Study: Resource Adequacy Concerns Mostly Stem From Restructured Electric Markets
Most issues concerning resource adequacy have arisen in the context of restructured wholesale and retail electric markets, rather than from traditionally regulated electric markets, a new study from the Electric Markets Research Foundation (EMRF) suggests.
The nonprofit EMRF, established in 2012 by “academics and other experts” to fund studies on electric market issues, notes in its June 16–released study, “Ensuring Adequate Power Supplies for Tomorrow’s Electricity Needs,” that the U.S. power sector “now serves consumers under two distinct market models.”
One, stemming from restructuring of both retail and wholesale power markets that began in the mid-1990s, relies on competitive bidding to establish market prices for wholesale power delivered to end-use customers by retail suppliers (who may or may not own generation, transmission, and distribution facilities). These “restructured” markets serve two-thirds of the U.S. population.
The other, serving the remaining one-third of the U.S. population, relies on traditional regulation of vertically integrated utilities that provide generation, transmission, and distribution services to end-use customers at prices approved by state regulatory bodies.
However, over the last 15 years, resource adequacy—or the sector’s attempts to keep the lights on—has also emerged, and it is “perhaps the greatest challenge facing the electric power industry,” the report notes. Potentially serious issues were highlighted during the “polar vortex” of January and February 2014, for example, when cold snaps across most of the Eastern and Midwestern U.S. drove natural gas prices to as high as $100 per MMBtu and sent power prices soaring to beyond $2,000/MWh in central Pennsylvania and to the wholesale market price cap of $5,000/MWh (for the first time ever) in the Electric Reliability Council of Texas (ERCOT).
Both traditional and restructured markets require mechanisms for assuring resource adequacy. In all markets (with the exception of Texas, where retail energy providers serve retail consumers), load-serving entities (LSEs) are obligated to procure enough capacity to serve their own retail load and cover reserves.
But, “restructured markets are still trying to prove the workability of their model for assuring resource adequacy,” the study conducted by Christensen Associates Energy Consulting concludes. And that dilemma is compounded by the continued, significant role played by restructured states in determining capacity requirements for LSEs and by mandates for investments in renewable capacity.
“By contrast, capacity reserves have been successfully maintained in almost all regions that have not restructured and that continue to rely on franchised electric utilities that take direct responsibility for resource adequacy under an obligation to serve.”
The study underscores, however, that how traditionally regulated electric markets maintain resource adequacy is not “without controversy,” noting that concerns have been raised about “how those reserve requirements were satisfied and at what cost.”
Distinct Concerns for Restructured Markets
The debate over whether traditional or restructured markets offer more benefits continues to be lively. This April, the COMPETE coalition, which supports “well-structured competitive electricity markets,” published its own dataset alleging that consumers in states that restructured to promote retail competition saw their rates drop by 3.6% between 1997 and 2013, while consumers in the traditional model saw theirs increase by 8.2%.
But EMRF’s study, focused on resource adequacy, notes that while reserve margins across most of the U.S. have diminished and will continue to decline over the next decade (primarily because of coal plant retirements), restructured markets have disparately suffered more pronounced declining reserve margins. Even so, with the exceptions of ERCOT and Midcontinent Independent System Operator, whose reserve margins are projected to decline to levels well-below the North American Electric Reliability Corp., all regional transmission operators (RTOs) project adequate reserve margins for the “foreseeable future.”
Low average wholesale market power prices in restructured markets have also made “it difficult for owners to recover plant operating costs,” EMRF’s study claims. That has induced the retirement of two nuclear plants, and “additional nuclear plants are in danger of closing for similar reasons.”
Meanwhile, concerns are mounting whether restructured markets are over-relying on natural gas for the majority of newly installed or planned generation capacity—making them more vulnerable during availability and pricing issues, such as was suffered during the polar vortex. The study also suggests that increased reliance on intermittent resources raise more concerns for maintaining resource adequacy, and that subsidies, such as production tax credits for wind energy, “tend to distort competitive market outcomes.”
Perhaps more significantly, it claims: “A host of public policies interfere with the operation of restructured electricity markets. Consequently, these markets provide only limited support for investment in generation and other resources.”
For one, with prices capped in restructured markets, “the market-clearing price paid to resources under capacity shortage conditions cannot reach levels high enough to encourage the provision of sufficient additional resources or induce sufficient load reductions.” Additionally, restructured markets do not provide market participants with mechanisms to arrange long-term price hedges that can be critical to investments in long-term capacity.
And finally, “restructured markets have been subject to frequent revision, thus creating uncertainty about their durability and adding to investment uncertainty.”
The report claims that these and other factors have resulted in “supplier bankruptcies and disincentives for arranging long-term supplies.”
It adds: “Because of these and other problems, the RTOs are continually reforming their capacity markets, sometimes in major ways, often through contentious proceedings, as they search for a market solution that cannot exist. Some RTOs have attempted to implement a market solution through the institution of short-term centralized capacity markets; but these markets have the key deficiency of going at most three years into the future, which cannot provide incentives for long-term capital-intensive generation investments with lives of thirty years or more.”
A Comprehensive Solution Is Needed
Perhaps at the heart of the problem is that restructured markets’ centralized capacity markets tend to be mandatory. As the report points out: “There are few places in the American economy wherein one can find a free market in which participation is mandatory.”
And because RTO markets, being short-term markets, do not and cannot address long-term capacity needs, and because political processes will not allow peak-period demand pricing that is consistent with a market solution, the “resource adequacy problem does not lend itself to a market solution,” it concludes.
“The RTOs, as they struggle to fit a square peg into a round hole, must therefore continually reform their capacity markets, sometimes in major ways, always through contentious proceedings, as they search for a market solution that cannot exist under existing political and regulatory frameworks.”
A more “comprehensive” solution is necessary, the report advocates.
For example, the restructured markets could be designed so that capacity is procured “in ways similar to those used in traditional regulated markets.” That means capacity requirements should be set “according to engineering criteria; impose high penalties on those LSEs who fail to meet their requirements; and offer a centralized market for those parties who find the centralized market’s terms attractive.” At the same time, generation could be procured through competitive solicitation as it is done successfully in some traditionally regulated markets as well as in some restructured markets.
“And RTOs could continue to operate energy markets in the same way as they do today,” it says.
—Sonal Patel, associate editor (@POWERmagazine, @sonalcpatel)