Outline What is a blackout? and how do we deal with them? What - PDF document

Power Plant Investment and Electricity Restructuring James Bushnell University of California Energy Institute www.ucei.berkeley.edu Outline • What is a blackout? – and how do we deal with them? • What is Resource Adequacy? – who’s supposed to build the generation? – how are they to be paid? • Proposed solutions – Commodity (‘energy-only’) models – Explicit capacity product models 7/31/2006 2 What is a Blackout? Name Area Predictable? Example Frequency Effected Distribution Local Not Very My House 1.5-2 problem (probabilities per year only) Cascading Many No US East ?10 -20 Transmission States Coast years? Blackout problems Supply Parts of Yes California 1 in 10 Shortage Cities 2001 years (goal) 7/31/2006 3

How do we deal with shortages? (not very well) • Different customers have very different costs of interruption (value of service) – but for the most part we ignore that • random blackouts – “essential facilities” – interruptible customers • Individual customers also have very different values for the electricity they consume – the difference between interruption and real-time pricing 7/31/2006 4 Investment in Restructured Electricity Markets • Old model: Utility builds capacity to meet a forecast of load, gets a guarantee to recover the costs (plus ROR) • Market model: Firms build capacity based on expected market revenues – no guarantees if they make a mistake – nobody explicitly responsible to ensure there is “enough” investment 7/31/2006 5 Restructuring has Produced Investment in the US Year Capacity Added 1997 4,000 1998 6,500 1999 10,500 2000 23,500 2001 48,000 2002 55,000 2003 50,000 2004 20,00 total 217,000

Alternative Paths to Resource Adequacy • “Energy only” markets – higher price caps – more and better defined ancillary services purchasing – May be combined with hedging requirements • Backstop procurement – Energy only market with resource “guidelines” – ISO or other agency makes a payment or long-term contract with specific resources it deems necessary for reliability – LSEs are billed for cost (probably controversial) 7/31/2006 7 Alternative Paths to Resource Adequacy • Capacity Markets – ISO or other agency makes a periodic payment to all certified “resources” (monthly, annual) – LSEs are billed pro-rata by demand – LSEs may sell into the market (take both sides) – Price may be influenced by a “demand curve” for capacity • Resource Adequacy obligations – all load serving entities must procure “resources” to cover their forecast demand – procurement left to LSEs – penalties for non-compliance 7/31/2006 8 International Overview for most part capacity markets are a US “innovation” • Energy-based – UK, Australia, New Zealand, US MISO? – Implicit backstops (procured by Gridcos,etc.) – With mandatory options contracts? (Texas) • Capacity markets – ‘1st generation’ PJM, NEISO, NYISO – ‘2nd generation’ PJM, NEISO • Longer-term, more targeted incentives • Resource Obligations – California • Impeneterable - Spain 7/31/2006 9

Reasons Offered Why Capacity Markets Are Needed • Factors present in other industries – inelastic demand – lack of storage – capital intensive industry, long-lead times • Inefficient rationing of shortages – unwillingness to match demand and supply at retailer level – relatively low price caps in some markets (compared to airline bumping) 7/31/2006 10 Arguments for Capacity Markets • random rationing creates a “free rider” problem – capacity markets eliminate shirking • No one likes price volatility, so it is costless to establish standards that reduce volatility • The costs of getting investment wrong are much greater on the downside than the upside • To what extent are these self-inflicted problems? – Lack of RTP, critical-peak pricing, and the randomization of outages creates the disparity 7/31/2006 11 Concerns About Capacity Markets • Implementation creates a bias towards higher reserve levels • Allocation of costs tend to be smoothed amongst many hours • Capacity markets in practice distort markets by artificially smoothing price volatility – means more consumption & capacity on peak – means higher average cost • Buying capacity does not guarantee you get energy • Could empower more subtle forms of supplier market power 7/31/2006 12

Capped and Uncapped Spot Prices Price + "Scarcity" spot_price 1000 900 800 700 600 500 400 300 200 100 0 1 12 23 34 45 56 67 78 89 100 111 122 133 144 155 166 177 188 199 210 221 232 243 254 265 276 287 Day 7/31/2006 13 Impact of annual capacity market spot price annual capacity cost 300 250 200 150 100 50 0 1 9 17 25 33 41 49 57 65 73 81 89 97 105 113 121 129 137 145 153 161 169 177 185 193 201 209 217 225 233 241 Day 7/31/2006 14 Monthly Capacity Markets spot_price monthly 350 300 250 200 150 100 50 0 1 11 21 31 41 51 61 71 81 91 101 111 121 131 141 151 161 171 181 191 201 211 221 231 241 Day 7/31/2006 15

Daily Capacity Market spot_price daily 600 500 400 300 200 100 0 1 12 23 34 45 56 67 78 89 100 111 122 133 144 155 166 177 188 199 210 221 232 243 254 265 276 287 Day 7/31/2006 16 Summary: The Big Picture • Goal is to provide reliable service at lowest possible cost – what is the “right” definition of reliability? • Are “energy only” markets viable? – what’s wrong with the high energy price approach? – can we mitigate those concerns? • market power mitigation, forced financial hedging • Are capacity markets the best form of regulation? – do we want our capacity markets to replicate high energy prices as closely as possible? 7/31/2006 17