This week's #energytwitter nerd thread: Are capacity markets useful? (You can tell we're close to an election when I pick such a popular topic that is driving the national zeitgeist.) Thread: https://twitter.com/SeanCasten/status/1293905402686574592

1/ First, I should note that - unlike prior #nerdthreads - I'm not confident of my own intuition on this one. So I'm posting as much to explain the issue as to see if any of you have great insights.

2/ For the uninitiated, here's the basic issue: electricity markets (mostly) sell energy and capacity. If you imagine an electric grid as a pipe full of water, energy is the total gallons you buy. Capacity is the maximum gallons/minute you can access.

3/ When power markets were deregulated in the 1990s, there was an idea that if we set a real-time spot price for energy ($/MWh), driven by supply and demand, we would incentivize lowest cost suppliers to produce more often, driving down the price of energy for consumers.

4/ That idea proved to be hugely successful and accurate. The nuclear fleet went from 60% -> 90% annual load factor. We built 200 GW of high efficiency combined cycle gas turbines. Power prices fell. (And CO2/MWh fell because cheap energy = clean energy.)

5/ But that wasn't enough. Because you don't only want cheap energy. You also want to know that when you turn on the lights, there is some generator, somewhere that can suddenly ramp up to meet that added load. That's capacity.

6/ That market, which prices in $/MW (or, per our prior analogy, $/gallon-per-minute of available supply) pays you not for how much you generate, but for how much you have available to generate at any given time.

7/ So as those markets were developed (excluding Texas), they set up spot prices for energy ($/MWh) and capacity ($/MW). One pays you to generate, the other one pays you for the peak you have the potential to generate.

8/ To be clear, you have to be able to meet that peak as well, and markets have tests to ensure you can actually deliver that power on a moment's notice or else you can't get paid.

9/ But the key point is that you can't sell into energy markets unless you have a generator that is generating. And you can't sell into capacity markets unless you have a generator that can be counted on to deliver some number of demonstrable MW when called.

10/ Now to the tricky question: did capacity markets work?

11/ From personal experience, I built a small cogen project in Vermont after ISO-NE created their Forward Capacity Market that never would have penciled with out it. So anecdotally, I know of an increase in capacity that only came about because of capacity markets.

12/ But - as our illustrious Speaker likes to remind us - "the plural of "anecdote" is not "data". And I'm not sure my experience is globally true.

13/ Here's the problem. If I want to build a new power plant I have to design it, finance it, permit it, build it and commission it. At best that's a 2 year process. More like 3 - 5. But I have no idea what capacity prices are going to be that far in the future.

14/ By contrast, if I want to run an existing plant *a little bit harder* tomorrow, I know exactly what revenue I'll earn for each additional unit of output.

15/ That means that for capacity markets to *work* they have to factor in all the construction starts, handicap for load growth and a lot of other variables and then a bunch of independent actors need to factor that in to gradually ramp up the $/MW price.

16/ That's a beautiful theory. But can you point to ANY market that factored in supply/demand balances 5 years in the future and got it right? Especially for capital intensive, low margin industries like electricity? I can't think of any.

17/ Which effectively means that - at worst - capacity markets are a gigantic experiment that will either yield gradual ramps in price and asset allocation or a sudden step function that leads to regional blackouts.

18/ And - at best - they are functionally irrelevant because generation investors and consumers know they don't work and the real game is all in the energy market (and a host of other legacy market inefficiencies). This latter view is basically the ERCOT model.

19/ I don't know which view is right. But I do know that by the time we know for certain it will be too late to change course. And that there are VERY different approaches to this question being taken by different parts of the US electric grid.

20/ Which leaves me with a bigger question: can you name ANY industry that was (a) capital-intensive and (b) sold a low-margin, commodity product that made sufficient investments to meet demand subject only to pure free-market incentives?

21/ Because that's the underlying premise of capacity markets (at least when stapled to full deregulation). If there are examples, what can we learn from them. If not, what do we learn from that?

22/ I don't know the answer to that. But I wish I did. And hopefully some one will point me to some thoughtful person who's settled this once and for all. Until then, I leave you with Lloyd Dobler. /fin