The following is a contributed article by Joseph Cavicchi, vice president, and Charles Wu, manager, at Analysis Group. The views presented in this article are those of the authors and do not necessarily reflect those of Analysis Group, its affiliates or its clients.
Is the Federal Energy Regulatory Commission experimenting with how an essential component of capacity market reform is determined? It would seem so, based on their decision to adopt two different electricity capacity accreditation approaches: one for the New York Independent System Operator and another for the PJM Interconnection. Why would they do this and what impact will this have on renewable project development?
The fundamental question is this: If a developer is planning to build a 100 MW renewable project, how many MW can it sell as capacity? This “capacity accreditation” problem is directly related to market reforms and FERC’s decision to accept two fundamentally different methods to calculate the answer is certain to cause frustration across the industry.
In particular, the selection of an “average” or “marginal” capacity accreditation framework is at the heart of each regional transmission organization's newly developed accreditation protocols. The stakes are high: as more intermittent resources enter markets, the quantity procured and capacity payments will depend on each market’s specific capacity accreditation rules. In addition, the long-term impact of the accreditation approach on resource mix and consumers must also be considered. While FERC has stated that “there is no single ‘correct’ method” of calculating capacity accreditation, economic principles underlying capacity market design should be taken into account as the cost and system resource mixture over the long-run can be expected to be different.
The heart of the debate: Average versus marginal ELCC
For decades, capacity accreditation frameworks based on the historical performance of dispatchable resources, such as Equivalent Forced Outage Rate Demand, orEFORd derating, were used to set capacity market quantities. However, the ongoing growth in intermittent resource capacity requires that such capacity accreditation protocols be updated. Effective Load Carrying Capability, or ELCC, based on statistical modeling is the most widely accepted approach for accounting for capacity resource intermittency.
ELCC modeling can capture the impact of uncertain weather patterns, including wind and sun, on projected intermittent resources’ output, as well as the complementarities, or lack thereof, between different types of intermittent resources in different geographic locations — the diversity benefits. However, ELCC can be calculated using different approaches, and ELCC capacity accreditation quantities can vary considerably depending upon the structure of the analysis.
An ELCC analysis can be used to estimate either the average or marginal capacity accreditation of intermittent resources. Roughly speaking, average ELCC is estimated by calculating the expected reliable capacity of a type or class of intermittent resources (such as wind or solar) together. An average ELCC analysis produces a total ELCC for a portfolio of resources. Capacity accreditation amounts must then be allocated to individual resources after determining the average contribution of the resource portfolio as a whole. This allocation procedure must also be seen as equitable by resource owners.
An ELCC analysis can also be used to calculate the marginal ELCC associated with the addition of individual intermittent resources. Thus, a marginal capacity accreditation process provides the prospect for an orderly measurement of intermittent resource capacity accreditation. Each added resource is measured relative to all other intermittent resources that were added ahead of it. The figure below shows a simplified explanation of the historical, average ELCC, and marginal ELCC capacity accreditation methods applied to an example with a wind-powered new entrant. Of course, RTOs may choose approaches that are hybrids or modifications of the simplified methods described here.
Due to the relationship of the output profiles of solar and wind resources and system loads, both average and marginal capacity accreditation values decline as a greater number of intermittent resources are added to the power system, all else equal (if storage does not also grow at the same time). However, because marginal accreditation values decline more quickly than average accreditation values, the sum of all individual intermittent resource capacity marginal accreditation quantities is less than the total average capacity accreditation of all resources combined. Thus, the total reliability benefit for a portfolio of intermittent resources is measured using the average approach, but independent system operator/RTO capacity market prices are set by the marginal cost of meeting reliability objectives. Regulators and policymakers are therefore faced with the emerging importance of disentangling how average and marginal ELCC accreditations affect ISO/RTO capacity markets.
Marginal versus average accreditation in centralized capacity markets: NYISO v. PJM
At this point, FERC has not taken a strong stance on the marginal vs average ELCC debate, and instead has approved both approaches, in the neighboring RTOs of NYISO and PJM. PJM’s “Adjusted Class Average” approach was approved by FERC in 2021, and NYISO’s “Marginal Capacity Accreditation” approach was approved by FERC in May 2022.
NYISO proposes to calculate the marginal ELCC of intermittent resource capacity by location and resource class such as wind, solar, hydro, storage or combinations thereof. NYISO will then use these marginal resource accreditation contributions along with unit derating factors to define individual resources’ unforced capacity, or UCAP, quantities. NYISO capacity market sellers’ auction offer quantities are capped at resources’ UCAPs.
In contrast, PJM’s rules use an average, or portfolio, ELCC methodology to determine intermittent resource capacity accreditation quantities. PJM categorizes “ELCC resources” as intermittent, limited duration, or combination resources. PJM calculates the reliability contribution of all ELCC Resources as a portfolio, then class-level ELCC for wind, solar, etc. separately to capture resource diversity benefits — PJM refers to these results as “adjusted class averages.” Ultimately, PJM assigns capacity accreditation values to individual resources based on class-level results and resource performance, and the total of each of the individual resource values equals the average capacity contribution of all ELCC resources.
FERC’s decision to adopt different accreditation approaches for NYISO and PJM promises to be controversial. In its latest order for New York, FERC has set a precedent that both marginal and average accreditation approaches can be designed to be just and reasonable and not unduly discriminatory. In doing so, they have effectively opened the door for individual RTOs to experiment with different accreditation approaches based on local circumstances.
What does marginal versus average accreditation mean in the real world?
Central to the marginal versus average ELCC debate is the concern that the use of a marginal approach under-accredits intermittent/energy-limited resources and does not capture resources’ diversity benefits. However, the debate between the two accreditation approaches is more appropriately characterized as an assessment of which approach leads to the most efficient, least-cost mixture of capacity resources over the long-run. The following observations help illuminate this distinction in the context of ISO/RTO centralized capacity market designs:
- The key difference between average and marginal accreditation approaches will be the quantities accredited to the different resource classes and individual resources used in the capacity auctions. As a result, the resulting capacity resource mixture incentivized by the market over the long-run can be expected to be different. The two approaches lead to different speeds for signaling market saturation for specific resource classes. Critics of marginal accreditation approaches have argued that accredited quantities for intermittent resources may decline precipitously relative to previously expected values from year to year, while critics of average accreditation approaches argue that it may encourage overinvestment in resources that have already saturated the market.
- Differences between marginal and average accreditation approaches for the purposes of capacity market compensation do not necessarily translate to differences in calculations of resource contributions to resource adequacy or calculations of system reserve requirements. For example, NYISO proposes to use marginal capacity accreditation for intermittent resources’ offers into capacity auctions, but use estimated average resource production for the resources’ overall contribution to meeting system reliability requirements or installed reserve margin. Potomac Economics’ analysis shows that NYISO’s marginal accreditation proposal results in an installed reserve margin that is comparable to the value calculated using an average accreditation approach. Therefore, adopting one accreditation approach or the other does not necessarily change the amount of steel in the ground needed to ensure power system reliability.
Capacity market designs are based on the well-known economic principle that consumer costs are minimized and efficiency is maximized when market clearing prices equate marginal cost with marginal value of reliability. Capacity resources make capacity market offers based on the marginal cost of supplying capacity. Capacity market clearing prices are set where resource marginal costs and the marginal capacity value to consumers are equalized. A marginal capacity accreditation approach is consistent with the economic principles that form the foundation of capacity market designs.
Moreover, the relevance of state supported resource procurements can be expected to decline over the long-run, while the outcomes of centralized capacity market auctions will continue to be important. Inconsistencies between market design principles and policy objectives can undermine the importance of ensuring capacity market prices guide investors’ long-term exit and entry decisions. The stage is set for a vigorous debate focused on whether a marginal accreditation approach is consistent with the economic principles of capacity market design.