Written by Charles Park, Energy Systems Engineering B.ASc. Candidate, University of Toronto

On April 29, 2015, Mindfirst hosted a seminar entitled “Ontario Capacity Auction: Analysis of Feasibility and Criteria for Design Elements.” This blog summarizes the seminar’s key ideas by exploring the motivation for a capacity auction (CA) in Ontario, the potential benefits from its implementation, and technical and regulatory challenges requiring attention for proper integration into Ontario’s electricity market.

To meet Ontario’s future resource adequacy requirement (RAR), the CA is a short-term, market-based procurement method that is an alternative to the current method of long-term contracts motivated by government directives. The contracting method has brought Ontario into a strong supply situation; however, this will not be the case over the next two decades. One reason is the capacity shortfall attributed to upcoming refurbishment of nuclear facilities. Exacerbating this shortfall is that existing procurement contracts will expire over the same period of refurbishment. Given Ontario’s impending supply situation, the IESO has considered the implementation of alternative procurement mechanisms like the CA.

A properly designed CA confers key advantages that long-term contracting does not. One advantage is flexibility. While the long-term contracting approach was effective in addressing RAR, it led to an oversupply market, the operating costs of which were borne by ratepayers. In contrast, a CA would not lock in costs for consumers. By adopting a market-based approach allowing entry and exit from the market, it promises a fairer balance of risk in response to uncertain demand profiles. The CA would target Ontario’s incremental capacity needs, not supplanting the current procurement model with its related baseload and renewable energy targets. By this scope, the CA is estimated to provide as much as $500 million of annual cost savings. It also offers price signals on the value of capacity that we currently do not see in Ontario. This awareness would encourage competition between resources to drive innovation in step with technological advancements that enable increased levels of consumer participation in the electricity market.

The design of a CA requires discussing some key issues. One topic is investment risk related to the new build which a CA can attract. More so than new build, a successful CA relies on calling upon the cost-effective resources needed at a certain point in time, which could indicate maximizing the use of existing assets that are not currently online but can be brought back later. A made-in-Ontario CA is not to replace the entire supply mix, but targets incremental capacity needs that may or may not be required in future years. Another key parameter of the auction is the lock-in period for participating resources. It should not be too long to undermine flexibility benefits, but at the same time it should not favor one resource over another. The suppliers would have the opportunity to determine their needs to help size a suitable commitment period. Based on the resource’s risk appetite with respect to political and regulatory forces, suppliers can reflect offer prices accordingly. Finally, in return for a capacity payment, the resource should have a clear understanding of its obligations. This could take the form of a must-offer requirement into the energy market during peak hours so that the control room can count on the available capacity.

A review of several regulatory cases related to CAs in the United States highlights that although they sound great in practice, the challenge is in the details of the implementation. One example related to the Federal Energy Regulatory Commission’s denial of complaints against the New England Independent System Operator (ISO-NE) that lock-in rules for new generation capacity were unjust and discriminatory. In the event that that offers in the CA clear, the resources that submitted these offers would have to specify whether the relevant clearing price should continue to apply for an additional 6 commitment periods. This provision was intended to enable resources to lock in their clearing price and avoid future price risks. By electing this, however, they would not be able to offer a higher price nor be able to submit de-list and export bids during that commitment period, hence forming the basis for complaint. Another case for ISO-NE concerned the identification of criteria for non-compliance in capacity obligations. If the resource was unable to procure fuel for reasons attributed to stock delivery and not due to economics, then that would be a valid reason to not participate in a CA. Technical issues like this would have to be proven on an individual basis. The final example discussed the ISO-NE’s efforts to create a compensation scheme for reliability resources whose delist bids were rejected due to reliability reasons. These cases highlight the importance of a robust stakeholder engagement process to anticipate issues and design measures to address them.

Some think that due to anticipated difficulties in the details of implementation, Ontario may have challenges in hosting a CA that provides the benefits described earlier and could burden ratepayers with greater system costs. Despite a CA’s aim to target the incremental needs of the system, this does not preclude Ontario from issues inherent to the centralized clearing auction process with respect to acquiring new build. A functional CA depends on Ontario’s need for more capacity over the long term – this is the only way that building new capacity is justified under the reduced time frame of 3 to 5 years. This assumption may be challenged by Ontario’s current stance on conservation measures and renewable energy integration targets, which could send a market signal to crater raw capacity prices and diminish investor confidence. Another issue is potential market gaming: without sufficient planning, the intricacies of the CA design can facilitate the exercise of market power by various resources, which may be particularly problematic in Ontario due to the lack of locational energy pricing and geographic issues related to the North West.

In conclusion, a CA is an alternative method of procurement that the IESO is designing in response to Ontario’s supply outlook. The benefits are promising, but require extensive stakeholder engagement to consolidate an implementation plan that will overcome the technical and regulatory challenges to its effective design.

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