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.
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. Â
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.