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Mechanisms 2.0 Study – Phase II: Mechanisms Analysis

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Dated: April 9, 2018

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Renewable and Clean Energy Scenario Analysis and Mechanisms 2.0 Study
Phase II: Mechanisms Analysis
Spring 2018

This paper describes an economic analysis of some of the possible incentive mechanisms states may wish to use to support meeting their renewable and clean energy requirements.  Specifically, it further analyzes the mechanisms NESCOE describes in the Renewable and Clean Energy Scenario Analysis and Mechanisms 2.0 Study – Phase I: Scenario Analysis (“Phase I”).[1]

Table of Contents

 

  1. Executive Summary. 6
  2. Introduction and Background. 8
  3. Phase I Scenarios and “Missing Money”. 9
  4. Phase II FCEM Scenario and Mechanisms. 11

III.          Renewable Portfolio Standards 13

  1. RPS Mechanics. 13
  2. RPS Illustration. 14
  3. RPS Design Considerations. 16
  4. RPS Benefits and Challenges. 17
  5. RPS Implementation Questions. 20
  6. Clean Energy Standards 22
  7. CES Mechanics. 22
  8. CES Illustration. 24
  9. CES Design Considerations. 25
  10. CES Benefits and Challenges. 27
  11. Investment Risk Balance. 27
  12. Market Power 27
  13. Similarities to an RPS. 28
  14. CES Implementation Questions. 28
  15. Long-Term Contracts 30
  16. Long-Term Contract Mechanics. 30
  17. Solicitation and Review Process. 31
  18. State Determinations. 31
  19. Long-Term Contract Illustration. 32
  20. Long-Term Contract Design Considerations. 33
  21. Long-Term Contract Benefits and Challenges. 34
  22. Risk Allocation. 36
  23. Long-Term Contracts Implementation Questions. 37
  24. Strategic Transmission Investments 40
  25. The Objective of Strategic Transmission Investment 40
  26. Approaches to State Transmission Funding in New England. 40
  27. Elective Transmission Upgrades. 40
  28. Public Policy Transmission Upgrades (PPTUs) 42
  29. Traditional Indirect Funding of Transmission Upgrades. 43
  30. Strategic Transmission Investments Design Considerations. 44
  31. Strategic Transmission Investments in Other Areas of the Country. 46
  32. Strategic Transmission Investments Implementation Questions. 47

VII.        Forward Clean Energy Market 49

  1. FCEM Mechanics. 49
  2. FCEM Illustration. 51
  3. FCEM Design Considerations. 52
  4. FCEM Benefits and Challenges. 55
  5. FCEM Implementation Questions. 57

VIII.      Comparative Analysis 59

  1. Mechanism Benefits and Challenges Comparison. 59
  2. Mechanisms’ Costs: Comparisons and Their Challenges. 64
  3. Consumer Costs. 65
  4. Mechanism Design Cost Impacts. 73
  5. Power Sector Carbon Dioxide Emissions and Mechanism Costs. 77
  6. Key Observations 79

Appendix A: Renewable and Clean Energy Target Estimation and Alternative Compliance Payments 81

  1. Forecast the Demand for Wholesale Electricity. 81
  2. RPS Target Percentages. 81
  3. RPS Target Energy Amounts. 83
  4. Alternative Compliance Payments. 86

 

List of Tables and Figures

Figure 1:  Relationship Between Market-Based Revenues and Resource Profitability. 10

Figure 2: Overview of Phases I and II. 10

Table A:  Overview of Phase I Scenarios and Assumption Details. 11

Table B: Overview of FCEM Scenario and Assumption Details. 12

Figure 3:  Illustration of RPS Mechanism.. 15

Figure 4:  Illustration of RPS Mechanism with Two Tiers. 17

Table C: Overview of State Clean Energy Standard Programs. 23

Figure 5: Illustration of CES Mechanism.. 24

Figure 6: Illustration of CES Mechanism with Two Tiers. 26

Figure 7: Illustration of Long-Term Contract Mechanism.. 32

Figure 8: Investment Risk, Energy Resources in a Capacity Market, and Attribute Values. 36

Figure 9:  New On-Shore Wind Resources’ “Missing Money” Estimates Across All Scenarios in 2025 and 2030  45

Figure 10:  Illustration of IMAPP FCEM Proposal’s Dynamic Attribute Valuation. 49

Table D:  IMAPP FCEM Attribute Components. 50

Table E: Overview of FCEM Scenario and Assumption Details. 51

Figure 11: Illustration of FCEM Mechanism.. 52

Table F:  FCEM Demand Bid Design Considerations. 54

Table G: Illustrative List of Mechanism Benefits and Challenges. 59

Table H:  New England State Experience with the Mechanism.. 62

Table I:  ISO-NE and Market Participants Experience with the Mechanism.. 62

Table J:  Mechanism Risk Considerations. 63

Figure 12:  Comparing Mechanism Costs: Apples, Oranges, and Bananas. 67

Figure 13:  Missing Money, Market Prices, and Customer Costs. 68

Figure 14: Scenarios and New Resource Assumptions. 70

Figure 15: Wholesale Energy and Capacity Costs Across All Scenarios. 71

Figure 16:  Energy, Capacity, and Representative Mechanism Costs Across Scenarios. 72

Figure 17:  Illustration of the Shift in Customer Costs from Markets to Mechanisms. 73

Figure 18:  Representative Mechanism Costs Across All Scenarios. 74

Figure 19: Range of Mechanism Cost Estimates. 76

Figure 20: Avoided Carbon Emissions and Mechanism Costs. 78

Figure 21: Total RPS Percentage Calculation. 82

Table K: Effective Regional RPS Under Current Law.. 82

Figure 22:  Expanded RPS Percentage Calculation. 83

Table L: 35-40 RPS Targets and Associated Energy Amounts. 84

Table M: 40-45 RPS Targets and Associated Energy Amounts. 84

Figure 23: Expanded RPS Scenarios – New Renewables Targets Calculation. 85

Table N:  35-40 RPS – New Renewable Energy Targets. 85

Table O: 40-45 RPS – New Renewable Energy Targets. 85

Table P: Expanded RPS Scenarios – New Renewable Energy Targets. 86

Table Q: Alternative Compliance Payments in New England. 87

Table R: Hypothetical Future Alternative Compliance Payments in New England. 88

Table S: Assumed Future ACP Values in the Study. 89

 

  1. Executive Summary

There are a variety of means by which states may choose to support meeting their renewable and clean energy requirements.  No one mechanism is inherently superior and directly comparing mechanisms is challenging.  Consideration of whether and to what extent one mechanism might better achieve a state’s objectives than another requires judgment and depends in large part on a state’s short-term and long-term specific objectives. This paper provides information about the factors a state should consider when weighing mechanism options and directional consumer cost implications. This paper is not an endorsement of, or judgment about, any particular mechanism or public policy and should not be interpreted as such. 

Specifically, this paper further analyzes the mechanisms NESCOE described in the Renewable and Clean Energy Scenario Analysis and Mechanisms 2.0 Study – Phase I: Scenario Analysis.  This paper, Phase II: Mechanisms Analysis, examines potential economic, regulatory, and market implications of mechanisms to support new and existing renewable and clean energy resources.  The mechanisms include (1) Renewable Portfolio Standards (“RPS”), (2) Clean Energy Standards (“CES”), (3) Long-Term Contracts, (4) Strategic Transmission Investments and (5) a Forward Clean Energy Market (“FCEM”).

The latter, an FCEM, is more a concept than a mature mechanism.  The concept emerged in New England stakeholder discussions about potential ways the region’s wholesale competitive markets might be harmonized with the requirements of state laws.  Unlike the others that fall under state jurisdiction, the FCEM would be administered by ISO-NE, and thus fall under the jurisdiction of the Federal Energy Regulatory Commission.  This paper seeks to facilitate consideration of the FCEM concept along with other options.  Because the FCEM is new and untested, NESCOE particularly welcomes comments, criticisms and alternative analysis that merit states’ consideration.

As noted, judgment about a particular mechanism requires a fact- and objective-specific assessment.  When assessing mechanisms, some questions a reader should consider include the following:

  • What quantity of resources are required?
  • How frequently will new resources be required?
  • Is diversity of resources important, such as resource size, type, operational characteristics, and/or location?
  • Is large-scale transmission required or desired?
  • In light of required volumes, does the mechanism maintain a competitive wholesale market that sends proper price signals to all resources to serve consumers at the lowest cost over the long-term?
  • What is the preferred placement of risk by and between resource developers and consumers?
  • How are jurisdictional issues weighed?

Against that backdrop, three of the mechanisms – the RPS, CES, and FCEM – would have similar costs if they had the same resource eligibility and quantity targets.  That is because these mechanisms pay all eligible resources the same price – the price of the most expensive eligible resource.

The Strategic Transmission Investment mechanism appears to cost less than the RPS, CES and FCEM because it places the cost of transmission in a bucket separate from the clean energy resource.  Consumers hold that bucket too, but the costs in it are separated from the clean energy resource’s bucket.

The Long-Term Contracts mechanism also appears, in this analysis, to be less expensive than the other mechanisms. That is because the Long-Term Contract mechanism pays each resource exactly the amount of the specific resource’s missing money where, as noted, the RPS, CES and FCEM pay all eligible resources the same amount equal to the price of the most expensive eligible resource.  The Long-Term Contract mechanism’s costs do not show, however, the costs of getting one or more assumptions wrong, the costs consumers would not pay if that (or other) resource’s costs drop over the contract term, or the missed opportunity for diversity in resources’ type, size, operating characteristics, costs and/or location.  The Analysis is based on assumptions,

many of which will turn out to be inaccurate with the passage of time.  In addition, the renewable and clean energy resource additions in Phase I were assumed, hypothetical future scenarios and may not necessarily represent actual future outcomes.

Perhaps the most significant factor influencing consumer costs is a state’s target quantity of renewable or clean energy.  Generally, the cost differences from mechanism to mechanism are smaller than the cost differences that result from adjusting state targets and the costs of resources capable of meeting state objectives.

  1. Introduction and Background

This paper describes an economic analysis of some of the possible incentive mechanisms states may wish to use to support meeting their renewable and clean energy requirements.  Specifically, it further analyzes the mechanisms NESCOE describes in the Renewable and Clean Energy Scenario Analysis and Mechanisms 2.0 Study – Phase I: Scenario Analysis (“Phase I”).[1]

The Phase II: Mechanisms Analysis (“Analysis”) follows the March 2017 Phase I Report.[2]  Phase I analyzed various future scenarios based on modeling conducted by London Economics International (“LEI”).  Building on Phase I, the Analysis examines potential economic, regulatory, and market implications of mechanisms to support new and existing renewable and clean energy resources.  The Analysis also explains the mechanics of various tools the states may use to achieve public policy requirements.

Various state laws require increasing levels of renewable and/or clean energy.  Other laws require specific reductions in carbon emissions.  As the requirements of state laws increases, the mechanisms states use to execute those laws are increasingly important.  These mechanisms have implications regarding consumer costs, the region’s electric resource mix, the competitive wholesale markets, the balance of risk between investors and consumers, and impacts on system reliability.

The Analysis focuses on the five mechanisms listed below.  There are others, such as the Regional Greenhouse Gas Initiative (“RGGI”), and various other requirements in states’ laws.  Some of the mechanisms examined in this paper have been used in New England. Some have been used in other regions.  One is a potential wholesale market mechanism that has been discussed preliminarily in the New England stakeholder process known as Integrating Markets and Public Policy (“IMAPP”).[3]

This paper begins with a discussion on each of the five mechanisms:

  1. Renewable Portfolio Standards (“RPS”)
  2. Clean Energy Standards (“CES”)
  3. Long-Term Contracts
  4. Strategic Transmission Investments
  5. Forward Clean Energy Market (“FCEM”)

Each of these sections describes the identified mechanisms that states could use to help meet the requirements of state laws. The Phase I and additional modeling results inform economic analysis and graphical illustrations for each mechanism. The illustrations show how the mechanisms work and the impact of certain design features.  Next, these sections identify and describe various economic and implementation issues associated with each mechanism, including components of each mechanism that provide benefits and present challenges.  For each mechanism, the paper identifies some questions for state consideration if a state wishes to implement such mechanism.  Finally, the paper makes broad comparisons across mechanisms and presents some observations for consideration.

 

This paper is not an endorsement of, or judgment about, any particular mechanism or public policy and should not be interpreted as such.  Any views that may be expressed in, or inferred from, this paper should not be construed as representing those of NESCOE, any NESCOE Manager, or any state agency or official.  While the paper draws on examples and research from outside the region, the scope of the paper pertains to New England.  The information provided is largely based on modeling and assumptions or drawn from publicly available reports and other documents.  The results are directionally indicative and are not a substitute for actual project costs that would be identified through competitive or market processes.  A reader should not make decisions based on the information in this paper without independent verification.

 

  1. Phase I Scenarios and “Missing Money”

Phase I, completed in 2017, analyzed various future scenarios based on modeling that LEI conducted. Phase I shows the potential implications of various hypothetical renewable and clean energy futures on existing and new resources in New England, and ultimately on the consumers who pay for them.  LEI analyzed New England wholesale electric energy and capacity market dynamics in two future years – 2025 and 2030 – under various hypothetical future market conditions that NESCOE defined.  LEI estimated the going-forward costs and future electricity market revenues for existing and new generation resources in New England with a focus on renewable and clean energy resources. Importantly, LEI estimated the amount of “missing money” for each resource type. In this paper, “missing money” means the amount by which a resource’s costs exceed its forecasted wholesale electricity market revenues. LEI also examined power sector air emissions under a range of future scenarios.

The concept of “missing money” is of central importance to this Analysis. “Missing money” is a substitute for resource profitability.[4]  In this analysis, a resource type that has “missing money” is less likely to be profitable on electricity market-based revenues alone.  The mechanisms discussed in this paper are different ways that eligible resources can recover “missing money” and become or remain profitable.

Phase I and the additional FCEM modeling presented in this paper provides “missing money” estimates for a range of hypothetical future scenarios with varying levels of renewable and clean energy resources. Phase II uses these “missing money” estimates to inform the mechanisms analysis.  Figure 1 below presents the calculation of “missing money” estimates.

Figure 1:  Relationship Between Market-Based Revenues and Resource Profitability

Phase II uses the Phase I modeling results and additional modeling results for an FCEM scenario to inform economic analysis and provide graphical illustrations that explain and compare each mechanism. The analysis in this paper is based on the scenario analysis assumptions.  Figure 2 below presents, at a high level, the ways in which the Phase I: Scenario Analysis and the Phase II: Mechanisms Analysis fit together.

Figure 2: Overview of Phases I and II

As a reminder, Table A below presents the Phase I hypothetical renewable and clean energy scenarios.  These scenarios (and the associated amounts of additional renewable and clean energy resource additions) directly influence the Phase I “missing money” estimates discussed throughout the paper.

Table A:  Overview of Phase I Scenarios and Assumption Details

Scenario 2025 2030
1: Expanded RPS 35%-40%
(“Expanded”)
+ 2,750 MW On-Shore Wind

(+2,400 MW HVDC)

+ 600 MW Solar PV

+1,500 MW Off-Shore Wind

 

+3,575 MW On-Shore Wind

(+2,400 MW HVDC)

+1,000 MW Solar PV

+2,000 MW Off-Shore Wind

2: More Aggressive RPS 40%-45% (“Aggressive”) +4,250 MW On-Shore Wind

(+3,600 MW HVDC)

+1,000 MW Solar PV

+2,000 MW Off-Shore Wind

 

+5,500 MW On-Shore Wind

(+3,600 MW HVDC)

+1,250 MW Solar PV

+2,500 MW Off-Shore Wind

3: Clean Energy Imports
(“Imports”)
+7,800 GWh Clean Energy

(+1,000 MW HVDC)

(90% Capacity Factor)

 

+7,800 GWh Clean Energy

(+1,000 MW HVDC)

(90% Capacity Factor)

4: Combined Renewable and Clean Energy (“Combined”) +4,250 MW On-Shore Wind

(+3,600 MW HVDC)

+1,000 MW Solar PV

+2,000 MW Off-Shore Wind

 

+7,800 GWh Clean Energy

(+1,000 MW HVDC)

 

+5,500 MW On-Shore Wind

(+3,600 MW HVDC)

+1,250 MW Solar PV

+2,500 MW Off-Shore Wind

 

+7,800 GWh Clean Energy

(+1,000 MW HVDC)

5: Nuclear Retirements
(“No Nuclear”)

 

 

Retire remaining nuclear resources by 2025;

Nuclear resources replaced by gas-fired resources

 

Retire remaining nuclear resources by 2025;

Nuclear resources replaced by gas-fired resources

6: Expanded RPS Without Transmission

(“No Transmission”)

+4,250 MW On-Shore Wind

(+3,600 MW HVDC)

+1,000 MW Solar PV

+2,000 MW Off-Shore Wind

 

+5,500 MW On-Shore Wind

(+3,600 MW HVDC)

+1,250 MW Solar PV

+2,500 MW Off-Shore Wind

 

 

  1. Phase II FCEM Scenario and Mechanisms

Building on Phase I, Phase II provides economic, regulatory, and market analysis of mechanisms to support new and existing renewable and clean energy resources needed to meet state requirements.  Phase II uses the Phase I modeling results and analysis of an FCEM scenario to explain the various mechanisms states could use to satisfy the requirements of state laws.  The analysis of an FCEM provides another scenario with an updated[5] renewable and clean energy supply outlook that meets the aggregated states’ hypothetical requirements.

The additional modeling for the FCEM is directly comparable to the Phase I modeling.  For example, this scenario used the same load forecast and natural gas price forecast as Phase I.  The difference is the supply of new renewable and clean energy resources, the prices and available quantities of which will be based on LEI’s updated outlook for these resources.  All other modeling assumptions will be the same as Phase I.

The FCEM has complex features, discussed further below in Section VII. This Analysis simplifies the FCEM mechanism to focus on the economics of the clean energy attribute. LEI performed computer modeling to examine the potential impacts of an FCEM.  LEI’s FCEM analysis included a supply outlook for eligible clean energy resources.[6]  All existing and new Class I RPS-eligible resources plus new imported hydropower were eligible for participation in the FCEM. LEI assumed demand for clean energy attributes in the LEI FCEM analysis equal to the Phase I analysis ‘More Aggressive RPS 40-45%’ scenario’s demand for renewable energy.  LEI combined all of these elements to project FCEM market participation and forecast the resulting resource mix.  LEI then forecasted prices in the FCEM and estimated consumer costs for an assumed level of demand for clean energy (the RPS 40-45 level of demand).

Table B: Overview of FCEM Scenario and Assumption Details

Scenario 2025 2030
Forward Clean Energy Market 40%-45% (“FCEM”) +7,875 GWh Clean Energy

(+1,000 MW HVDC)

(90% Capacity Factor)

 

+925 MW On-Shore Wind

+2,275 MW Solar PV

+3,550 MW On-Shore Wind

(+3,600 MW HVDC)

+7,875 GWh Clean Energy

(+1,000 MW HVDC)

(90% Capacity Factor)

 

+925 MW On-Shore Wind

+4,775 MW Solar PV

+4,050 MW On-Shore Wind

(+3,600 MW HVDC)

 

 

[See PDF for remainder of Document]

Document Source Citations

[1]           The Renewable and Clean Energy Scenario Analysis and Mechanisms 2.0 Study follows a December 2015 Whitepaper, Mechanisms to Support Public Policy Resources in the New England States
(2015 Mechanisms Whitepaper).  The 2015 Mechanisms Whitepaper identified a range of mechanisms, such as Renewable Portfolio Standards, clean energy standards, and long-term contracting, available to states to support resources capable of satisfying various objectives, such as the use of renewable fuels, carbon dioxide emissions reduction, supporting emerging technologies, and promoting fuel diversity. It described various mechanisms’ mechanics, as well their interaction with New England’s competitive wholesale markets and some legal and regulatory issues. See http://nescoe.com/wp-content/uploads/2015/12/PublicPolicyMechanisms_December2015.pdf.

[2]           Phases I and II of the Mechanisms 2.0 Study are intended to be complementary and, once completed, should be read in conjunction with one another. Phase I is available at http://nescoe.com/wp-content/uploads/2017/03/Mechanisms_PhaseI-ScenarioAnalysis_Winter2017.pdf.

[3]           The New England Power Pool’s (“NEPOOL”) IMAPP initiative examined the interaction between wholesale markets and state policy requirements.  Within the IMAPP process, ISO New England, New England states, market participants, and stakeholders explored potential solutions to address such interactions.  In general, potential solutions were categorized as either near-term “accommodate-style” proposals or longer-term “achieve-style” proposals.  For more information, see NEPOOL’s website, available at http://www.nepool.com/IMAPP.php.  NESCOE’s perspective on some other mechanisms discussed in the IMAPP context (e.g, carbon pricing and two-tier capacity pricing) is available at http://www.nepool.com/uploads/IMAPP_20170517_NESCOE_Memo_20170407.pdf and http://www.nepool.com/uploads/IMAPP_20161021_NESCOE_2Tiered_Pricing_Analysis.pdf.

[4]           “Missing money” is shorthand for costs exceeding revenues (i.e., not breaking even). Some resource types are projected to earn enough electricity market revenues to more than cover estimated costs (i.e., more than breaking even). Mathematically, resources whose revenues exceed costs would have ‘negative’ missing money (i.e., profits).  Separately, estimated costs for new resources are generally higher than existing resources’ costs.  For example, existing resources have much lower debt payments, compared to new resources.  Importantly, LEI also does not include equity returns or significant capital expenditures for existing resources, which further increases the cost difference between new and existing resources.

[5]           The Phase I Scenario Analysis assumed certain levels, types, and timing of renewable and clean energy resource development. The Base Case did not meet states’ collective RPS requirements due to LEI’s view on transmission system limitations inhibiting further development of resources in the interconnection queue in the summer of 2016.  The FCEM scenario includes LEI’s updated renewable and clean energy development outlook in proportion to states’ collective hypothetical requirements.

[6]           In contrast, the Phase I analysis assumed certain levels and types of new renewable resources would be developed.  The LEI FCEM analysis forecasts the resource types and offer prices based on an assumed level of demand.