POWER February 2014 - 53

Power Policy
In the pre-restructured world of electricity,
the cost of inventory-excess generating capacity-was
simply folded into overall rates;
customers never really saw those expenses
of backup power. Supporters of competitive
markets assert that the result of the old system
was too much excess capacity, or power
inventory, also known as " gold plating. " The
utilities were able to reap a return on the investments
in inventory, which encouraged
them to stockpile generation. The more they
spent, the more they earned.
Then competitive electricity markets
came along, beginning with Federal Energy
Regulatory Commission (FERC) Order 888.
One of the questions arising from the competitive
world of electricity procurement was
how to handle reserves. When restructuring
and competitive markets kicked in, driven
by FERC policies, the new markets had to
decide how to deal with the issue of backup
power, or capacity. One choice, which Texas
took, was to rely on daily energy markets to
supply the needed power. Markets would determine
how much inventory to carry. Texas
had always enjoyed an excess of electric supply,
and there was no obvious reason in 1995
to expect that would change. Its restructured
market, among the most aggressive in the
country, elected to face shortages rather than
paying for excess generation.
In the East, where a massive blackout in
2003 hit some 50 million electric customers
from Canada to New Jersey, the new regional
transmission organizations (often created out
of long-standing existing power pool sharing
agreements such as PJM) decided to structure
competitive markets for both energy and capacity
(see sidebar " PJM's Capacity Market " ).
PJM, ISO-NE, and NYISO now conduct auctions
for generators to bid to supply backup
power supplies to the energy market. The basic
concept is that market prices from capacity
auctions will be high enough to encourage investment
in new electric generating plants and
to encourage large consumers of electricity-
or companies that can aggregate small users
into large consumers-to reduce their use.
This latter concept is " demand response " in
electricity industry argot. In the capacity markets,
large consumers and aggregators of load
can bid demand response into the markets on
the same basis as generation. FERC blessed
this concept in its Order 745 in 2011.
Texas decided to keep the prices that consumers
must pay for electricity lower by
avoiding capacity costs. The choice between
an energy-only market and a capacity market
is clearly a matter of money.
A FERC technical conference last fall
explored the cost implications-expressed
as the " missing money " -of introducing
capacity costs into the wholesale cost of enFebruary
2014 | POWER
PJM's Capacity Market
The PJM Interconnection, which covers a
wide swath of the U.S. from New Jersey to
Ohio, has the most robust and developed
capacity market among the organized
wholesale electricity markets. Known internally
as the " reliability pricing model, "
the PJM capacity market rests on an auction
each year to reserve capacity three
years ahead. As PJM describes it, " PJM's
capacity market provides forward pricing
signals to encourage retention of existing
resources and development of new
resources in the PJM region. Adequate
capacity resources are required to support
the reliability and stability of the
ergy. The " missing money " -as economist
David Patton, market monitor for both ISONE
and NYISO, explained-is the difference
between the levels of excess capacity
that an energy-only market would provide
(probably in the range of 7% to 10%) and
the higher planning levels that most electric
system operators want to see (in the range
of 17%).
electric grid for consumers' demand. "
The most recent PJM capacity auction
last May produced good results for
the wholesale market, drawing a record
amount of new generation at lower prices
than previous sales. " The results of this
year's capacity auction reaffirm that welldesigned,
mature markets are a powerful
tool for procuring new resources at
competitive prices, " said PJM CEO Terry
Boston. " Again this year, we see record
amounts of new conventional generation
and strong showings from renewables and
energy efficiency. "
presumption that federal agencies have rights
that trump state regulatory commissions
blocked both Maryland and New Jersey. As
is often the case when it comes to the operation
of sophisticated wholesale competitive
markets where state-regulated monopolies
once prevailed, considerable contention remains
about the need for capacity markets.
In overturning the New Jersey and Maryland
The choice between an energy-only market
and a capacity market is clearly a matter
of money.
The substantial costs of buying capacity in
advance, as opposed to buying energy today,
have proven controversial. In the PJM region,
both Maryland and New Jersey state regulators
and their governors objected to the higher
costs of PJM's inventorying capacity at market
rates. The public service commissions in
both states hatched schemes to use taxpayer
funds to subsidize new gas-fired generating
plants that would bid into the PJM capacity
market. The states perceived that the prices
awarded in the market's auction were too
high and the state-subsidized plants would
win in the auction and lower costs of future
generation. But PJM and FERC objected,
arguing that the state subsidies would drive
down bids in the capacity market auctions
because the subsidized plants would drive
out nonsubsidized competitors.
Federal courts in both states last year
nixed the Maryland and New Jersey plans,
saying that the federal government was in
control of these interstate markets and FERC
had blessed the capacity purchases. The legal
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attacks on FERC, the courts didn't address
the economics in play in the debate over capacity
markets.
Because buying reserve energy (inventory)
is expensive, consumer interests often
oppose the idea. That's what motivated the
state governments in New Jersey (with a supportive
Republican governor) and Maryland
(with a supportive Democratic governor) to
offer their now-illegal options. A paper for
the libertarian Cato Institute concludes, " The
theoretical case for capacity markets is weak
at best. Many of its arguments depend on
oversimplified assumptions that are at variance
with reality, particularly those that are
necessary to produce the missing money phenomenon. "
But the capacity markets in play
in the Northeast and Middle Atlantic states
are working, a powerful argument for their
wider use.
Texas Bucks Capacity Markets
The issue of capacity markets has now landed
squarely in Texas, where the three-member
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POWER February 2014

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