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New England's wholesale markets cost grew by $1.5B in 2017, report says

New England's wholesale electricity and capacity markets were competitive in 2017, according to a new report.

In its 2017 Annual Markets Report issued May 17, the ISO New England's internal market monitor said the total cost of wholesale electricity markets was $9.1 billion in 2017, which is a 20% increase, or $1.5 billion, over 2016's record-low costs. The report attributed that substantial hike to higher capacity market costs associated with the eighth forward capacity auction, or FCA 8, that took effect during the second half of 2017.

Capacity costs increased in 2017 by $1.1 billion, or 93%, to $2.2 billion. Up until FCA 8, capacity prices were relatively low and set administratively at the market floor prices due to surplus capacity conditions. The market monitor said capacity costs will increase further in 2018, to an estimated $3.5 billion, as higher capacity prices from FCA 9 take effect. The report said the capacity costs represent an increasing share of overall wholesale costs, which rose from constituting 15% of those overall costs in 2016 to 25% in 2017.

The report said capacity costs will begin to decline after June 2019, as new resources enter the market and a higher capacity surplus applies downward pressure on capacity prices.

The market responded to lower clearing prices in FCA 12 by temporarily removing capacity. A total of 1,430 MW of capacity from 30 resources dynamically delisted for a period of one year. Two dynamic delist bids for units 7 and 8 of Exelon Corp.'s natural gas- and oil-fired Mystic Generating Station outside Boston in Middlesex, Mass., were rejected for reliability reasons. The two Mystic units' combined 1,278 MW of capacity was held in the auction, even though the dynamic delist bid prices were above the auction clearing price.

Energy costs increased in 2017 by 9% to $4.5 billion, or $37/MWh, with both capacity costs and regional network load costs at $2.2 billion in 2017. Energy costs constituted the remaining $400 million increase in overall wholesale costs. The costs for reliability services such as operating reserve, regulation, and net commitment period compensation, totaled about $200 million.

The report said the increase in energy costs was driven by higher natural gas prices, which averaged $3.72/MMBtu — up 19% from 2016. That upward pressure of natural gas prices on energy costs was mitigated by lower wholesale electricity demand, particularly in the third quarter of 2017.

The market monitor said the trend of declining wholesale electricity demand continued in 2017, down 2% or by an hourly average of 341 MW. In 2017, third-quarter demand was down by 8%, or by almost 1,280 MW on average per hour, compared to third-quarter 2016. The downward trend was driven primarily by the increase in state-sponsored energy efficiency measures and, to a lesser but growing extent, the increase in behind-the-meter solar photovoltaic installations.

In March 2017, the ISO-NE implemented fast-start pricing rules to better reflect the operating costs of fast-start resources through the real-time price and to strengthen performance incentives. The resulting market prices were as expected, with real-time locational marginal prices, or LMPs, having better reflected the costs of committing fast-start resources.

Those changes have had the effect of increasing real-time LMPs, reducing uplift payments and increasing operating reserve payments, the report said. As the fast-start pricing mechanisms are not applied to the day-ahead market, the market monitor said higher real-time LMPs may increase the opportunity for virtual demand to converge day-ahead and real-time prices. So far, both offered and cleared virtual demand bids have increased since the implementation of fast-start pricing.

During 2017, the market monitor said, the ISO-NE and its stakeholders made significant progress in crafting a mechanism to protect competitive capacity market pricing while accommodating the entry of state-sponsored renewable resources.

The initiative, known as Competitive Auctions with Sponsored Policy Resources, or CASPR, recently was approved by the Federal Energy Regulatory Commission. The CASPR design will continue to rely on the minimum offer price rule, with the intention of protecting competitive pricing, in the primary auction. But a new second-stage auction will allow resources that are willing to exit the capacity market to trade their capacity service obligation position with new state-sponsored resources that did not receive a capacity service obligation in the primary auction.

The market monitor acknowledged that concerns remain about how effective CASPR will be in protecting competitive capacity market prices over time and, as a result, said the initiative will need to be closely analyzed and monitored.

Finally, the market monitor noted that the forward capacity and energy markets displayed competitiveness despite the presence of structural market power. Measures are in place within both markets to identify and mitigate market power.

The identification of seller-side market power in the energy and capacity markets relies on a pivotal supplier test that measures the ability of a supplier to increase price by withholding supply, the market monitor noted. Buyer-side market power mitigation in the capacity market prevents the use of buyer-side subsidies from allowing a resource to enter the market at prices below competitive levels and artificially lower the market clearing price. According to the report, both mitigation processes have functioned reasonably well and resulted in competitive outcomes.

However, the report said a number of areas require further evaluation, including the forward reserve market's current lack any active provisions to mitigate market power and existing structural market power issues. And while the energy market has rules to identify and mitigate seller-side market power, which has generally produced competitive outcomes in the real-time market, mitigation measures for system-level market power in the real-time energy market provide suppliers a considerable degree of deviation from competitive marginal-cost offers before they would trigger and mitigate a supply offer.

Noting that some energy supply portfolios have structural market power in almost half of the hours in the real-time market, the market monitor said the potential impact of the situation and the effectiveness of existing mitigation thresholds will be further evaluated this year.