The Integrated Perspective on Power Market Development in the US:

The Issues are as Important as Ever, But Who’s Responsible?

Benjamin F. Hobbs

Dept. Geography & Environmental Engineering Dept. of Applied Mathematics & Statistics Whiting School of Engineering The Johns Hopkins University Baltimore, MD 21218 USA California ISO Market Surveillance Committee [email protected]

Dublin 31 January 2005

Outline

• • • •

“Old style” vs. “New style” IRP

– –

Old: central planning to address market failures New: market design to address market failures

Do tradeoffs (environment, costs, renewables, reliability, etc.) no longer matter?

–

No: Addressed in more appropriate forums

Examples of new planning processes

– –

TEAM: CAISO transmission planning method Capacity markets

Remaining quandaries

– –

Valuing reliability Nonlevel “playing field” (market designs) for DSM, renewables

Definition of IRP

Integrated resources planning

Definition of IRP



Integrated , comprehensive consideration of a … … full range of resources (demand, supply, transmission) … …as part of investment planning … considering societal benefits and costs and their distribution (dollar & otherwise) … …considering risks … …in consultation with stakeholders…

Central IRP at the Vertically Integrated, Regulated Uility

The Planner

Consultation

Stake holders Regulator

The Plan

Generation Planning Gen 1 Gen 2 Gen 3 Gen 4 Transmission Planning System Operation Environmental Planning Demand-Side Planning

Prices, DSM, Power

Consumers

A Classic IRP Process

Source; USAID Office of Energy, Environment & Technology

Is such IRP hopelessly dated?

www.nps.gov/edis/wrlist.htm

Central IRP vs. Decentralized Markets

The Planner

Consultation

Stake holders Regulator Stake holders Regulator

The Plan

Generation Planning Gen 1 Gen 2 Gen 3 Gen 4 Transmission Planning System Operation Environmental Planning Demand-Side Planning

Prices, DSM, Power

Consumers Gen 1 Gen 2 Gen 3 Gen 4 Emissions Markets Demand-Side Planning System Operation Transmission Planning Consumers

Methods

• •

Old IRP:

Simultaneous

consideration of resources; coordination by

optimization models

–

EGEAS, PROVIEW/PROSCREEN, MIDAS

Multiple objective

tradeoffs, externality adders

•

1 Feb. Dublin workshop

•

Societal risks: sensitivity analysis, decision trees, physical hedges

•

Markets:

Separate

consideration of resources by different market parties; coordination by

prices

•

Primary objective (

profit

), s.t. environmental constraints, emissions allowance costs

•

Financial risks:

Option pricing, financial hedges

•

Stakeholders

express social values

•

1 Feb. workshop

•

Regulators

reflect social values in emissions caps, infrastructure (transmission) decisions

Dimensions of Economic Efficiency

Productive Efficiency Squeeze most you can out of inputs Right mix of inputs Technical innovation

Dimensions of Economic Efficiency

Productive Efficiency Squeeze most you can out of inputs Right mix of inputs Technical innovation Allocative Efficiency:

Motivate consumers to use the “right” amount

Purpose of IRP: To Overcome Barriers to Efficiency (“Market Failures”)

Productive Efficiency Allocative Efficiency

Purpose of IRP: To Overcome Barriers to Efficiency (“Market Failures”) For instance:

Productive Efficiency

efficient (



market power)

Gracie Allen once called a repairman to fix her electric clock.

After fiddling with it, the repairman said “There ain’t nothing wrong with the clock, you just didn’t have it plugged in” Gracie: “Well, I don’t want to waste electricity. I only plug it in when I want to know what time it is.” Allocative Efficiency

Transaction costs, lack of information (



unconsummated deals, too little DSM)

Purpose of IRP: To Overcome Barriers to Efficiency (“Market Failures”) Can’t buy things you want (e.g., hedges) (e.g., network, environmental) Bigger is more efficient (



market power) No one owns and can sell valued resource (e.g., resource adequacy)



Government sets prices, which don’t

Allocative Efficiency

reflect marginal cost, value Transaction costs, lack of information (



unconsummated deals, too little DSM)

Good Market Design Can Correct Many “Market Failures” Addressed by IRP

1. Environmental externalities:

  •

Internalized by cap-and-trade systems

Title IV; NO x SIP Call

Floor-and-trade systems for renewables (Renewable portfolio standards, green certificates)

 •

Legislature now makes tradeoffs

For regional or global pollutants, more appropriate forum than individual IRPs 2. Network externalities:

 

Internalized in operations by LMP Market-based transmission: scale economies still a problem

Good Market Design Can Correct Many “Market Failures” Addressed by IRP

3. Free riding on generation adequacy:



Corrected by capacity markets, e.g., “ICAP” (Installed Capacity) Markets

•

Regulator or ISO makes tradeoffs (how much reserve margin)



In long run: reliability can be priced, and consumers select their preferred level

•

“ACAP” (Available Capacity Markets) in which ISO cuts off customers lacking contracts if there is shortage (need control equipment, political guts)

•

Real time pricing (“economic reliability”) (need meters, consumer acceptance, financial hedges) 4. DSM

  

“Market transformation” to overcome information, transaction cost barriers Real time pricing could replace load controls (“legacy programs”) Government or regulated entity subsidize instead of generation company

Tradeoffs, Societal Benefits, Resource Substitution Must Still Be Considered by Planning Process

But in More Appropriate Forums

• • •

Transmission infrastructure planning

– –

Largely centrally planned, considering effects on all market players Merchant transmission will be niche

Energy efficiency

–

Government appliance standards; USEPA’s “Green Lights” certification program

–

Public benefits funds subsidizing DSM

Environmental tradeoffs

– –

Caps on emissions Renewable portfolio standards More appropriate geographic scope, create level playing field for market players Now generators focus on what they do best: producing efficiently at the right times

New Integrated Resource Assessment Process, Case 1: Transmission Planning in the CAISO

California ISO:

M. Awad, S. Broad, K. Casey, J. Chen A. Geevarghese, K. Johnson, J. Miller, A. Perez, A. Sheffrin, M. Zhang Consultants: E. Toolson, G. Drayton, F. Rahimi

CAISO Market Surveillance Committee

An integrated economic benefits methodology. Considers:

–

Savings in resource operation & construction costs

–

Efficiency gains due to market power mitigation

•

Improve supplier access to markets



lower bid markups

•

Less incentive for strategic withholding of inexpensive generation (replaced by higher cost imports/competitive generation)

–

Transmission-DSM-Generation substitution

Then and now:

•

The economic benefits of transmission to a regulated monopolist were:

– – –

Lower reserve margin requirements Lower production costs Not as important as reliability

•

In a market environment, economic benefits include:

– –

Savings in resource operation & construction costs Efficiency gains due to market power mitigation

•

Improve supplier access to markets



lower bid markups

•

Less incentive for strategic withholding of inexpensive generation (replaced by higher cost imports/competitive generation)

–

Transmission-DSM-Generation substitution

•

TEAM attempts to calculate these benefits

Plan-- But Consider Market Response!

Regulator Stake holders

Transmission Planner

•

A “multilevel” (Stackelberg) game:

–

Upper level:

planners (& regulator, stakeholders), who anticipate reactions of …

–

Lower level:

market response of consumers, generators

Gen Gen 2 3 Gen 1

MARKETS

Emissions Markets Gen 4 System Operation Demand-Side Planning Consumers •

Possible methods:

–

Multilevel program/math program with equilibrium constraints

–

Solve iteratively (adjust resources if prices exceed trigger, account for capacity markets)***

TEAM Principles

• • • • •

Benefits framework: Multiple perspectives

– – –

Consumers; Generators; Grid operators; Societal (excluding market power profits?) No one perspective is “right” Exclude reliability benefits (hard to monetize)

Full network representation (linearized DC loadflow) Market-based pricing

–

Recognize how upgrade might mitigate market power

Recognize uncertainty

– –

Transmission as insurance against extreme events Different parties have different probability distributions

Resource (supply/DSM) substitution

– –

Simulate market response to changed prices Account for savings in all resource costs

Zone

Example TEAM Application: Path 26

Zone Zone

Example Effects of Considering

Market Response

and

Alternative Scenarios

Load Scenario Gas Price

Base Base

Hydro

Base

Base Base Base Base Base Wet

Total Cost Market Pricing

None

($M) ($M)

$17,045 $17,044

Moderate $17,096 $17,092 None $14,604 $14,599

Net Benefits, Various Perspectives($M) Modified ISO ISO Societal Societal Participant Ratepayers*

$1.00

$4.28

$5.05

$1.00

$7.04

$5.05

$2.10

$19.00

$11.63

$0.50

$11.99

$5.90

Classic IRP Product

Sensitivity, 2013 Benefits

Expected Value

Market Pricing Gas Price Load -3 0 3 6 9 12 15 18 21

CAISO Participant Benefit (mil. $)

24 27 30

A Product of the New IRP:

Projected Markups

• 16%

Ne

14% 12% 10% 8% 6% 4% 2% 0% Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov 08 month Dec-08 ARIZONA MEXICO-C NEVADA PG AND E SOCALIF

Case 1: Conclusion

•

In a market environment, economic analyses of transmission should consider:

– – – –

Full network model Multiple scenarios Market power mitigating effects Resource substitution

•

TEAM shows it’s possible!

–

Market power mitigation benefits crucial

New Integrated Resource Assessment Process, Case 2: Planning Markets for Generation Adequacy 3 Keys for Successful Market Design (Steve Stoft) Energy Market Ancillary Services Markets Capacity Markets

•

Three dials can be adjusted (price caps, mitigation rules, …)

•

Altogether, they should:

–

Prevent market power abuse

–

Provide appropriate investment incentives

• •

Ample when generation shortage present or imminent Absent under surplus conditions

The Energy Market is Incomplete

• • • •

Unfulfilled

: Saint Fred’s (Schweppe) 1978 vision of a market where demand responds to real-time prices The market does not provide information on the value of reliability at appropriate times.

–

Height of price spikes reflects:

• •

regulatory decisions willingness of ISOs and load serving entities to stomach political fallout of curtailment

–

Least valued uses are not curtailed Unlikely that the optimal amount of generation will be added under a pure energy market Would a capacity market improve efficiency?

U.S. Policy Change 2003: US FERC “Standard Market Design” “Wholesale Power Market Platform”

• • •

FERC has oversight of ISO-based markets and “market based rates” “Resource Adequacy” was mandated for ISOs by SMD

– –

But under WMP, a state responsibility A thousand flowers blooming Two things FERC still insists on:

–

Market power mitigation must recognize interaction with resource adequacy

–

Energy, ancillary services markets must include scarcity pricing

Alternative Incentives for New Capacity “Price Spike” (Energy Only) Enhance demand-side price response Compensate customers for outages Operating Reserves Mandatory Call Options/ Contracting Installed Capacity Payments from ISO Tradeable ICAP requirements Bidding to ISO

2 Options:

Fixed payment from ISO or penalty if capacity inadequate ISO declining demand curve P CAP P CAP Capacity [MW] Capacity [MW]

Status of ICAP markets in US Existing/Proposed ISOs

Peak ~5GW

Load and Capacity

90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 [MW] 0 Peak Projection Summer 2002 Expected Available Resources Summer_2002 Projected Resource Addition MAR-SEP_2002 NE-ISO NYISO PJM PJM WEST (est.) MISO ERCOT CAISO

Status of ICAP markets in US US market designers deeply & consistently committed to …… ambivalence about whether capacity markets are needed and how they should be designed

}

ISO Demand Curves for ICAP Mandated Forward Contracts ISO Operating Reserves Markets

Challenges for all Capacity Markets

• • •

All markets involve political/regulatory decisions about price caps All markets (except pure price spike) require political/regulatory decisions about desired reliability levels (LOLP) Without demand-side involvement, the above decisions will be based on non-market valuations (engineering judgment, contingent valuation, regulatory decree, stakeholder processes, etc.) …

… Rather than consumer preferences, as revealed by their responses to real-time prices

Issues in Designing Capacity Markets

• • • • • • • •

Installed or available capacity?

–

Incentives to improve performance vs simplicity Tied to physical assets?

–

Flexibility vs credit risk Lead-time and duration of commitment?

–

4 yrs PJM, 1 yr ISO-NE

–

Flexibility vs assurance of adequacy Geographic distribution?

Markets for different types of capacity? (Flexible vs inflexible; bonus for “green”; supply diversity) What is the “optimal” penalty for noncompliance?

Creation of opportunities to “game” Relationship with energy & operating reserves markets

–

ISO-NE proposal to deduct year-by-year turbine revenues

PJM ICAP Demand Curve Proposal: Four Years Ahead

ICAP Demand Curve ICAP Supply Curve

P ICAP Q ICAP

PJM ICAP Demand Curve Proposals

160 140 160 120 140 120 100 100 80 80 60 60 40 40 20 20 0 0 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% 32%

Reserve (Target IRM = 15%)

#1 No Demand Curve #3 Cost at IRM+4% #5 Cost at IRM+1% #1 No Demand Curve #2 PJM Original #4 Cost at IRM #2 PJM Original #4 Cost at IRM #5 Cost at IRM+1%

Example Comparison of Five Curves: Tradeoffs between Cost, Reliability, and Overacquisition Curve 1. No Demand Curve (Vertical) 2. Original PJM Curve 3. Case 4 + 4% 4. Curve with P = New Entry Net Cost at Target Reserve Margin 5. Case 4 + 1% % Years meet or Exceed Target % Reserve over Target (Standard deviation) Generation Profit $/kW-yr (s.d.) Scarcity Revenue $/kW/yr (s.d.) 37 28 100 -0.4

(2.0) -0.1

(0.6) 3.6

(0.8) 64 (116) 29 (79) 10 (34) 51 (90) 43 (77) 14 (31) Energy & Ancillary Services Revenue $/kW/yr (s.d.) 10 10 10 53 0.3

(0.8) 24 (73) 38 (71) 10 89 1.1

(0.7) 19 (64) 31 (62) 10 ICAP Payment $/kW/yr (s.d.) Scarcity + ICAP Payment by Consumers $/kW-Peak Load/yr 75 (56) 48 (12) 58 (10) 143 (127) 104 (86) 85 (36) 48 (8) 98 (79) 50 (9) 93 (69)

Source: PJM-JHU dynamic analysis (2005)

Conclusions: Remaining IRP Challenges in U.S.:

Responsibilities falling through cracks; Uncertain benefits of policies

•

What should be the economic objective of grid planning?

•

Motivating efficient investment in transmission infrastructure and controls

–

“Performance” difficult to measure (avoiding rare events)

•

Resource adequacy markets:

–

Remaining controversy over the best designs: physical (ICAP) or financial (contracts)?

•

Reliability is largely unpriced and consumers can’t choose

Conclusions, Cont.

Responsibilities falling through cracks; Uncertain benefits of policies

•

How can we incent efficient load controls in a retail access environment?

• •

Inefficiency of differing resource portfolio standards in different jurisdictions

•

Hammering of renewables by punitive balancing market designs Are portfolio standards a cost effective way to promote technological progress and environmental quality?