What are Capacity Markets and would they have helped with the current electricity market crisis?
Capacity markets have been around for a long time in electricity markets around the world. The UK, Ireland, Spain and Sweden all run some mechanism for ensuring there is adequate capacity to meet demand, along with the PJM market in the USA, which serves 13 States, and here in Australia the Western Australia (WA) capacity market.
Though all capacity markets differ in the detail, they all have a regulator who determines the potential need into the future for additional generating capacity, and then runs some form of market tender or auction to try to meet the need for the capacity at lowest cost. Payments are made typically to new generators based on having the capacity available to be used if required. In this way it differs from the energy only market (as we have in Australia in the National Electricity Market or NEM), where payments to generators are only paid for energy actually produced.
Depending on the design of the capacity market, payments can also be made to allow existing generation to remain available, as well as for new generation to be brought into the system.
Importantly for our later discussion, capacity markets are generally concerned with capacity (MW) rather than energy (MW over time or MWh). The debate is almost always, do we have enough capacity to meet our likely peak loads? In Australia these almost always occur over hot summer evenings when people are arriving home after 40 plus degree days and turn on their air conditioning. The peaks are typically short-lived – a few hours only.
Over the years there has been much discussion about the effectiveness and the cost of capacity markets, especially in those markets that are operating one. Back in 2015 the WA Government reviewed their capacity market as, at the time, they were concerned that prices in WA were much higher than in the NEM which operates on the Eastern Seaboard of Australia. The WA capacity market was identified as a key reason for the price discrepancy, with regulators being conservative in estimates of future needs, resulting in overcapacity and higher bills for consumers. Ultimately it was a close run thing, but WA decided to remain with its capacity mechanism.
So are capacity markets a good thing? The jury is still out on this question. Many people like capacity markets because it allows an accountable centralised body to control the amount of supply in the system. There is a general acceptance that capacity markets increase costs as they encourage supply to be built, or maintained, that would otherwise not be built, however to supporters this extra cost is like insurance – a valuable product that prevents really high costs that can occur in an energy only market.
Those against capacity markets normally are concerned about decisions being made by conservative regulators, too much capacity being built and overly high costs. Other are opposed because they may see the mechanism being used to maintain old, polluting generators in the market.
Would a capacity mechanism have helped with the current electricity market crisis?
As a follow on to the unprecedented suspension of the electricity market a couple of weeks ago, the big main that the Australian Governments (Federal and State) came up with was to accelerate the development of a capacity market – long been promoted by the Electricity Security Board (ESB). This was proposed some years ago and was supported by the previous Federal Government, however a number of State Governments had opposed it at the time due to the recommended inclusion of all fuel types (including gas and coal) into the capacity market. The latest proposal only differs by allowing States to decide if they want to exclude some fuels such as coal and gas from the market.
To understand if a capacity market would have helped the current situation we need to understand a little more about what caused the scenario where we ended up suspending the market. First the problem was not a short term, high demand issue. Demand itself was well below any historical records. Nor was it caused by lack of supply (capacity). Much has been made by the amount of coal fired generation that was out of service, and yes this was high, but this is the time of year when, because demand is down, coal fired plant are often out on planned maintenance. There were more unplanned outages than expected but there was still plenty of other generation that was available.
The issue that we had leading into the crisis was a fuel price and availability issue. East coast high rainfall had led to flooding of some coal mines, reducing the coal supply to power stations as well as impacting on the quality of the coal to others.
At the same time both black coal and gas spot prices were at historically high prices. Coal generators looking to source alternative coal supplies were forced to pay spot prices, if they could get hold of coal at all, while gas generators who were trying to fill the gap left by coal were themselves faced with huge prices for gas.
Prices in the electricity wholesale market went to extraordinary levels – not just for an hour or two, but for days on end as the offers from the generators (not just gas and coal, but also hydro and battery offers) were pushed to levels that reflected the new fuel price and scarcity scenario.
An added complexity in the Australian electricity market is that it has a price cap set at $15,100/MWh and a cumulative price threshold (CPT) of $1,359,100 over a 7-day period (2106 trading intervals) in each State. Once the CPT is exceeded the market operator (AEMO) is obliged to reduce the market cap to $300/MWh and it remains in place as long as the CPT is exceeded. Not all energy only markets have these caps and, in my view, this is one of the key reasons why the market ended up being suspended.
With many generators forced by fuel prices to offer at well above $300/MWh, the CPT ended up being exceeded in all States in the NEM. Prices were capped at $300/MWh, however this left many generators losing money if they were running, so they did not offer their generation into the market, waiting instead to be directed by AEMO, as then there would be a mechanism for them to be compensated. AEMO got tired of trying to operate the market in this way and suspended it on the 15th June.
Returning to capacity markets and would having one have helped. I don’t believe so. Each year AEMO produces its Statement of Opportunities (ESOO) where it looks at the NEM over a 10 year period into the future. It considers changes in supply and demand and identifies potential capacity shortfalls. In the 2021 ESOO it concluded that there were “no reliability gaps forecast for the next five years”. Under a capacity market it is very likely that a regulator such as AEMO would determine requirements for additional capacity and, from their own analysis, none was required until around 2027-28!
Some may ask, how did AEMO get their forecast so wrong? They didn’t! AEMO’s modelling is based on capacity and as previously discussed capacity was not the main concern that drove this particular crisis. It was fuel – availability and price, caused by a number of domestic and international influences, many of which were not foreseen, that were the main drivers.
So what can we do now?
First we should be putting everything in place to maximise fuel supply and generation in the NEM. I would set up an emergency short term team to work with AEMO, generators, grid operators, and fuel suppliers to identify and remove any barriers to getting as much generation into the system as possible.
- If coal supplies are a problem, is there somewhere else we can source coal from and fix any delivery issues.
- If there are transmission constraints preventing energy getting to where it’s needed, is there any way to reduce the constraint short term?
- Is there new generation waiting on grid connection? Can we speed up the process?
- Are there back-up generators around the NEM that could be called on (and paid) to run?
- Are there any large loads that could be paid to reduce output during this time?
I would also look to modify the Rules which govern the electricity market to either get rid of price caps altogether or to enable them to be modified at times like these to reduce the chances of a CPT occurring and/or set the new cap, currently $300/MWh, to a level that would avoid generators having to be directed to operate.
Medium to long term, fuel availability needs to be as much a priority as capacity.
NZ also operates an energy only market like Australia. However it is fuel constrained, being 70% hydro generation and only having about 3 months of water storage from full to empty. NZ produces hydro minzones – graphs that show current water (read fuel) storage and superimposes critical levels where action is required to conserve energy.
Something similar could be useful in Australia especially as we move away from coal fired generation and rely more on other forms of stored energy. Gas is of particular concern as the main transition fuel – how do we make sure we have enough of it when we need it going forward?
