V. Discussion
Q 14: You noted that in the September 2014 Order, the Commission expressed a preference for a market-based solution to this problem. Please describe what in general constitutes a “market-based” approach to a procurement problem.
A market-based approach would be one that is structured to define a product or service, and then allow eligible entities to compete to provide the product or service. The purpose of this approach would be to achieve some of the potential benefits of markets. The alternative to a market-based approach could be bilateral or “out of market” procurement, in which the ISO as buyer might purchase from individual sellers or groups of sellers based on prices set through negotiation or through administrative calculations.
Q 15: In general, are market-based approaches to be preferred, and if so, why?
Market-based approaches in general are preferred under circumstances where they can achieve the short-term and/or longer-term benefits of competition. In the short term, a market-based approach can achieve efficient production and consumption reflecting the marginal cost of production. The sellers with the lowest marginal costs are selected to satisfy the demand; and a price is set that generally reflects the marginal cost. Over the longer term, a market-based approach can lead to efficient exit and entry resulting again in efficient production and consumption from the long-term perspective. Prices over time reflect the full incremental cost of production and the most efficient producers are in the market.
Q 16: Under what circumstances can market-based approaches be applied effectively?
To use a market-based approach, the product must be clearly defined so that sellers know exactly what they must provide and can determine their cost to provide the product. Then sellers can compete based on price to provide the product. This requires defining a single product (or perhaps a small number of products), or at least defining how different product attributes will be valued for the purpose of selecting among competing providers. In addition, there must be multiple potential sellers of the product for a market-based approach to achieve some degree of competition and be worthwhile.
Q 17: Would you characterize the ISO’s Forward Capacity Market construct as a market-based approach?
Under FCM, the FCA auctions are held to acquire commitments from multiple potential providers to provide capacity under well-defined CSOs. This is a market-based approach.
Q 18: Is the specific problem that is addressed by the Winter Reliability Program one to which a market-based approach can effectively be applied?
As described earlier, the problem here is that the ISO has come to believe that the CSOs resulting from earlier FCAs, in combination with the ISO’s energy and ancillary services markets, may not provide certain types of resources sufficient incentive to make fuel arrangements to the extent the ISO would like. The Winter Reliability Program, in essence, identifies a few “holes in the FCM fence”, and attempts to patch those holes until the longer-term market-based solution (as part of the PfP reforms) can be implemented.
Q 19: Would a market-based approach be as effective as the most recent Winter Reliability Program for addressing the ISO’s concern about fuel assurance?
A market-based approach would be less effective. To use a market-based approach, it would be necessary to define a standard service and to allow sellers to make offers to provide the service. Depending upon how the service is defined and the associated penalties, this approach might not attract as much participation as the most recent Winter Reliability Program, or might not provide sufficient incentives for additional fuel arrangements. Thus, this approach might not achieve fuel assurance to the extent the most recent Winter Reliability Program Or, if the service imposes substantial obligations and penalties, it might achieve the same level of fuel assurance, but only at a much higher cost. The ISO has also noted that a market-based approach would likely be less effective.[11]
Q 20: You also noted that the Commission expressed support for making the program more resource-neutral. As a general matter, do you agree that the ISO should strive for its market design elements to be resource neutral?
Yes, as a general matter, market design elements that are resource neutral are preferred, despite the complexity that inevitably is introduced by attempting to accommodate very different resource types.
There are two principal reasons why, in general, we should strive for resource neutrality. First, markets will be most competitive and efficient when they are open to the broadest participation possible. Markets that are only open to certain types of resources will generally be less competitive, and result in higher prices, than markets for which the product definition and eligibility requirements have been designed to accommodate a broader group of resource types.
Second, when market design elements are crafted in a more resource-neutral manner, they are more likely to avoid potentially unfair or discriminatory treatment of some resource types. This can be a difficult challenge, because different resource types have different characteristics which ultimately may be of some commercial significance. For instance, in most contexts, it is not appropriate to overlook that some resource types are intermittent, or that some have slower ramp rates, than others.
Q 21: Is resource neutrality an appropriate objective in the context of the Winter Reliability Program?
In pursuing the objective of the program – to encourage incremental winter capacity – it is appropriate to strive for resource neutrality. In this regard, from the original concern about oil storage, the program was extended to compensate unused LNG contractual amounts, and to encourage incremental demand response.
Q 22: Should the Winter Reliability Program be defined in a more resource-neutral manner to extend its compensation to additional resource types, even if the additional resources are not expected to provide incremental capacity?
Extending payments to additional resources that are not expected to provide incremental capacity would be contrary to what should be the objective of the program, as stated by the ISO last year (quoted above: “ Ensure generator winter fuel inventories… are sufficient … where/when they might not otherwise be…”), and as recognized by the Commission in accepting the most recent program:[12]
- We also reject arguments that, because the Winter Reliability Program does not pay all resources for providing firm fuel service, it is unduly discriminatory. The Program is designed to help ensure fuel adequacy by creating incentives for resources to procure more fuel than they would have procured in the absence of the Program. Given this objective, we find that ISO-NE reasonably limited participation in the Program to market participants that ISO-NE, as the system operator responsible for ensuring reliability in the region, determined will procure additional fuel ahead of winter as a result of payments through the Program. For instance, ISO-NE explained that identifying incremental fuel requirements for hydro or nuclear resources is challenging because those resources typically have low-cost fuels or extended fuel supplies. Thus, it would not be appropriate to make separate payments intended to incent resources to make the same fuel procurement decisions they would have made, and been compensated for, absent the Program. To the extent that the Program is not entirely fuel-neutral, we expect that a long-term market-based solution should address these concerns in the future. [citations omitted, emphasis added]
More recently, ISO-NE stated that the narrow program objective would still be to compensate generators for adopting ISO-NE’s rather than their own estimates of fuel needed at the beginning of the winter.[13] It would be inconsistent and inappropriate to extend compensation under the Winter Reliability Program to additional resources not expected to provide incremental capacity as a result.