Rethinking Electricity Capacity Markets

In the field of electricity regulation, the primary goal of a capacity market is to ensure that sufficient power “capacity” exists in a region to maintain grid reliability and prevent blackouts. Unlike short-term energy markets, which help to manage the balance between energy supply and consumption on a daily basis, capacity markets look farther into the future. Capacity markets focus on whether the grid will have sufficient energy capacity to meet the predicted peak energy demand on any day of the year, which usually occurs during the hot summer months.

Centralized capacity markets are regulated by the Federal Energy Regulatory Commission (FERC) under the authority of the Federal Power Act. Several regional grid operators operating under FERC’s jurisdiction currently have capacity markets. They include the “Independent System Operator” for New England (ISO New England), the New York ISO, and PJM Interconnection. (“PJM” stands for three of the states in the PJM region: Pennsylvania, New Jersey and Maryland. PJM is now the largest ISO in the country.)

Not coincidentally, most of the states in these regions no longer directly regulate their long-term power needs through “integrated resource planning.” The wholesale capacity markets exist in part to fill those needs, although some states, such as Maryland and New Jersey, often question the effectiveness of the capacity market.

The Midcontinent Independent System Operator (MISO) also operates a capacity market, but since most MISO states continue to regulate their utilities’ long-term energy needs, the MISO capacity market is not especially active. MISO’s market does, however, provide MISO with more assurance that the sum of all of the state-regulated energy requirements will at least be sufficient to meet regional energy needs.

Capacity markets in each of these regions have different requirements, but they mostly share several similar attributes, including:

  • The companies within each region that sell power to residential, commercial and industrial customers must secure sufficient energy resources to meet the expected future demand from those customers – usually one to three years into the future. These companies are called “load-serving entities,” or LSEs.
  • An auction occurs where eligible offers to sell capacity are compared to the expected future demand of all of the LSEs. The capacity market clears at the price where the power supply equals that demand (including a small “reserve margin,” which is a bit like an insurance policy in case the actual demand for power is higher than predicted).
  • All resources which submit bids at or below the clearing price receive the market clearing price.

Energy Efficiency and Demand Response

The four regions with capacity markets treat demand side resources such as energy efficiency and demand response differently. (Demand response means customer-driven reductions in electricity consumption in response to high energy prices – for example, reducing air conditioning use). Three of the four regions allow both energy efficiency and demand response to participate in their capacity markets. Only New York ISO does not allow energy efficiency to participate in its capacity market.

A major goal of The Sustainable FERC Project and its allies is to maximize the amount of clean, cost-effective demand response and energy efficiency resources in capacity markets. Demand response is a significant part of the PJM capacity market, as shown below.

Demaind Side Participation In Capacity Market

While energy efficiency participates in PJM’s capacity market, only about 0.7% of the total resources clearing the market are energy efficiency resources, compared with more than 4% in ISO New England:

Why Capacity Markets Matter – Especially in a Low-Carbon Future

The growth of renewable power, energy efficiency, demand response and small power resources are changing how we look at the types of energy resources we will need in the future to assure a reliable power supply. For example, wind and solar power work extremely well and are dependable. But their energy output varies with weather conditions – wind speed affects wind turbine generation and the sun’s brightness affects solar power arrays. That variability affects the levels of other power generation needed to maintain the balance between energy supply and demand at any given moment.

More wind and solar power aren’t the only recent drivers for a changing resource mix. Others include:

  • Expanding demand response technologies, allowing more options and for shifting demand;
  • Energy efficiency improvements, which reduce daily peak loads and overall energy consumption; and
  • Small power production resources, called “distributed energy resources,” especially home-installed solar power, which reduce the need for grid-supplied power.

With these developments, the new, more flexible grid will need new tools to keep the grid reliable while we make it cleaner. Electricity storage and new gas-fired power plants, for example, can fill in the gaps in variable energy production with their fast-acting ramping and cycling abilities. Complementing these resources are sophisticated new control systems allowing variable energy resources to respond more accurately to grid operator dispatch instructions, together with more accurate forecasts of renewable energy output.

The Sustainable FERC Project’s Priorities

As power flows on the grid become more diverse and variable, the rules governing the operation of the grid also need to evolve. The stakes are high, both for a low-carbon future, and in pure dollar terms (PJM’s auctions clear resource bids of totaling billions of dollars each year). Our interests, which may vary somewhat depending on the region of the country, currently include:

  1. Supporting capacity markets or other long-term markets, when needed, to encourage the development of fast-acting and reliable resources – like gas turbines and demand response – needed to complement and integrate variable energy resources into the grid.
  2. Full participation of demand response, energy efficiency and energy storage in capacity markets.
  3. Non-discrimination against government-authorized or subsidized clean energy resources, which should be able to participate in capacity markets without penalty.
  4. Since capacity market procurement goals are based on load forecasts, those forecasts must fully account for energy efficiency and small-scale distributed generation resources so as to avoid the unnecessary purchase of resources in the capacity market auctions.


Regulatory Assistance Project work on “Beyond Capacity Markets

MISO Ramp Capability Products Update (August 2013) – used in combination with MISO’s energy and ancillary services markets; intended to provide sufficient ramp capability to meet real-time variability in net load

California ISO Flexible Ramping Product Update

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