United States: Enhancing The Efficiency Of Resource Adequacy Planning And Procurements In The Midcontinent ISO Footprint

Executive Summary

We have been asked by NRG, an independent power producer (IPP), to evaluate options for achieving resource adequacy more efficiently in the Midcontinent Independent System Operator (MISO) footprint. NRG is concerned that MISO's current non-forward capacity construct and utilities' procurement practices do not adequately recognize the value of IPPs' resources even when they cost less than utility-planned projects.

We are similarly concerned about the current resource adequacy construct and planning practices within MISO, but from a resource adequacy and total cost perspective. The MISO centralized resource adequacy construct is not likely to support sufficient market-based investment to meet the capacity needs of retail choice states, due to the mechanism's reliance on a non-forward auction with a vertical demand "curve" and a relatively low price cap. We anticipate that this design will not produce prices high enough to attract merchant generation investments until reliability is unacceptably low. Further, the lack of forward visibility means that the shortage might not be identified until it is too late to address through administrative intervention. Any resulting shortages for retail choice customers could impair reliability of the local zone (and possibly all of MISO unless traditionally regulated states maintain sufficient excess capacity).

Most of the MISO system is traditionally regulated, with utilities planning sufficient supply to meet their own needs. Thus, regulated utilities do not face the same under-investment challenges as retail choice states. However, utility planning is hindered by a lack of transparent information about neighboring utilities' commitments, regional supply and demand, and transmission availability. Resulting plans could end up being resource-inadequate if they have counted on procuring resources and using transmission that turns out to be unavailable. To avoid this possibility, utilities may plan conservatively, without relying on resources that they do not own or that are remote. But such uncoordinated planning can come at the expense of economic efficiency. Utilities may incur extra costs by investing in retrofits or new generation without comparing to a transparent forward capacity price (no such price yet exists in MISO) and without conducting competitive solicitations to see whether lower-cost alternatives are available from IPPs or neighboring utilities.

To address these concerns, we propose a set of possible solutions at both the regional MISO level and at the regulated state and utility levels. The solutions we propose recognize the predominance of regulated states in MISO, with only a minority of states relying on unregulated merchant investment under retail choice. We recognize that any enhancements to traditional mechanisms need to maintain the regulated states' ability to oversee utility resource planning decisions while ensuring that these decisions are cost effective, support state policy objectives, and complement MISO mechanisms. Thus, we do not consider the mandatory forward capacity market approach that we have found to be effective in largely restructured regions. We recognize that regulated states do not want to be required to participate in centralized capacity auctions. Their biggest concern appears to be the risk that state-approved resources might not clear in the auctions and thus might not be counted toward capacity obligations. Such an outcome would undermine state and utility planning processes designed to meet resource adequacy needs and other policy objectives.

At the MISO regional level, we identify three complementary options to increase forward capacity transparency to inform planning for regulated customers and to support merchant investment for retail choice customers:

At the state and regulated utility level, we recommend more fully incorporating "market tests" into resource planning, particularly to test the timing and cost-effectiveness of major investments against market alternatives. Such market tests would either confirm the cost effectiveness of a resource plan, or else identify alternative ways to meet resource adequacy needs and other policy objectives more cost-effectively.

In its most simplified form, a market test would compare the levelized investment costs (minus net energy value) of proposed utility generation investments against a transparent forward capacity price. Currently, transparent prices are only available from MISO's centralized nonforward auctions, and little capacity pricing information is available one or more years forward. We therefore recommend that utilities compile market data on capacity prices by either: (a) gathering quotes from third-party brokers with visibility into bilateral bids or offers several years into the future; or (b) regularly procuring or selling at least small quantities of the standard capacity product for up to five or more years forward. (We do not recommend relying solely on simulated or estimated capacity price projections without real market information.) Such improved capacity pricing data would help utilities and commissions better evaluate short- and medium-term resource planning decisions. In many cases, the market data may support utility plans such as low-cost plant uprates. In other cases, the market data may suggest that a major new generation project should be delayed.

For major long-term generation investments or those that do not clearly pass the simplified market test, a formal solicitation for capacity can be conducted to help determine whether the investment is cost-effective. Some utilities already conduct solicitations, but very few we are aware of in MISO result in selecting a competitive market alternative over a self-build project.

Ideally, a solicitation would be open to many types of solutions to the identified need, and it would apply fair and transparent evaluation criteria. However, there are often tradeoffs between openness and transparency. For example, a more open solicitation may allow for solutions that differ so much in their attributes that comparing them becomes quite complicated. We recognize that there is not a single recipe for conducting a cost-effective and productive solicitation, but there are several guiding principles and best practices that can be considered.

Solicitations would ideally allow offers over a range of terms and resource types to determine: (1) whether the in-service date for a new build can be postponed by procuring lower-cost supplies on a short- or intermediate-term basis, thereby reducing investment costs; and (2) whether market-based capacity purchases are less expensive than building new generating plants, as in cases where long-term power purchase agreements (PPAs) might be available at a lower cost. To ensure the most cost-effective solution is selected, it is also important that competitive solicitations be designed to provide a level playing field among all potential bidders. Solicitations for capacity should ideally be open to offers from new and existing resources of all technology types, including generation and demand response. Ideally, solicitations should also admit capacity-only offers as well as bundled energy plus capacity offers, and they should consider allowing contracts of any term including as little as one year.

When evaluating long-term market-based supply offers against a utility's self-build option, the evaluation criteria would be similar to those applied in existing integrated resource plan (IRP) processes. Similar to the short-term market test described above, this longer-term resource evaluation would compare the levelized capacity costs of each offer. However, any offers that are not for a standard capacity product would need to be adjusted for economic equivalence by translating the offers into an equivalent capacity-only offer that accounts for the expected energy value as measured against energy forward curves. The utility may also wish to evaluate the relative costs by comparing the present value of revenue requirements (PVRR) across a range of scenarios. Full PVRR comparisons are more complicated, however, making it difficult for competitive bidders, commission staff, and consumer advocates to fully understand or validate the results of competitive solicitations. We therefore emphasize the importance of complementing this exercise with the simpler capacity cost test.

Other adjustments to offers obtained in utility solicitations may also be needed to allow for an apples-to-apples comparison, accounting for factors such as: (1) costs not included in the offer price, such as network upgrade costs; (2) the "imputed debt" effect of PPA payment obligations that increase the risk of utility debt and equity, similar to the effects of adding debt to the utility's books; (3) the option value of using short-term market-based supply to defer a major investment until uncertainties are resolved; and (4) other non-price attributes such as environmental objectives and risk profiles. The solicitation should clearly define these factors in advance so that competitive bidders will have a reasonable opportunity to address them in their offers.

Pursuing some or all of these solutions has the potential to mitigate the concerns regarding reliability and economic efficiency within the MISO footprint.

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This report was prepared for NRG.

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