Capacity Market – Lipstick on a Pig – Part 2
“The desire for safety stands against every great and noble enterprise” Tacitus
If you do not already know about the capacity market please read Part 1 – History of Capacity Market.
The Proposed Capacity Market
Due to the polar vortex of 2013/2014, several hours observed extremely high outages leaving a potential reliability concern. The deduction from PJM for the cause of this issue was that the compensation and non-performance penalty was not sufficient to ensure system reliability. Therefore, they have created a modification of the RPM Model. The new rules will add significant constraints to participation in the capacity auction plus adds more penalties. The bulk of the capacity value will come from Capacity Performance (CP) resources. These resources need to provide sustained, predictable operation 16 continuous hours per day for three consecutive days – during both summer and winter peak load and extreme weather conditions. CP resources must also have a startup time of less than 24 hours under normal conditions, and 14 hours under hot or cold weather alert periods. This essentially eliminates any consumer behavioral options including many popular Demand Response programs such as A/C cycling since this will not likely occur in the winter.
In general, all the utilities are supporting this move other than a little maneuvering to lower the penalty cost. This new layer of RPM will essentially give existing generation a huge boost in earnings – hence the upgrades of many utilities. This certainly smells and feels like a knee jerk reaction by PJM. This move appeases the utility and will very likely avoid the societal backlash of having to deal with brownouts.
The consumer is not seeing the price signal nor the real cost of power by overlaying it with such a high level of capacity value with limited participation from outside technology. The utilities and PJM are certainly making sure to take advantage of the situation by pushing this through.
My first concern is the extrapolation from the outages being related to the capacity payments. It is true that RPM is designed for the peak- which is summer not winter. However, the balance issue cannot be attributed to the RPM construct. In order to understand the PJM issue that occurred in January 2014, you have to have an appreciation of what occurred in the past two years.
For the past two years, PJM observed relatively mild winters. In addition, in each of those two years, natural gas price eroded the energy share of coal generation. For most of 2013, you had the natural gas price forward prices below $4/mmbtu throughout the winter of 2013/2014. In addition, 2012 and 2013 were not good years for any generators in particular coal generators due to the low power prices. It would be very reasonable to expect a Sr. Commercial Operations Manager to question the budget for winterizing coal units to run in the winter time leading into the 2013/2014 winter. Based on two years of history, one could see the coal plants did not run significantly, yet required a fixed cost that was not being recovered. In my estimate, many took the gamble to cut the FOM allocation for winterizing the coal units. The data potentially shows this to be the case. On January 7th 2014, coal units represented the largest component of the outages at 34% with gas following at 23%. This is not a case of capacity rules having to be modified. The reason I state this is because it is clearly a free market lesson on not being penny wise and pound foolish. AEP coal units fared well in the outage and they ended up with record profits almost doubling 2013 1Q profits – $560 million in profits. I can promise one thing this year. The Sr. Commercial Operations Manager is not questioning the budget request from the coal plants to winterize the facility. He can get fired for making the mistake twice, but he won’t get fired for spending more fixed cost on a unit that may not run this winter.
In terms of the gas unit outages, this can be partially attributed to the past. Typically, gas units did not run very much particularly in the western PA and Ohio regions. Firm gas capacity can be purchased by the utility. Because the units historically didn’t run much, fixed cost would translate to much higher gas bidding cost which, in turn, would lead to even less running of the gas plants. When I was at AEP, I was promoting buying firm capacity and selling the capacity to various counter parties during low usage time periods to mitigate some of the cost. However, as noted before, change is very hard in a utility and there is more risk than reward to change behavior. Even though many utilities generation are de-regulated, it still takes time to change the culture. It will change. But, one shouldn’t expect it to change within only a few years. However now that gas prices have been competitive for multiple years, the utilities should have learned the value of buying firm capacity. I am confident firm gas transport is being purchased now and will grow in the future. Sometimes, the market needs time to learn from first-hand experience vs. people advising them.
The very party who stands to benefit from the de-regulation and the free market model is not allowing the model to be free. Free markets need to learn from the market not to be coddled by additional monetary mechanism, or else you get a system that would extensively be more costly than regulation. This new capacity construct eliminates innovation. It will produce a safe environment for reliability – but so did regulation. If we continue down this path of coddling the system and not allowing the consumer and participants to see their consequences of their actions, we will be no better than regulation and likely potentially worse. PJM will be creating a system of limited downside risk with all the upside rewards. Case in point, AEP Ohio historical earnings for 2014 Q1 would have been shared back to the rate payers in Ohio. Because AEP Ohio generation spun off in 2013, it was all kept in house – Good Timing for AEP!
If we want to keep it safe then let us go back to regulation or let the market learn its lesson and remove the knee-jerk safe call so we can create something great and noble.
Your Open to New Ideas and Thoughts Energy Analyst,
David
David K. Bellman
All Energy Consulting LLC- “Independent analysis and opinions without a bias.”
614-356-0484
[email protected]
@AECDKB
blog: http://allenergyconsulting.com/blog/category/market-insights/
“allowing the consumer and participants to see their consequences of their actions,…” Really? Even if it means no electricity in today’s world where many houses are electric only heat at -20 degreesF. People would end up dying. Surely it is our responsibility in the utility industry to ensure that does not happen.
I agree with your sentiment hence my notion of going back to regulation. You will notice because of the social concern I lean towards regulation. However being in hybrid world of regulation and competition leads to the worse case for society. If the market were to “kill” people than it would likely move back to regulation and be done with this Economic theory derived from textbooks regardless of the realities of the situation.