An important difference between regulated and deregulated generation is that the revenues received by generators in a regulated market are tied to actual costs. In a deregulated market, a large part of the net revenue earned above the operating costs is fungible and does not necessarily go toward the capital costs of generating capacity in a particular region. In a regulated market, customers know what they are paying for. This is no longer the case in a deregulated market and a sizable portion of the bill a customer pays for generation may, in fact, be transferred to another region or another country or another industry within the structure of a given holding company. Given the complexity and the rapid changes of the structure of many companies that now own power plants, it is extremely difficult to determine exactly where this money goes.
Of particular concern is the lack of the NYISO capacity markets to stimulate merchant power companies to build new power plants:
Hundreds of millions of dollars are being paid through the capacity market to the owners of installed generating capacity to supplement their earnings in the wholesale market. The main accomplishment of these extra payments is to increase the market value of existing generating capacity. There is no obligation placed on generators to build new capacity when and where it is needed. The NERC report on reliability discussed earlier shows that projected capacity margins above the peak loads are falling in all deregulated regions. Delays by investors in their commitment to build new generating capacity are developing into a serious national problem. The overall conclusion is that the current performance of deregulated electricity markets is poor in terms of ensuring that there is enough installed generating capacity to meet projected loads reliably. This is true even though substantial payments have been made to generators through capacity markets to supplement their earnings in the wholesale market.
As a result of the reliance on market forces, the spare capacity needed to maintain reliable service is shrinking:
In the 2004 report, the forecasted reserve margin was always above the 18% needed to meet the reliability standard up to the end of the forecast period in 2013. However, in the 2005 report and the 2006 report, the forecasted reserve margins fall below the 18% standard by 2008.
The reason for the recent drop in the forecasted reserve margins is that there have been delays in the construction of new generating units even though they have been issued construction licenses. The lists of new generating units are essentially the same in the different reports, but the proposed in-service dates are quite different. In 2004, nine generating projects, with a total capacity of 2,038 MW, were under construction. This was two-thirds of the total of 3,120 MW approved. Another 1,605 MW had applications pending. In 2005, the amount of capacity under construction was still 2,038 MW, but none of the other projects had proposed in-service dates. The important implication is that it is no longer realistic in a typical deregulated market to assume that a generating unit will be built after regulators have approved a license for construction. This was typically not the case under regulation. In a deregulated market, merchant generators have no obligation to complete projects if the prospects for recovering capital costs deteriorate during the construction process.
The problem is most acute in the New York City area:
Given the age and low ACF of many existing generating units in NYC, some of these units are scheduled for retirement in the near future. Combining this situation with the current reluctance of investors to build new generating capacity33, the most important region to consider at this time is the LICAP market in NYC. The basic questions are: 1) how much money is paid to generators in NYC, and 2) is this amount enough to finance the investment needed to maintain generation adequacy? The answers imply that the LICAP market in NYC is an example of how a capacity market can be expensive for customers and still not provide an effective way to maintain generation adequacy. This is true even though the state regulators designed the LICAP market specifically to deal with the issue of generation adequacy.
While claiming to rely on market forces, New York has relied on stop gap measures, and called upon publicly owned utilities and Con Edison to effectuate construction of most of the new power plants built in the past decade:
[T]he larger incumbent firms can exploit the LICAP market given the pattern of ownership of generating capacity in NYC. In spite of the fact that the cost of the LICAP market is very high, investors have not stepped forward to build new generating capacity and in 2006 the regulators had to resort to ad hoc ways to meet reliability standards for 2008 in NYC.
The amount already wasted on capacity payments to existing power plant owners to induce a market response totals billions of dollars, and would have been enough to build the needed new power plants:
Even though steps have been taken to deal with the projected shortfall, this does not change the overall conclusion that the LICAP market has been an expensive and an ineffective way to maintain generation adequacy. In 2005 and 2006, customers paid over $1 billion/year in the LICAP market in NYC and merchant investors were still reluctant to commit to specific in-service dates for new generating units that have already received licenses for construction. This amount of money is enough to finance over 12,000 MW of new peaking capacity at a capital cost of $80/kW/Year (from Table A1 in the Appendix), and this amount of additional capacity would more than double the installed generating capacity in NYC.
At this point, it is likely that New York City or state agencies will need to be more proactive before it is too late and reliability is sacrificed. In 1996, when it envisioned the current system of market reliance, the PSC refused an effort of Enron to reduce the reliability reserve margin, saying reliability is paramount. Last year, the PSC lowered the capacity reserve margin deemed necessary for reliability from 18% to 16.5%. This reduction had the effect of extending the time limit for construction of new plants needed to maintain reliability. The PSC reduction was made on the recommendation of the New York Reliability Council, after a divided vote with several members voting against the reduction.