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Capacity Payments and Electricity prices explained

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Richard Brooks's picture
Co-Founder and Lead Software Engineer Reliable Energy Analytics LLC

Inventor of patent pending (16/933161) technology: METHODS FOR VERIFICATION OF SOFTWARE OBJECT AUTHENTICITY AND INTEGRITY and the Software Assurance Guardian™ (SAG ™) Point Man™ (SAG-PM™)...

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  • Jan 26, 2019

Recent feedback has indicated that an explanation of capacity payments versus electricity prices may be in order, so I'll use an analogy to explain why consumers have to pay for both capacity and electricity.

Suppose you're flying from mainland US to Hawaii. You might want to rent a car during your visit, so you stop in at the rental car agency, i.e. the Capacity Owner (of cars). The owner of these cars had to make an investment to acquire the cars, setup shop and pay people to work the counter, with the hope that they will make a profit renting cars.  You walk up to the counter to rent one of these cars and you're told the car will cost you $50/day - this is the capacity payment, just so that you will have a car at your disposal, when you need it, and 10 cents per mile driven. Even if the car sits in the driveway and never moves, you're paying the $50/day (capacity payment) for the "right to drive the car", but you pay nothing for miles driven while it sits idle.

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Electric generating capacity works in a similar fashion to the car rental scenario above. ISO's pay capacity owners (the companies that own generating resources) a capacity payment, in kW/Month in New England, to ensure that the resource is available to produce electricity, if needed. Just like the rental car sitting in the driveway when you're not driving, ISO’s still have to make the capacity payment to these generators; in the car case it's $50/day, for electric generators it's $4.50/kW per month, as an example.

Electricity prices are analogous to the cost per mile. There is a “wear and tear” charge for those times the car is being driven of 10 cents per mile, which you agreed to when you rented the car. The same is true for the electric generator, which is paid to deliver electrons, when asked to do so by the ISO. This is the price of electricity, which the generator will receive payment for based on the amount of electricity produced (using revenue quality metering). Suppose the electricity price is $40 per megawatt hour. A generator producing 2 MW per hour of energy would receive $80 for each hour the generator is producing 2 MW of energy, assuming no price changes occur.

Consumers, the beneficiary of this electricity are charged for both the capacity and electricity they use (just like the rental car scenario), which appears on their bills as the amount of electricity they consumed during the billing period, usually in cents per kWh (the retail price of electricity) and another line item, which varies in name across utilities, but is essentially the cost of capacity and other items which the utility may charge for.  

Just like there are different types of vehicles for rent, based on user requirements to satisfy different needs (i.e. 4 passenger car getting 40/mpg, versus a 2 passenger pickup truck that gets 8/mpg), we are beginning to see changes to the way generating capacity is valued. Historically, all generating capacity was considered equal and it was all about paying the lowest cost to meet forecasted demand. Now, with States demanding reductions in greenhouse gases and higher penetration of renewables, ISO’s will have to rethink they way they secure generating capacity in order to ensure that these State targets are being met, along with reliability needs to satisfy peak demand in each hour.

Our industry is undergoing epic changes and the front line for many of these changes is the capacity market. This is one area to watch if you want to get a sense for how some of these disruptive changes will play out in our industry. Enjoy the ride.

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Bob Meinetz's picture
Bob Meinetz on Jan 26, 2019

Richard, thanks for your patience. I understand the point you're making; I will do my best to help you understand mine.

Say ABC Rent-A-Car, my car rental agency, offers Tesla Model S electric vehicles for rent. They're more expensive than a Mazda CX-3 - much more - but I'm willing to make the investment to help fight climate change. I've reserved, and paid for, the five days I'll need the car ahead of time. But I arrive at the rental facility and for reasons beyond their control ABC doesn't have a Tesla for me (factory recall, whatever). The apologetic agent instead offers me a Chevy Suburban, a fine car in its own right, but a gas guzzler. I need a car, so I accept his offer - but am denied a refund for the premium I've already paid for a Tesla.

Over time factory recalls of Teslas become pervasive (the Tesla Model S is by all accounts an extraordinarily-reliable car, but it's an analogy - sorry, Elon). ABC's customers begin to realize 4 out of 5 times they're wasting their money if they rent one, and just rent the Suburban instead.

Like the Tesla in this example, the public is making capacity payments for solar electricity to individual facilities and not getting it 80% of the time (U.S. capacity factor is an average of ~20%). But unlike the Tesla, the public has no choice - they are being charged a non-refundable premium for the inavailability of renewable electricity.

It's not your fault or mine - but since it has little to do with "capacity", let's at least call it what it is, and multiply the levelized cost of solar by five so customers understand why their electricity bills are so high.

Richard Brooks's picture
Richard Brooks on Jan 26, 2019

This is a great discussion, Bob. This is why I believe it's going to take really smart people, working together in a formal standards development organization, like NAESB, where all parties have the ability to make their case in the search for an industry wide solution. The fact that you are engaged in this discussion is productive, now we need more smart people to engage in the conversation. It would be great to hear from Generators, State regulators, System Operators, Utilities, Consumer Advocates and others with an interest in how this evolves. The conversation needs to continue, in my opinion. Thanks..

Matt Chester's picture
Matt Chester on Jan 28, 2019

Great analogies, these are the kind of 'explain it like I'm 5 years old' ways to convey sometimes complex information that I think more aspects of the energy model could use. 

Bob Meinetz's picture
Bob Meinetz on Jan 28, 2019

Matt, some measure of humility is requisite in discussions of energy, and particularly how electricity is priced in the U.S. - it's a complicated subject. I've been corrected many times on what I knew for sure, that "just wasn't so". Hopefully, we all walk away a little wiser for the experience.

Frightening is the lack of understanding of energy in public administration. I was once told by a member of the California Assembly that public utility commissioners can be expected to have an understanding of energy "somewhere between a smart eighth-grader and your drunk uncle." Experience has pretty much borne that out.

Matt Chester's picture
Matt Chester on Jan 29, 2019

Well cheers to us all doing better to learn and educate ourselves, and to hoping those in public offices can do the same

Richard Brooks's picture
Richard Brooks on Jan 29, 2019

I totally agree with Bob's viewpoint here. I'm surprised by the confusion about capacity payments across a broad swath of people in the industry. I'm also surprised by the response when I tell people that capacity price is fixed for a specified term (i.e. 1 year), but electricity prices are calculated every 5 minutes across ~1,000 location in New England. I felt compelled to put this piece together just so that we could establish some basline agreement of what these terms mean and how they differ, within the community. What I find really strange though is the type of resources that are considered capacity today, i.e. energy efficiency programs and demand response to name a few.

Matt Chester's picture
Matt Chester on Jan 29, 2019

That's great-- I love that you put the resource together just for that purpose. Hope to see more of this as I continue to strive to know more & understand better today than I did yesterday!

Bob Meinetz's picture
Bob Meinetz on Jan 30, 2019

Richard, don't forget to add storage to the list of nonsensical energy "resources", a term misappropriated to help conceal the reliance of renewable energy on natural gas. 

According to OED a resource is "a stock or supply of money, materials, staff, or other assets..." A stock of efficiency? A supply of storage? Efficiency, demand response, and storage qualify less as potential resources than pixie dust - at least, we might be able to burn that.

Richard Brooks's picture
Richard Brooks on Jan 30, 2019

Thanks Bob, I'll have to check if Battery Storage devices receive a capacity payment today. Good point.

Eric Winkler might know - he's one of ISO New Englands capacity experts that's out on his own now. Eric?

Thanks, Dick.

Eric Winkler's picture
Eric Winkler on Jan 31, 2021

Very late to the party, but the answer is yes.  Batteries can qualify to participate in the capacity market.


Matt Chester's picture
Matt Chester on Feb 1, 2021

Better late than never-- thanks for the follow up, Eric!

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