Capacity Payments – What You Need to Know

In many parts of the world today people expect electricity to be always available. Yet making electricity available on demand can be challenging to suppliers. One way they account for this is with capacity pricing. Your monthly capacity payments are determined by both the actual energy you consume (the kilowatt hours) and the amount of energy that needs to be available to serve your account based on your peak load kW demand. Read on for an overview of capacity pricing and how these capacity payments are determined.

Understanding Capacity Pricing

When a user seeks energy on demand, they do so regardless of time of day, location, or simultaneous requirements of other account users. Thus the supplier must produce electricity as needed. This despite the challenges of storing electricity and of planning for demand and supply on the transmission grid.

Related Article: Peak load Management Strategies

The capacity market exists to ensure there’s enough generation available to meet the grid’s peak load. Without the capacity market to incentivize investors to develop generating capacity where and when it’s needed most (e.g. a hot day in a highly constrained area such as NYC), we would have brown- and black-outs whenever the grid approaches peak levels.

Basically, a centralized generation/distribution grid is built to ensure reliability for a few hours of the year, with the cost spread out over the rest of the hours.

Understanding Capacity Payments

Capacity prices are determined differently in the seven regional grids, yet serve the same purpose: ensuring the regional transmission organizations or independent system operators will recoup the costs of guaranteeing supply for peak demand.

• ISO-NE
  ISO-NE oversees the Forward Capacity Market (FCM), which aims to attract new investment in resources, and maintain existing ones where and when they will be needed in the region. The ISO-NE also assesses the potential retirement of power plants and other changes to the system that could affect system needs.

The FCM works to procure enough capacity to meet anticipated demand for the next three years, compensate suppliers for the capacity cost of existing generation, import or demand resource, attract new resources to constrained regions, and penalize those who don’t provide enough capacity during a shortage event.

• NYISO
  NYISO capacity prices are determined by auction (six-month strip, monthly, spot) and bilateral transactions. For each capability period, the NYISO publishes a demand curve that reflects various requirements (installed reserve margin, locational minimum unforced capacity) which ultimately affect pricing for the period.

Capacity is priced on a $/kw-month basis with prices varying based on the amount of capacity generation bid into the market. Plant outages, maintenance, mothballing and more can impact the amount of capacity bid. As a result:
When there is more excess capacity is available beyond the minimum requirements the price lowers.
If the bid is low and closer to minimum requirements, then the pricing will be higher.

• PJM
  PJM’s capacity prices are determined by its Reliability Pricing Model, procuring capacity on a rolling three-year schedule.

The specific capacity price for an account is determined by the user’s peak load contribution (PLC). The PLC, which define the amount of capacity a supplier needs to procure the account monthly, are based on the user’s peak demand usage during PJM’s five Coincident Peak Hours from the previous June 1 through September 30 period.

The ratio between the capacity tag and annual kWh is a major determinant in the $/kWh of the capacity rate component of electricity pricing.

Download: Electricity Markets Explained Report for ISO-NE, NYISO, or PJM territories

How to Manage Capacity Costs

Annual capacity and transmission rates are set based on consumption during peak hours. A business might, as a result, act to curtail consumption during peak demand timeframes.  To see significant cost reductions, work with energy economics experts to make the best choices in terms of energy efficiency upgrades or other initiatives to lower electricity costs.

Download The Complete Guide to Peak Load Management to learn more about how you can manage your peak load contribution.