I don't have the "capacity" for that, right now....

Since becoming Executive Director of the Western Power Trading Forum (WPTF) eight years ago, I’ve tended to ignore much of the debate, litigation, and histrionics surrounding “capacity” markets in the East. At first, owners of generation were upset that prices were too low. Indeed, as late as 2023 the largest U.S. market (PJM) had an installed reserve margin that hovered above 20% which would suggest plentiful supply and thus lower prices in that centralized capacity mechanism[1].

However, as older fossil assets began to retire, the reserve margin began to decrease - even prior to the sudden appearance of large new electric demand which began to appear in early 2024. This, of course, was driven by data centers to meet the needs of Artificial Intelligence (AI) uses. In my recollection, this new demand epoch came on us suddenly and was often blamed on shortcomings of system planners or, in some organized markets, on capacity mechanisms. It was, in my view, an easy target for politicians and media.

A little background

Capacity – what we in the West call “resource adequacy” (RA) – is a hard concept to get right. It doesn’t exist in other “commodity”[2] markets. In the old era of individual utilities building out a system to meet its needs, “capacity” was a term of art, not an accurately quantified term of a utility’s portfolio that was to represent a possibility of maximum capability. The need to more precisely define it and quantify it was to allow for utilities to share resources once we evolved to a system of moving or sharing power. This evolution developed after the slowdown of rapid economic growth in the first three quarters of the 20^th century; the industry could not rely upon constant large load growth as demand grew much more slowly.

Power markets emerged out of this era of higher prices for energy (1970s and 1980s). It found its basis by many utilities recognizing the challenge to predict demand that would allow procurement of new investments to be covered by captive rate payers. Given the emerging reluctance of regulators and customers to approve additions to rate base, a consensus began to develop in some areas in favor of “open access” to the transmission system.

The reason for “open access” – making the transmission system a common carrier – was not to increase competition for generation as is sometimes thought to be the case. Having access to the transmission system – while paying the utilities for its use – was necessary for non-utility generators (NUGs) to take the risk to invest in new resources that could meet demand without putting the burden on captive ratepayers. As hard as it is to imagine the reluctance of utilities going to regulators or the public power board to get an investment to build new stuff in the current data center environment, NUGs were a way to get resources without the permitting, the regulatory approval for rate base and signing a contract for resources to meet needs.

Open access was very successful in most areas of the country. Heat rates dropped, utilization of older generation assets increased. But there was still a need for something to cover unusual demand events, decreased supply, unusual weather, or system failures.

Now back to our current situation

Since the electric system was wringing efficiencies out of markets for energy and doing so on a regional basis, a discussion arose: Why not address capacity needs by attempting to create a kind of “market” or mechanism to count and allocate the “just in case” capacity[3]? I will not bore you with the early efforts of PJM, New England or New York to count capacity. CAISO and ERCOT didn’t even try in their first years. Suffice it to say, it evolved into a central part of market design[4].

I was working at PJM when the very capable staff there came up with what still seemed an elegant concept: a centralized capacity procurement with prices set on the “cost of new entry” for a natural gas unit with a downward sloping demand curve called the “reliability pricing mechanism” (RPM)[5]. This mechanism would be adjusted from time to time, but it began to be viewed – depending on where one stood in the market – either as underpricing capacity or over pricing it. However, the real challenge to the RPM came with the introduction of efforts of some states to direct utility investments to either affect prices or to meet a policy goal such as decarbonization. This led to struggles to maintain the RPM pricing so that it would still highlight the cost of new build and thus signal investment needs.

It would be folly of me to try to catalogue how consensus over RPM and capacity in PJM broke down. Fingers are still being pointed. However, I will offer my own view of its main flaw that I developed in my last years on FERC staff and my recent work in the West.

It’s all about the “Benjamins” …

Everybody associated with electric procurement will agree on the need for capacity (or RA). They will mostly agree even on the level of capacity/RA that should be procured by every entity serving customers (load). What gets everyone upset is the pricing. While central capacity markets provide great transparency on prices, a single-price auction (as occurs in central capacity markets) has more problems than benefits.

The solution that suggests itself has elements of a systematic tracking of capacity procurement but purchased on a bilateral basis. Thus, the pricing is done between willing buyers and sellers. However, a regional entity can keep track of capacity/RA procured to make sure there is no “double counting” or “free riders” going short into the market while relying on those that have sensibly procured.

While some regions may be able to get away without an entity keeping track of capacity/RA, most regions require this mix of enforcement of standards to accompany bilateral procurement.

I don’t know what my friends in PJM will do but I think movement to something along the lines of maintaining standards while procuring bilaterally will allow the excellent staff at PJM to do what it does so well – administer the energy market to ensure reliability and efficiency.

We in the West have the bilateral part down pat. We just need to effectively establish the standards and oversight institutions. The West will get there. But what about our friends in the East?