American Gas - March 2014 - (Page 24)

c over sto ry marKETS: time to eNd caPacity auctioNs By Cliff Hamal T he electric industry's difficulties in making long-term commitments to support gas pipeline investment can seem shortsighted and irrational. Gas supplies are plentiful, prices are down, and additional pipeline capacity would readily solve problems with the reliability of electricity supply that have vexed markets, most notably in New England. Yet, when potential pipeline investors try to point out the obvious benefits to their electric industry brethren, the conversation generally devolves into a discussion of electricity industry restructuring, electric generation capacity market dynamics, and the difficulties in crafting short-term incentives that produce long-term investments. It is true: in some areas, the electric industry is committed to a market design where obvious problems, with obvious solutions, cannot be solved. But there is an alternative. It promises to bring common sense and market forces together to solve problems and fund needed long-term investments. And it lowers costs. This is done by eliminating the annual capacity auctions run by the system operators in the eastern markets. Capacity markets were largely an afterthought in the design of competitive electricity markets, put in place in response to concerns that energy payments alone would not provide sufficient revenues to generators. But the auction methodologies adopted to clear these markets are highly controlled administrative processes that have not worked well. They require the specification of a rigid short-term product and produce volatile prices that are doing a poor job of incent- 24 AmericAn GAs march 2014 ing long-term investments. There are more than two dozen proceedings ongoing before FERC concerning problems with these auctions. And FERC is reviewing dozens of filings responding to last fall's technical conference on how these markets are working. The alternative structure is to rely entirely on bilateral contracting. Such contracts have the flexibility to incorporate requirements for long-term fuel supply and thereby fund new pipelines. With bilateral contracting, new generators could attract low-cost debt financing, locational needs could be targeted readily, replacement generation could be timed to match needs that result from retirements, and renewable generation could be integrated into other procurement decisions. The problem has been that competitive suppliers of energy to customers (i.e., load serving entities) often do not have the financial Under this alternative approach, which has been called BiCap, they would have to re-enter the market to procure capacity for their long-term captive customers. Energy markets would stay competitive-this is not a return to vertical integration-and distribution utilities would stay out of that part of the market. The states know where investment is needed. Under BiCap, state regulators would oversee the procurement of capacity that meets local needs, whether involving new pipelines, specific kinds of generation, desired environmental attributes, locational requirements, or other features. The cost of these contracts would be passed on to all customers through regulated rates. The benefits of competitive procurement would be captured through the solicitation process of the distribution utilities. While the states are currently behind a great deal of gas infrastructure development, the Bi- there is aN alterNative. it Promises to BriNg commoN seNse aNd marKet forces together to solve ProBlems aNd fuNd Needed loNg-term iNvestmeNts. strength to sign long-term capacity contracts, particularly since their customers can leave at any time. The solution is to adopt a structure that relies on a different entity to purchase capacity for customers. The entities uniquely able to make long-term commitments on behalf of customers are the distribution utilities. These are the utilities that own the distribution systems that connect to the customer and provide the means of delivering electricity. In places where competitive retail markets have been established, like New England, these are primarily investor-owned, regulated utilities that have largely exited from any involvement in energy supply. Cap approach would give states the means to "pull" gas infrastructure investment through the electric generation procurement process. Financial benefits could result from the ability of developers to use long-term contracts to increase the use of debt to finance projects. In the capital-intensive world of new generating capacity, long-term contracts could drive down the cost of capacity by 20 percent or more. So, under BiCap, not only would customers benefit by buying only what is needed to keep the system reliable, but they would do so in a way that lowers financing costs. The broader problems with the current

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American Gas - March 2014