Reborn to Run Clean? Advancing Renewables on a New Capacity Market

Texans are still suffering from the effects of the power crisis, which began on February 14th. Subzero temperatures then froze energy supplies, leaving over 4.5 million people without power.  Finger-pointing began immediately. Governor Greg Abbott blamed renewables. Representative Ro Khanna blamed insufficient regulations. It eventually became clear that preventing future climate-related disasters will require planners to coordinate decarbonization goals and resource adequacy objectives. New Jersey convened a working session in March to prepare.

While the effects of climate change stressed Texas energy markets, New Jersey is questioning whether energy markets can support renewable deployment to meet state climate commitments. Five days after the blackouts began, Kathleen Spees of the Brattle Group, an energy economics consulting firm, addressed the subject at a working session held by the New Jersey Board of Public Utilities. 

As New Jersey considers different methods to provide 100% zero carbon energy as its governor has promised , concern is mounting around whether state climate policies align with the objectives of regional grid operators who must keep up resource reliability. “States have declared that they don’t want to buy power from carbon emitting resources, but grid operators have declared that any power from any resource is the same [on a reliability test],” explains Doug Hurley from Synapse Energy Economics. 

The working session was scheduled to address the strain between New Jersey and PJM, the multistate grid operator that spans from New Jersey to Ohio. As states attempt to reconfigure capacity markets to meet clean energy goals, several design alternatives are being proposed. 

The consulting firm Grid Strategies LLC argues that an energy-only market can help states achieve clean energy goals. The Sierra Club believes a Voluntary Residual Capacity Market can facilitate zero carbon policies. However, Spees and her team at the Brattle Group claim that an Integrated Clean Capacity Market can preserve PJM’s market approach to ensure resource adequacy, while giving New Jersey agency to dictate the state’s clean energy makeup. 

Currently, PJM estimates the electric capacity needed three years into the future to supply New Jersey with power at peak demand. To meet projected demand, PJM runs a forward-looking auction, called the capacity market, which pays generators who promise to remain operational for at least three years. “Capacity markets are like insurance programs,” explains Marten Ovaere, an Energy Economist at Ghent University. “While we pay for more capacity, we reduce the risk of outages by ensuring that generators will be held accountable for meeting peak demand.”

The auction structure is intended to increase competition and minimize the price PJM pays generators for providing capacity. The plants that offer bids at the lowest price until capacity is met are rewarded. For instance, if PJM estimates that peak demand on the grid will be 1,000 MW in 2024, it will hold a capacity auction in 2021. If twelve 100 MW powerplants enter the auction to supply capacity, the ten plants that offer bids at the lowest price will be paid by PJM for supplying capacity. 

“Capacity markets have really proven to be quite valuable in terms of driving down costs and maintaining reliability,” explains Philip Martin of Enel X, a demand response and storage provider that bids into PJM’s capacity market. However, critics argue that the structure of capacity markets favors fossil fuel. Because PJM’s capacity market pays generators three-years before operations, these auctions suit already-built resources with low upfront costs and high operating costs, such as gas plants. Meanwhile, for new fossil generators, the capacity market payments allow these plants to cover their upfront costs.

Abigail Krich from the consulting firm Boreas Renewables notes: “Capacity markets were designed in the 1990s around an assumption that all new resources look like fossil fuel-fired power plants in their operating characteristics and their economics.” While renewables are now cost-competitive with fossil plants when comparing levelized costs, new wind and solar providers have a hard time underbidding in the capacity market due to their high upfront costs. This imbalance shows especially when new wind and solar providers compete with established fossil operators. 

Capacity markets were designed around an assumption that all new resources look like fossil fuel-fired power plants.

Additional tension stems from differences in how PJM and New Jersey value power. “To achieve competition, capacity market design has focused on being resource-agnostic,” says Martin. “While achieving low costs to meet resource adequacy is the foundation of the capacity market, there now has to be a focus on addressing the climate crisis.” The ICCM mechanism attempts to expand the scope of the capacity market’s structure.

That redesign highlighted Brattle’s presentation at the working session. In a recording, Spees begins by presenting the similarities between the ICCM and PJM’s current capacity market. The ICCM preserves the method used to secure capacity. Using a three-year forward-looking auction model, both fossil fuel and renewable generators can offer bids to meet the grid’s resource adequacy needs. Moreover, PJM will continue to determine the capacity required to serve reliability. 

In addition to securing capacity, the ICCM introduces a lever that enables New Jersey to set the quantity of clean energy it hopes to procure to meet capacity needs: Clean Energy Attribute Credits. Under the ICCM, New Jersey sets Clean Energy Attribute Credits to reflect the state’s reliability and decarbonization goals and then hosts a CEAC auction into which renewable generators can competitively bid. Similar to PJM’s capacity market, the lowest renewable energy bidders receive CEAC payments.

The two auctions occur simultaneously, explains Spees. Fossil fuel plants bid into the capacity market while renewables bid into both the capacity and clean energy markets. A Brattle whitepaper uses the following example. A 100 MW gas fired power plant could sell 95 MW of unforced capacity into the capacity auction while a 100 MW wind facility generating 250,000 MWh each year could sell 13 MW of unforced capacity into the capacity auction and 250,00 MWh of CEACs into the clean energy auction. 

As the capacity and clean energy auctions take place, a clearing price for each auction is produced. The ICCM then co-optimizes the two products within a single auction to meet the required clean energy volume and capacity needs at the lowest blended cost. 

Since clean energy providers can receive payments from both markets, the ICCM potentially erases the advantage inherent in fossil generators’ low upfront costs in capacity markets. Spees tells the audience, “Renewable energy generators are indifferent as to whether they earn revenue from the capacity or clean energy market. Because clean resources earn revenues out of the clean energy market, the price they demand in the capacity market is lower.”

In other words, the revenues that wind and solar plants can collect from Clean Energy Attribute Credits allow renewable developers to offset high upfront costs. This enables lower bids in the capacity market, accelerating renewable energy penetration in PJM’s capacity market. Beyond amending biases within PJM’s capacity market, Spees states that the ICCM eliminates one of the largest barriers of entry for renewable energy producers—the Minimum Offer Price Rule. 

The MOPR was born out of a FERC determination that state clean energy subsidies give renewable resources an unfair advantage in the PJM capacity market. To prevent subsidized renewables from underbidding fossil plants, the MOPR set a price floor for renewables to enter into capacity auctions.

According to Spees, the ICCM can eliminate state subsidies for renewables by allowing the state to replace all direct subsidies with Clean Energy Attribute payments. Because clean energy objectives are reached using a competitive mechanism under the ICCM instead of through direct state subsidies, renewables can bid into the capacity market below the price floor. 

Beyond lowering system costs by eliminating the MOPR, Spees claims that bridging PJM’s capacity market and New Jersey’s clean energy goals will reduce market redundancies. While New Jersey conducts clean energy solicitations to meet its Climate Action Plan, PJM’s market design effectively excludes renewables from offering useful capacity. This incentivizes the buildout of additional fossil fuel plants to supply capacity. By keeping clean energy and resource adequacy objectives siloed, New Jersey customers are paying for duplicate resources. The ICCM attempts to blend both renewable and resource adequacy objectives, enabling renewable generators to meet clean energy and capacity objectives. 

After Spees concludes her presentation, the audience’s clarifying questions begin to highlight important considerations. One audience member notes that CEACs, which reward MWh of energy, seem to favor high energy output resources like wind and solar. This mechanism may fail to reward low MWh solutions, such as demand response. 

Another audience member asks how the ICCM would be implemented. Spees proposes that PJM could potentially serve as the auction administrator and create a new entity to implement the market. Alternatively, if PJM is unable or unwilling to administer this program, States could create a third-party entity to implement the ICCM. Despite these two potential solutions, federal-state jurisdictional issues may impose roadblocks and few paths have been laid to create the foundation for employing an ICCM. 

Regardless of whether an ICCM is adopted, questions remain around the ability of grid operators to accurately determine the capacity of various resources. Predicting electrical load three years into the future depends on delicate analyses. Performing this task as more non-dispatchable renewables come online brings a distinct set of challenges. Moreover, the Texas power crisis illustrates that even gas plants, lauded for their flexibility, are vulnerable to the unpredictability of climate shocks. 

“Economically the ICCM makes sense. The problem is that solar and wind do not have a capacity of value of 100%. If PJM overestimates the capacity value of solar and wind, this will reduce PJM’s ability to meet demand. A challenge with wind and solar is seasonal balancing, so having different capacity values for summer and winter makes sense”, explains Ovaere. 

Ovaere later states, “The ICCM proposal talks about 70% renewable energy generation by 2035. This is very forward looking, but in a way, 2035 is tomorrow. New generation being built today will be around for the long haul. If the U.S. has a goal of reaching net zero carbon electricity by 2035, redesigning policies to meet these goals should be made now.”