How capacity payments work

Energy efficiency and demand response are paid for via something called the Forward Capacity Market, an auction run by ISO-New England at which generators and others bid on electricity production three years from now.

Basically, ISO-New England predicts how much electricity will be needed at peak usage, and auction participants say, “I guarantee to be able to provide X amount of power in three years” or “I guarantee to be able to reduce my power consumption by X amount in three years.” A price per kilowatt-month is reached via the auction, and participants receive guaranteed monthly capacity payments that are separate from any payments for power produced.

(“Use less” or “make more” – when it comes to electricity, are those the same?)

The guarantees for long-term efficiency measures and demand-response, which is a promise to use less electricity on a moment’s notice if problems arise, are made by large companies like Wal-Mart, or by companies like EnerNOC that aggregate promises from many firms.

Think of capacity payments as a reward or insurance premium for creating and maintaining a system that we can depend on in three years, even though you’re not sure that daily market forces three years from now would justify the expense.

They are non-trivial: Seabrook Station, for example, picked up a capacity payment of $45 million, rising to $128 million by 2018. But then again, building and maintaining a power plant is a non-trivial task, too.

This clumsy-sounding system exists because it’s really expensive to create large new power sources, and it takes a long time. (Distributed solar power is changing that, but hasn’t had much effect yet.)

Electricity is so important that we haven’t wanted to depend on traditional market forces to create the supply, because it might send prices skyrocketing or cut off electricity to an area if there aren’t enough profits there; the capacity markets are one way to create a sort of semi-market to help set prices without leaving us in the dark.

There are big questions about how this system works, and the biggest is currently at the U.S. Supreme Court. The court is considering whether to support a decision by FERC, the federal body that oversees electricity production, that allows bodies like ISO-New England to add demand response to wholesale energy markets, which are similar to the capacity market but handle actual energy production rather than overall ability to produce.

The legal argument is dense, concerning what is a retail market, regulated by states, and what is a wholesale market, regulated by the federal government. If the court overturns the FERC decision, questions would arise about the whole capacity market auction, not just in New Hampshire but everywhere. Oral arguments were heard in October and a ruling is expected next year.