices rules do is basically force resources that are perceived as having bids that were too low to bid at higher levels into the capacity market," Aagaard said. That can cause state-subsidized resources to fail to clear the market, leaving consumers to pay twice for capacity.
Kleit said the use of MOPRs is "peculiar" for a number of reasons.
"If you throw generators out of the market, which is basically what the MOPRs try to do, you're increasing the cost of trying to achieve your goal, which is directly contrary to the whole point of using markets," Kleit said.
Pressure is now mounting on grid operators to accommodate states' public policy choices in capacity markets, and they are coalescing around a capacity accreditation method known as effective load-carrying capability, said Tom Rutigliano, a senior advocate at the Natural Resources Defense Council's Sustainable FERC Project.
That method involves running simulations on a power system to measure the capacity contributions of various resource types under a multitude of different scenarios.
Effective load-carrying capability represents "a tremendous improvement over the old way, where someone just picked a number out of a hat and stakeholders argued over it," Rutigliano said during a later panel discussion.
Future capacity market rule changes could have a major impact on decarbonization efforts for jurisdictions such as the District of Columbia, which is aiming for 100% renewable power supplies by 2032, said Kathleen Spees, a principal at consulting firm The Brattle Group. That target essentially means the District, which does not have its own large power plants, will be purchasing 100% renewable energy credits from within PJM's 13-state footprint.
"But we know full well when they have their peak load in the summer, the power plants that turn on to serve their load are coal plants" in West Virginia, Spees said. "Why are those resources around? It's because of the capacity market."
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