Electricity Markets

Very little new generation capacity built for sale into RTO markets

Just under five percent of new electric generation capacity that began operating in 2014 was built only for sale into an organized wholesale power market, a new report completed by the American Public Power Association found.

The paper, which was completed in December and written by Elise Caplan, Senior Manager, Electric Markets Analysis at APPA, analyzes data on new electric generation capacity in the U.S. that began operating in 2014, and the financial arrangements behind such capacity.

The analysis revealed that almost all the new capacity was constructed under a long-term wholesale power contract, or utility ownership, or a financial hedge guaranteeing a minimum price.

The paper, "Capacity Markets Do Not Incent New Electric Generation: Market Reforms for Reliable and Affordable Electricity," says that in 2014, 14 percent of new capacity was built within the footprint of the regional transmission organizations with mandatory capacity markets (PJM Interconnection, ISO New England and parts of the New York ISO), but these RTOs cover almost a quarter of the megawatt-hours consumed in that year. In addition, over half of the capacity built in the mandatory markets was a single plant constructed by a vertically integrated investor-owned utility.

Prior analyses of such data were conducted for new capacity that began operating in 2011 and 2013.

The December 2015 paper notes that there have been several developments since the last APPA study was released in October 2014:

• PJM and ISO New England have held capacity auctions under new rules with performance-based penalties and incentives and that were accompanied by significant price increases;
• The U.S. Environmental Protection Agency has issued its Clean Power Plan to limit emissions of carbon dioxide from electric generating units;
• Additional nuclear plant closures have been announced in RTO regions; and
• The Supreme Court has agreed to review the decision of the U.S. Court of Appeals for the Fourth Circuit upholding the federal district court's invalidation of the Maryland Public Service Commission's order requiring the state's investor-owned distribution utilities to sign long-term "contracts for differences" providing a fixed revenue stream to the developer of a new natural gas power plant.

"These developments have factored into the ongoing debate about whether the capacity markets operated by the RTOs — especially the mandatory capacity markets in ISO NE and PJM, as well as parts of the New York ISO (NY ISO) — are an effective means to provide a reliable supply of resources while addressing environmental, reliability, and other policy goals," the APPA report said.

The report found that just 4.8 percent of the new generation capacity completed in 2014 was built solely for sale into RTO markets, almost all of which was from one plant — the 738 MW West Deptford combined-cycle plant in New Jersey.

Natural gas accounted for half of the new capacity built, and a little over three-fourths of the capacity built under utility ownership. Solar and wind accounted for 19 and 27 percent of the new capacity, respectively. Natural gas builds were characterized by a smaller number of larger projects, while the solar installations consisted of a larger number of smaller projects with almost all built under utility or individual customer power purchase agreements. Wind capacity covered a range of differently sized projects, and a mix of financing arrangements.

Financial hedges

The report said that in 2014, an increased share of capacity was financed by "quasi-merchant" arrangements where a utility or end-use customer is not purchasing the power, yet the developer or an entity financing the project receives a guaranteed price for a period of time and for at least a portion of the megawatt-hours sold.

A financial entity would provide this hedge as a purely financial product -- such as a financial swap -- that guarantees a minimum price. Such arrangements can be structured as revenue puts, where the hedge provider sells an option to the developer for the sale of the power at a minimum guaranteed price.

Another arrangement is a synthetic PPA, the paper notes, where the hedging party provides a steady stream of revenue based on a benchmark price, similar to a PPA, but does not purchase the power. If the market price exceeds the benchmark, the hedging party earns the difference. Hedging parties may play a role in financing the project or be an unrelated third party. A number of the wind projects built in 2014, primarily in Texas, have some type of financial hedge, commonly for a 10 to 12 year period.

New merchant generation

Meanwhile, the report noted that although only a relatively small amount of pure merchant capacity has been built in the RTO regions to date, "a significant amount of capacity" from new merchant power plants has cleared the last three PJM capacity market auctions. These auctions are known as Base Residual Auctions, or BRAs. "But the extent to which this capacity will actually be built is still uncertain," the report said.

The approximately 11,000 MW of merchant generation that cleared the last three capacity auctions in PJM appears to indicate a change in the pattern reported in the study. But to date, just one purely merchant plant has been built in the PJM footprint — the West Deptford plant in New Jersey.

The report said that if a mandatory capacity market leads to a larger proportion of merchant plants clearing the auction, it is important for the Federal Energy Regulatory Commission and other policymakers to consider whether this trend is a beneficial model for energy resource planning.

"The uncertainty about whether and when the plants will be built makes it difficult to adequately plan for future reliability requirements. Moreover, should these projects be built, it is not clear if their impacts on fuel diversity, natural gas pipeline capacity and natural gas prices have been taken into account. Finally, the higher cost of capital also represents a significant drawback to relying on merchant capacity," Caplan wrote.