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Total Makeover: Wholesale Markets Need New Thinking

PJM electricity wholesale market in the U.S.

The integration of renewables into the grid is becoming an increasingly acute problem, writes Fereidoon Sionshansi, editor of newsletter EEnergy Informer. According to Sionshansi, this is especially true in energy-only markets that have no capacity mechanism of any sort. But market interventions in the form of subsidies are not the answer. Joe Bowring of independent consultancy Monitoring Analytics has an alternative: offering capacity against a minimum price. Courtesy EEnergy Informer.

It is becoming increasingly clear that the market designs of 1980s is not fit for today’s electricity markets, let alone those of the next decade. Among the main reasons is the growing penetration of renewables in many markets, which operate at zero marginal cost, and which typically bid their output in wholesale markets at zero, or even negative, prices while taking the market clearing price (MCP), usually set by the most expensive thermal unit dispatched to meet demand.

This phenomenon has resulted in persistently declining wholesale energy prices in some markets – and declining profits for some thermal generators. Moreover, even highly efficient peaking plants, which are increasingly needed as backup to maintain network’s reliability, are not getting dispatched frequently enough and/or for long enough number of hours to remain profitable. These conditions discourage investment in new capacity while forcing many of the less efficient units out of the market.

Energy-only markets

In a few cases, the grid operators have had to intervene in the market to prevent such unprofitable or marginally profitable units from shutting down, because that may make the network vulnerable at times when sufficient solar or wind generation is not available to meet demand. The problem tends to be more acute in energy-only markets, where generators are only paid when they are dispatched, not to keep excess capacity around for reliability purposes, such as in the PJM market in the U.S., which covers all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.

These issues are gaining considerable attention in a number of markets where the problem can no longer be ignored, and the topic is no longer of interest just among academics and scholars.

In an increasing number of cases, the market operators, regulators or politicians have had to intervene in the market by – for example – subsidizing certain critical fossil or nuclear units to prevent them from shutting down. In some cases, certain critical thermal units are designated as reliability-must-run (RMR), as in the Californian market (CAISO).

If too many units are paid out of the market merit order, and too many renewable generators bid at zero or negative costs, life becomes difficult if not unsustainable for the remaining thermal units

California does not have a formal capacity market but maintains adequate capacity through a mandatory administrative process using bilateral contracts. Much of the state’s thermal generation has been built under bilateral cost of service contracts, which – one can argue – are essentially indistinguishable from RMRs.

Such units are typically paid out of the usual market merit order because they are deemed critical to maintaining the network’s reliability either because of their location on the transmission lines, or proximity to critical load centers, or because the network needs the spinning reserves to maintain voltage or frequency. Plants designated as RMR no longer participate in daily wholesale auctions since they get paid regardless of getting dispatched.

Clearly, if too many units are paid out of the market merit order, and too many renewable generators bid at zero or negative costs, life becomes difficult if not unsustainable for the remaining thermal units, especially those with less flexible operating characteristics.

Very real threat

In its latest annual state of the market (SOM) report, Joe Bowring of Monitoring Analytics, the independent market monitor for PJM, warned that proposals to subsidize unprofitable generating resources – including a handful of unprofitable nuclear units – present “a very real threat” to the competitiveness of wholesale electricity markets.

The subsidies in question come in the form of zero-emission credits (ZEC) for otherwise uneconomic nuclear plants, which were included as part of New York’s Clean Energy Standard and are intended to aid the state’s transition away from fossil fuels and into renewables. Bowring points out that while NY is not in the PJM market, nevertheless these nuclear subsidies will still negatively affect PJM markets. He is also concerned about similar ZEC legislation in Illinois to subsidize Quad Cities nuclear plant, preventing it from shutting down.

In his 2016 SOW report, Bowring said, “Economists everywhere agree that … the most cost-effective way to do that (i.e., preventing unprofitable nuclear units from shutting down) is to have a carbon price…..,” adding, “It’s certainly not by picking (and subsidizing) individual power plants that are low carbon.”

Monitoring Analytics, whose job is to monitor the performance of the PJM market against a hypothetical functional market with no abuse of market power, no price manipulation, no gaming, no artificial or strategic withholding of energy or capacity, no out-of-market subsidies such as ZECs, or other types of manipulation or interference – is concerned that such interference, in the form of specific subsidies for specific market participants, will ultimately affect the market outcome.

“The market fundamentals are just fine. Market interventions, for example, in the form of subsidies, distort markets and create the need for more subsidies”

In addition to performing  its market monitoring function, Monitoring Analytics mitigates against exercise of market power while proposing market design changes to enhance competition.

In discussing the topic with EEnergy Informer, Bowring pointed out that markets such as the PJM, that include a capacity mechanism, “can accommodate increasing shares of renewables without too much difficulty,” adding, “Markets like ERCOT (the Electric Reliability Council of Texas) can also work fine if they correctly define scarcity pricing rules and recognize that the energy-only construct is riskier.”

Bowring believes that “the market fundamentals are just fine. Market interventions, for example, in the form of subsidies, however, distort markets and create the need for more subsidies.” Uneconomic units, he says, “should be allowed to retire. Fuel diversity has increased or remained flat over the last 10 years.”

Bowring points out that no market interventions have occurred in PJM, allowing substantial coal retirements and offsetting gas additions to take place entirely driven by price signals.

How would Bowring propose to address some of the issues confronting markets moving forward? He said, “Our proposal is to implement an existing unit MOPR (Minimum Offer Price Rule) which would prevent subsidized units from offering capacity in the PJM capacity market at less than a competitive level.”

The latest SOM report, which comes in 13 sections and 2 massive volumes, is available for download at Monitoring Analytics website. It has much more to offer, including a comprehensive list of recommendations.

Editor’s Note

This article was first published by EEnergy Informer and is republished here with permission.

Fereidoon Sionshansi is author and editor of many books on technological and policy developments in the utility sector. Hi’s upcoming book Innovation and Dirsuption at the Grid’s Edge, to be published in June 2017.

Content Discussion

Darius Bentvels's picture
Darius Bentvels on May 3, 2017

Would be smart when involved US power, grid & utility managers would pay a long visit to German and Denmark’s utilities, grid management, the EPEX, and supervising authorities (e.g. dena).

Those grids have high share of renewable already, e.g. Denmark >40% by wind alone, and have rather detailed plans about how to handle the continued increase towards 80%-100% renewable cheapest.*)
Denmark targets:
– that wind will generate >50% in 2020, and predicts that wind will then produce >100% of consumed electricity during ~100days a year.
– 100% renewable in 2040.

All while:
– German and Danish grids are >10 times more reliable than USA grid (they even became significant more reliable in the period when wind & solar became substantial).
– W.European power exchange markets are far more advanced.
Consider EPEX, one of the best.

Involved USA staff has something to learn.
*) Note that those countries don’t have a capacity market as they consider that a far too expensive solution.