By Bob Fallon, Engleman Fallon, PLLC, rfallon@efenergylaw.com
As the Independent System Operator of New England (ISO-NE) searches for a new “market design to better address regional fuel security concerns,”[1] the ISO-NE should develop a fuel security program that directly incentivizes natural gas fired generators to enter into physical fuel supply arrangements during the peak winter period on a forward basis. Calpine Corporation proposed such a program at the Federal Energy Regulatory Commission’s (FERC’s) July 15th technical conference. Adopting a program such as that proposed by Calpine should be the ISO-NE and the Federal Energy Regulatory Commission’s (FERC) highest priority as it attempts to solve fuel security concerns in ISO-NE. [2]
Let’s first define the problem that is trying to be solved. With the exception of the Northeastern United States, “there no longer are shortages of natural gas supply”[3] in the United States thanks to the competitive natural market created by Congressional action deregulating the price of natural gas and FERC action providing for open access transportation service. In the Northeast, however, during the peak winter period, there may not be enough gas – even with imported liquefied natural gas (LNG) – to support the needs of (1) traditional home heating and industrial users served by local distribution companies and (2) the more recent addition of natural gas fired generators in ISO-NE.
The lack of incentives in the ISO-NE market for generators to enter into the longer-term agreements necessary to support new supplies is one reason for the current problem. When the ISO-NE recently asked itself “whether the ISO-administered wholesale electricity markets – which were not originally designed for the challenges just-in-time generation technologies have wrought – provide adequate financial incentives for resource owners to make additional investments in supply arrangements that would be cost-effective and benefit the power system at times of heightened risk”, the answer “in many situations [was] no.”[4] The ISO-NE explained that the lack of incentives was “logical enough”, i.e., that new investment imposes costs on generators but results in lower revenues to recover those costs.[5]
There are two primary approaches being discussed to solve for fuel security in ISO-NE. Calpine Corporation has proposed a fuel security program that directly incentivizes natural gas fired generators to enter into physical fuel supply arrangements during the peak winter period on a forward basis.[6] Under its proposed Forward Enhanced Reserves Market, market participants would bid to provide fuel for specific MWhs for the three winter months three years forward. As Calpine explained:
Calpine has been developing a new product, referred to as the Forward Enhanced Reserves Market (“FERM”) to better align a market design with the identified problem. FERM is designed to procure fuel-secure MWhs for three winter months three years prior to the obligation year. ISO-NE would qualify resources based on their ability to contract for stored fuel or readily use stored energy. Suppliers would submit offers into the auction for a minimum or maximum amount of MWhs they commit to offer from stored fuel during an ISO-NE defined “Operating Procedure 21 Energy Emergency Event” during the commitment period. Suppliers that clear the market would be given a FERM obligation which would require them to offer into the energy market and generate when dispatched during an Emergency Event. Failure to operate would subject FERM suppliers to penalty.[7]
The ISO-NE has proposed to address the reliability concerns associated with fuel security by creating “several new, voluntary ancillary services in the day-ahead market that provide, and compensate for, the flexibility of energy ‘on demand’ to manage uncertainties each operating day.”[8]
The ISO-NE and FERC should make as its highest priority the development of a program such as that proposed by Calpine. First, ISO-NE’s proposed new ancillary services program is another indirect approach to fuel security that has not worked. The ISO-NE has previously tried to address fuel security indirectly — as a potential by-product of another program — but not with a program directly related to obtaining additional fuel supplies. Take, for example, Pay for Performance, a program to help ensure that capacity was made available when needed. One of the anticipated by-products of Pay for Performance was that a generator would be incentivized to enter into longer term fuel arrangements for natural gas in order to ensure that it could provide capacity. The indirect approach has not worked because the incentives were not sufficient to cover the additional costs of a longer-term investment in natural gas. The ISO-NE did not provide evidence at the July 15th fuel security conference that another indirect approach — the proposed ancillary services program — would successfully incentivize long-term fuel security, i.e., obtain more fuel supplies.[9]
Second, the Calpine proposal is a direct approach to fuel security consistent with how additional natural gas supplies are obtained. The competitive natural gas and electric industries do not speculate on the future recovery of costs. Like any participant in a competitive market, these industries invest based on commitments over the long term that support the costs of investment. Thus, if the Northeast gas market and in turn the ISO-NE electric market is to obtain the additional natural gas supplies needed, the ISO-NE must put in place a program that directly incentivizes its natural gas generators to enter into fuel commitments over a longer term.
Third, a fuel security program such as that proposed by Calpine will allow the ISO-NE to address its fuel concerns three years in advance rather than addressing these issues the day before the problem is to occur. When it is 20 degrees below zero in Boston, that is no time to be seeking fuel supplies.
Fourth, the ISO-NE’s reasoning for delaying a program such as that proposed by Calpine is not persuasive. While ISO-NE has offered various reasons,[10] its primary reason seems to be that a forward fuel program must await a well-defined spot market to settle against. The ISO-NE has said:
Without a well-defined spot market to settle against, a fuel approach may require administrative (i.e., out-of-market) decisions about how/when to use the fuel and/or ad hoc penalties that are hard to align with a product’s market value.[11]
Presumably, though not specified, the well-defined spot market the ISO-NE is awaiting is the spot market created by its new proposed ancillary services options. For purposes of fuel security and the ultimate solution of additional gas supplies, however, the ISO-NE knows, on a historical basis, when fuel will be needed and the price for that fuel. The ISO-NE has not specified any other information it needs.
In conclusion, implementing a three-year forward program will unleash the competitive US natural gas market into the ISO-NE market. The competitive US gas market has eliminated shortages of natural gas supply in the United States outside of ISO-NE. If ISO-NE market participants are properly incentivized, the competitive natural gas market, along with global LNG, can eliminate shortages of natural gas in the ISO-NE.
[1] ISO New England Inc., 164 FERC ¶ 61,003 at P 2 (2018)
[2] While this paper addresses natural gas, the Calpine proposal is fuel type neutral and could include fuel oil as well as natural gas.
[3] Qualifying Facility Rates and Requirements, Docket No. RM19-15-000, 168 FERC ¶ 61,184 at P 19 (2019).
[4] Energy Security Improvements, ISO Discussion Paper issued April 2019 – Version 1 at 2-3 (“Energy Security Discussion Paper.”)
[5] Id., at-3. (“The root cause is logical enough. Making these discrete investments, if they meaningfully reduce the risk of electricity supply shortages (and therefore the risk of high prices), entails up-front costs to the generator – yet reduce the energy market price the generator receives. The value that society places on making the supplemental supply arrangement is based on the high price it avoids with the investment. However, the value the generator places on the same arrangement is based on the lower price it receives in the energy market with the investment. This value difference, in turn, results in a divergence between the social and private benefit of the investment – a situation we call a misaligned incentives problem.”)
[6] Statement of Brett Kruse, Vice President of Market Design Calpine Corporation July 15, 2019 Staff-Led Public Meeting, filed July 17, 2019 in Docket No. EL18-182 https://www.iso-ne.com/static-assets/documents/2019/09/a2_e_2_calpine_presentation_ferm.pdf
[7] Id. at 4.
[8] Energy Security Discussion Paper at 5.
[9] At the July 15, 2019 Staff-Led Public Meeting, the ISO-NE said that it was studying whether the ancillary services solution would change generator fuel procurement practices. See webcast of July 15th conference available at 2:19:57 to 2:21:12, available at http://ferc.capitolconnection.org/071519/fercarchive_flv.htm.
[10] See Memo from ISO-New England to NEPOOL Markets Committee, August 30, 2019, outlining four main concerns with the Calpine FERM proposal.
1. FERM substitutes administrative procedures and ad hoc penalties in place of a sound spot market.
2. Establishing a demand for fuel inputs will be challenging.
3. Valuing fuel, rather than electrical services, is unlikely to encourage cost-effective or innovative solutions to meet the region’s reliability objectives.
4. Practically, there is significant administrative complexity yet to be addressed or explained (e.g., rules for validating contract terms, approving fuel delivery and storage types, measuring delivery on the forward obligation, etc.).
Without addressing each individual ISO-NE concern, all market design issues in an ISO involve “significant administrative complexity,” etc. For example, the ISO-NE’s proposed new ancillary services will involve the development of a “strike price”, “a new concept in the ISO’s energy and ancillary service markets.” Energy Security Discussion Paper at 61. The strike price will be a pre-defined value equal to the “expected value of price of the underlying good, in this case the real-time LMP for the hour(s) at which the option will be settled.” Id. at 62. Because this value will be one of the primary drivers of payment for the new ancillary services, questions will undoubtedly arise as to what administrative method should be used to set the strike price. The ISO-NE has suggested using “a several-day forward price, that will tend to reflect LMPs [locational marginal prices] on the relevant delivery day.” Id. at 63. The issue, of course, is whether the new ancillary services will (i) provide the revenues required to enter into the long-term fuel commitments necessary to increase current supplies or (ii) exacerbate the existing fuel problem as generators scramble to obtain more of the existing (and limited) supplies in the spot market in order to provide the new ancillary service. In the end, the ISO-NE has a fuel problem and a solution to a fuel problem must involve fuel. Calpine has proposed a fuel solution to a fuel problem.
[11] Energy Security Improvements: Long-Forward Design, Discussion of the framework for developing a forward component to the ESI design, ISO-New England, September 3-4, 2019