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March 25th, 2015

ISO-NE Capacity Market- Keeping the Lights On

by Andrew Price, President & COO

One of the primary functions of ISO-NE is to “keep the lights on.”  Boston, MATo do this, ISO-NE must ensure that there are enough generators available to operate to ensure that the total energy from these generators exceeds the total load requirements.  ISO-NE accomplishes this through what it now calls the Forward Capacity Market or “FCM.” 

Calling this a “market” is really a little bit of a misnomer. What ISO-NE does is to forecast loads three years into the future and based on these forecasts, determine how much generating capacity is required.  Once the amount of new capacity is determined, ISO-NE then conducts an auction (Forward Capacity Auction or FCA) to solicit bids from generator developers to develop generating capacity in the region to meet the identified need three years in the future.  Those developers that bid in the lowest prices for new capacity are the ones that ISO-NE selects – and the prices bid determine the price for capacity during the power year (June 1 through May 31) three years from now.

ISO-NE pays for this capacity by assessing every customer in New England its share of the cost based on each customer’s load as a percentage of region-wide demand during the single hour when demand is greatest during the year.  (This is referred to as the hour of annual system peak.)  For example, if a customer is using 500 kW during the hour of system peak when total load peaks at 27,500 MW (for example, at 3 PM on July 23 when the temperature is approaching 100o across the region), that customer is assigned a “Capacity Tag” of 0.500 MW and is responsible for .5/27,500 or 0.00182% of the total costs paid by ISO-NE to generators.  In practice, of course, there is a year lag, so each customer’s Capacity Tag is determined during a power year (June 1 – May 31) and that Capacity Tag applies for the next power year.

For the past few years there has been a surplus of generating capacity in the region.  Therefore, capacity prices have been relatively low, in the range of $2.50 per kW per month.  This means that the customer above, with a Capacity Tag of 0.500 MW, would pay 0.500 x 1,000 x $2.50 = $1,250 a month. If this customer has a capacity factor (ratio of average electrical demand to peak electrical demand) over the month equal to 50%, it will use approximately 180,000 kWh, so the $1,250 charge would equate to a $0.007 per kWh rate.  (This charge is levied by the competitive supplier either as a separate item or bundled in the contracted price per kWh for those contracts that include capacity.)

The surplus of generation will continue through the power year that ends May 31, 2017 for all of New England, except the Boston and North Shore area, and capacity prices will remain just below $3.00 per kW per month.  In the Boston and North Shore area (referred to in ISO-NE speak as NEMA/Boston), the closing on the coal fired Salem Harbor power plant created a capacity shortage condition requiring new generation in this region.  This new generation took the form of a gas-fired plant at Salem Harbor, which drove capacity pricing to around $7.00 per kW per month for customers in this region.

Beginning in June 2017 (for the 2017-2018 power year), the shortage experienced in the NEMA/Boston region will exist throughout New England.  The result is that capacity prices will increase significantly to around $7.50 per kW per month, or almost three times their levels today.  (They will increase to approximately $15.00 per kW per month in the NEMA/Boston region.)  In addition, beginning in June 2018, prices will increase further to close to $10.00 per kW per month.  The customer noted above will then pay $3,750 a month or about $0.021 per kWh on a per kWh basis in 2017-2018 and an additional 30% to 40% the following year.  These are very serious increases.  Remember, though, the first of the two increases will not happen until June 2017.  Until then, if you are not in Boston or along the North Shore, your capacity costs will remain essentially flat.

There is no action that any customer can take to avoid paying for capacity under the ISO-NE rules, short of disconnecting from the grid or moving its business to a jurisdiction outside New England.  However, since the amount (not price) each customer pays for capacity depends on the customer’s Capacity Tag, if a customer can reduce its Capacity Tag, it can reduce the amount of capacity costs it will have to pay.

This is not easy, but it can be done.  The key is for the customer to reduce its electricity usage during the hour of system peak.  The problem is that no one knows when this will occur ahead of time, and it is only finally determined after-the-fact by looking back at hourly loads on the system.  Very high loads, however, are not random.  They are caused by customers turning on large amounts of air conditioning, which occurs during the hottest, sunniest, most humid days of the year.  These days occur during the summer months of June, July, August and possibly early September, with the highest loads on these days occurring mid-to-late afternoon.

If a customer is able to reduce its load during these types of hours, it may be able to do so on the hour of annual system peak, thereby lowering its Capacity Tag and its share of the total capacity costs ISO-NE collects.  This is easier said than done for two reasons.  First, and most obviously, if many customers act in the same manner by reducing their loads on the hottest summer afternoon day, they may shift the annual system peak to some other hour and their actions will be for naught.  This is similar to what may happen when all drivers leaving Boston are listening to WBZ Traffic Reports and hear that there is an accident that has shut-down the outbound Tobin Bridge.  They will look for alternative routes and these actions will just shift traffic and congestion to those routes.  The problem is that when this type of information is widely disseminated and everyone knows it, it becomes much less useful to each individual.

The second problem is that it is necessary for a customer to make a decision about whether any given hour is likely to be the annual system peak.  For example, when the first heat wave hits in late June and temperatures are in the low-90s for three consecutive days, should the customer reduce loads during the afternoon hours, or should it ignore this event, expecting, instead, to see an even more severe heat wave later in the summer?  You can see the problem.  If a customer is too conservative, it will reduce loads during many hours and incur the consequent costs of those load reductions in terms of lost output or inconvenience.  If the customer is too aggressive, it will try to hit the nail on the head and may end up missing the annual system peak entirely. 

There is no easy answer to this dilemma.  In fact, if anyone could predict when the system peak occurs and just a few score of customers believed him/her, the actions of those customers could shift the peak to another hour. 

CES understands that predicting the hour of annual system peak is very difficult.  However, it also understands that for some of its customers the consequences of reducing loads during a few hours are not too significant, and therefore the costs to the customer of being a little more conservative are not too high. 

With these customers in mind, CES offers a service that we refer to as our “Self-Help” initiative.  Under this program, CES sends out an alert on those days when we believe there is a reasonable chance that the annual system peak could occur.  The alert summarizes load conditions and advises customers that are able to reduce loads during certain hours that day – usually a broad window from early to late afternoon – to take such actions.  It is entirely voluntary as to whether or not the customer takes any actions – hence the term “Self-Help.”  By participating in this program, customers are making use of CES’ market knowledge and monitoring to increase the odds that they will time their load reduction actions to coincide with the hour of annual system peak, while at the same time, reducing the number of hours in which they actually take such actions.

With current capacity prices low, the economic advantage to a customer from reducing its Capacity Tag is relatively small.  However, when capacity prices increase sharply in mid-2017, the ability to avoid capacity charges will increase proportionately, and we expect more customers to try to guess when the annual system peak will occur.  This will only make it even more difficult to do so, as with more customers “chasing the peak,” the peak is almost sure to shift.  Accordingly, CES is recommending that customers begin now to plan for improvements in energy efficiency, conservation and on-site generation that focus specifically on reducing loads during summer afternoons.  While these investments may not pay off in with current low capacity prices, they will look much more favorable by 2017, when capacity prices increase substantially, and since each customer’s Capacity Tag for the 2017-2018 power year will likely be set during the summer of 2016.

CES can help you think more carefully about this issue.  Please contact us if you have any questions.

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