\u201cThe desire for safety stands against every great and noble enterprise\u201d Tacitus
\nPlease ponder the above quote from a Roman philosopher.\u00a0\u00a0 This quote applies to many things beyond this discussion of capacity markets in the power sector.<\/p>\n
PJM is making a drastic change in its capacity model.\u00a0\u00a0 This is a two part article with the first part covering the creation of the capacity market. \u00a0 I believe if you understand how you got to where you are now, you will be better equipped to reflect on the future. \u00a0Part 2 will go over the issues in the new PJM proposed capacity market.<\/p>\n
History of Capacity Markets<\/strong><\/p>\n Unfortunately, an analysis on the capacity markets cannot be examined without a discussion of regulation vs. de-regulation.\u00a0\u00a0 To many, this is akin to discussing politics, race, and\/or religion.\u00a0\u00a0 I will attempt to stick with the facts and avoid absolutes.<\/p>\n In a regulated world, there is no need for a capacity market as investments are made once the utility shows to the utility commission the investment is prudent to meet a certain loss of load probability requirement.\u00a0\u00a0 In a perfect world, the commission, interveners (industrial lobbyist, consumer protections groups), and the utility produce some reasonable acceptance to the need of generation capacity and then, and only then, does generation get built.\u00a0\u00a0 In return for this consensus opinion, the utility is protected from a loss if the generation is not needed in the future. \u00a0At the same time, the utility is capped in its earning potential.<\/p>\n However, this regulated system does come with some cost as previously discussed in my Regulation vs. De-Regulation article<\/a>.\u00a0 A regulated system does not bode well for adoption of new methods and technology.\u00a0\u00a0 The system is focused on maintaining.\u00a0 Overtime cost can rise without proper oversight from the commission.\u00a0\u00a0 As I noted in a previous article, this is likely inevitable given the poor levels of compensation in the commission.\u00a0\u00a0 In my latest research, the Ohio public utility commission earns between $75-$160K per governor approval.\u00a0\u00a0 This is a full time job as commissioners are not only regulating electric utilities but also natural gas, telephone, water, railroad, and motor carriers.<\/p>\n Within the electric sector, they are dealing with the executives making multi-million dollar salaries each year.\u00a0\u00a0 Then the senior management team earns around $500K with directors making $130-300K.\u00a0 You have analysts coming out of college in the utility, potentially, making more than the commissioners and their staff.\u00a0\u00a0 With this design, it is no wonder the effectiveness of regulation would wane.\u00a0 It is certainly reasonable to expect commissioners and staff to have the potential desire to work at the utility in order to support their families.\u00a0\u00a0 This very fact could make it hard for some to really clamp down on their potential employer.\u00a0 Please note none of my statements are absolutes nor are they confirmed in anyway with current commissioners or staff.\u00a0 I use my practical insights on human behavior to potentially deduce these outcomes along with past history.\u00a0\u00a0 There has been confirmed revolving door in the electric utility space as in the Duke Energy Corp case where the chief legal counsel for the states utility regulatory agency joined Duke Energy Corp after presiding on two cases favorable to Duke<\/a>.\u00a0 I strongly suspect, if he ruled unfavorably in the cases, he might not have had the job.<\/p>\n The history of poor regulatory decisions led many to investigate the de-regulation option vs. fixing the regulatory process through increase budget to source and retain skilled and experience commission and staff.\u00a0 Ideally, competition will drive the inefficiencies out of the market that the regulatory body could not.\u00a0 Theoretically it made sense given poor decisions were not being punitive as in a free market and the drive for innovation was not there as there was no earnings potential beyond a set return.\u00a0 Both of these points still could have been somewhat managed by the regulatory agencies.\u00a0 Another bonus of de-regulation many touted was allowing greater transparency and market discovery which would potentially allow new companies to innovate and capture the market thereby reducing society cost.\u00a0\u00a0 De-regulation would drive the inefficiencies out of the market and the innovative nature of competition will drive the cost down further.\u00a0 It all sounds so good on paper.<\/p>\n Markets became de-regulated with California leading the way.\u00a0 We all know what happened there. The first market inefficiency they attacked wasn\u2019t the inefficient operation of the utility but the inefficiencies of the market model \u2013 Enron Strategy<\/a>.\u00a0 \u00a0To me, this highlights that the inefficiency of the utility really isn\u2019t that large compared to the inefficient market designs.\u00a0 If you think this was resolved due to the experience in California – think again.\u00a0 In 2010 JP Morgan hired John Howard Bartholomew<\/a>.\u00a0\u00a0 He wasn\u2019t hired to progress the electric industry nor drive out inefficiencies in the utility but to find the inefficiencies in the market design.\u00a0 Once again they quickly identified inefficiencies and targeted those arbitrages to the benefit of themselves.\u00a0\u00a0 A regulated entity would have not done that given the lack of incentive.\u00a0 However, these free market players realize there is more money in market manipulation than the boring optimization of power plant supply chain.\u00a0 In addition, the risk from getting \u201ccaught\u201d still produces a decent return on investment after accounting for the penalties.<\/p>\n As an outcome, many deregulated markets kept a price cap to \u201cprotect\u201d the consumer.\u00a0 PJM price cap is at $1000\/MWh.\u00a0 ERCOT is having to raise their price cap as they stayed on the moral high ground on de-regulation and continued without a capacity market.\u00a0 The one thing ERCOT is doing is raising the market price cap from $2,500\/MWH (2011) to $9,000\/MWH (2015) in order to incentivize generation build.\u00a0\u00a0 To prevent a market brownout or blackout, demand must be met even in the one instantaneous moment of ultra-high demand.\u00a0 Typically, power planners will build peakers to run for those given moments.\u00a0 However, in a free market system, they need to have enough revenue during those small times to make up for the cost of building the unit.\u00a0 Therefore, if your peaker cost you 85 million dollars for 85 MW and you only ran 40 hours in the year in order to have a payback in 3 years without any discounting you would need prices to average over $8300\/MWh PLUS variable cost during those 40 hours. \u00a0Variable cost can be over $100+\/MWh given rise in fuel prices in extreme times.\u00a0 \u00a0\u00a0ERCOT is running the grand experiment to drive new technology and new methods through price incentives \u2013 the quintessential mechanism of a free market.\u00a0\u00a0 It is just math.\u00a0 A market with regulation typically gets a return on investment between 8-12%.\u00a0\u00a0 If the market is free to compete, the risk is increased. Therefore, the reward needs to increase above the regulated return requirements.\u00a0 The returns will likely need to grow to over 15+% rate of return.\u00a0 The means to this return, I contend, is too great for society.\u00a0\u00a0 I do agree the potential for a more efficient market is very possible with an open market, but society and potentially the oversight body is not willing to take the means needed to achieve the ends of a more efficient market.<\/p>\n Other Regional Transmission Organizations (RTO) realized the incentive to build generation with power prices alone did not meet their historical comforts of market reserve margins and consumer pricing.\u00a0 They became concerned about the customer backlash to the de-regulated market, if they could not deliver the same comforts of a regulated market.\u00a0 The capacity market was born to hide this issue while still touting the free market solution as the answer to society\u2019s needs.\u00a0 PJM came out with Reliability Pricing Model (RPM).\u00a0\u00a0 RPM creates another layer of payment beyond the price of power.\u00a0 In theory, it is the value of having capacity available to serve load.\u00a0 Payment is based on the size of your capacity offer.\u00a0 The initial model was opened to all sorts of capacity options from coal plants to non-generating capacity from demand response aggregators.\u00a0\u00a0 This model still offered some innovation by just targeting the peak demand and not putting so many strings to the participation in the auction.\u00a0 At this point I still believed there was a possibility to obtain the promise savings of de-regulation.<\/p>\n However, the latest proposal to modify RPM by PJM goes against the \u201cfree\u201d de-regulated concepts of free market competition.\u00a0 The proposed RPM is likely losing all the value of being de-regulated compared to regulation.\u00a0 Stay tune for your early Sunday release as we detail the latest PJM PRM proposal in Part 2 Capacity Market \u2013 Lipstick on a Pig.<\/p>\n Your Willing to Step Out of the Box Energy Analyst,<\/p>\n David<\/p>\n <\/p>\n David K. Bellman \u201cThe desire for safety stands against every great and noble enterprise\u201d Tacitus Please ponder the above quote from a Roman philosopher.\u00a0\u00a0 This quote applies to many things beyond this discussion of capacity markets in the power sector. PJM is making a drastic change in its capacity model.\u00a0\u00a0 This is a two part article with the […]<\/p>\n","protected":false},"author":1,"featured_media":32,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1,6],"tags":[336,192,258,369],"class_list":["post-1427","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-market-insights","category-power","tag-capacity-market","tag-ercot","tag-pjm","tag-power"],"_links":{"self":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts\/1427","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/comments?post=1427"}],"version-history":[{"count":4,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts\/1427\/revisions"}],"predecessor-version":[{"id":1431,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts\/1427\/revisions\/1431"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/media\/32"}],"wp:attachment":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/media?parent=1427"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/categories?post=1427"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/tags?post=1427"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
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