This is an interesting summary of the California situation and makes mention of also financing a capacity mechanism rather than just funding power directly.
CERA says California must abandon bad market assumptions 2/1/2001 Fundamental design flaws need long-term repair, but some short-term steps may ease summer shortages Citizens, businesses and utilities in the Western U.S. are now "stuck with the bill for a huge and costly failure" in deregulation policy formulation because of California's decision to ignore power market realities, Cambridge Energy Research Associates (CERA) Senior Director for North American Electric Power Larry Makovich told the U.S. Senate Environment & Energy Committee this morning. "California set up a power market which guaranteed power prices that were too low to support enough timely investment in new supply," said Makovich the lead-off witness at hearings into the California energy crisis. "The crisis in California arose because people believed the electric energy markets were just like other commodity markets-that when demand and supply tightened, prices would gradually rise, stimulate investment and keep supply and demand in balance. That assumption is wrong." Unlike other commodities, electrical energy can't be stored in an inventory, Makovich said, and as a result, both capacity and the use of that capacity must meet consumer needs. "Unlike other non-storable commodities like telecom, a busy signal is not an acceptable way to get around this capacity requirement-when you're talking about electric power, a busy signal takes the form of a blackout," he said. "Setting up a power market with the right price signals requires payments for two electric commodities-energy and capacity." Other restructured power markets such as Texas, New England and the Middle Atlantic region successfully included a capacity payment mechanism in their new market structures, Makovich said. "Texas implemented its restructuring program after California and with less of an initial capacity surplus. The Texas power market is about the same size as the California market, yet last year Texas added more than 5,000 MW of new supply and expects to add 8,000 MW more this year." Flawed decision-making "The problem in California is not deregulation itself," Makovich said. "The system was only partially and not properly deregulated. The flaws in California's power markets resulted from a flawed process of deregulation based on an idea riddled with uncertainties-stakeholder democracy, the belief that if all of the stakeholders of a problem are brought together, the correct policy will emerge through negotiation and compromise." "When California formulated its deregulation policy with plenty of power plants already in place, it was no surprise that the majority of stakeholders voted not to pay for capacity as long as the reliability was free."
Similar problems afflict siting of new plants, according to Makovich. "The state's approval process creates significant obstacles to building new plants. These include an open-ended environmental review process, tough siting and permitting procedures and well-organized community opposition. These hurdles make California one of the most difficult places on earth to build a power plant." As a result, he said, year after year, California failed to approve anything approaching its annual requirement for new supply to keep up with its growing demand. Urgent short term action "Not only is urgent action needed to meet the current crisis, but swift and dramatic steps are needed to avert an ever more severe shortage in the coming summer," Makovich said before the committee. "California is currently about 5,000 MW short of supply. Unfortunately, there is not quick fix. Nevertheless, there are many short-run actions that can begin to attack the problem from both the demand and supply sides," including: * On the demand side, find more conservation and interruptible load; * On the supply side, add greater flexibility in legal and environmental limits, such as exploring back-up and emergency generating systems at hospitals, hotels and office buildings, and barge-mounted and mobile emergency power sources; * Reactivating mothballed generating units; and * Expediting permitting and construction of power development projects already underway in California. Long-term solution "The long-run solution is clear-California needs a mechanism to pay for capacity and needs to approve development plans each year for enough capacity to close the current gap and keep up with demand," Makovich said. "California could mistake long-term energy contracts for the needed capacity payment mechanism and wind up creating massive take-or-pay obligations in the future. In addition, the politics of 'not in my backyard' may subvert real attempts to site and permit needed supply.." "If this crisis drives California back to the heavy-handed regulation and control that launched power restructuring in the first place, then the state is likely to find its electric sector becoming increasingly inefficient and expensive and very much disadvantaged compared to regions with properly structured power markets," he said. "California is now at a critical juncture-the state can go backwards by re-regulating, or even taking outright ownership-or the state can fix the flaws in its power market. The latter is the way to go."
The capacity payment mechanism Power markets typically need a capacity reserve of an additional 15% beyond-peak demand to assure supply meets demand at all times. According to Makovich, California set up a market that paid generators to run their plants, but did not set up any market mechanism to pay generators for capacity. "This means prices were lower in the short run, but it also meant that prices would eventually explode in a future shortage," he said. When the California market tipped into a severe shortage last year, energy prices soared and volatility exploded at levels that were multiples of what was needed to support new investment. Besides being higher than needed to support investment, these price increases were also too late, Makovich testified. "A properly structured power market can not rely on periodic shortages and reliability crises to provide timely investment incentives. It needs a capacity payment mechanism, beginning with the simple requirement that anyone selling electrical energy to customers must also buy enough capacity to cover those customers' needs plus a reserve," he said. The real lesson of the California power crisis is that there is a right way and a wrong way to set up and run a power market. California's electricity crisis is the result of three critical failures, which are: * Setting up a power market with serious structural flaws that made timely investment in new power supply neither possible or profitable; * Allowing the power plant siting and construction approval process to become the most daunting in the nation, thwarting efforts by companies that could have averted the supply shortfall; and * Presenting as "deregulation" a system of only partial deregulation in which customers remain under controlled prices that are well below the prices paid by utilities to generators. This fundamental misalignment crates a liquidity problem for utilities and disconnects the demand side from the market. Based in Cambridge, MA and with offices around the world, Cambridge Energy Research Associates (CERA) advises major international companies, financial institutions and organizations, delivering strategic knowledge and independent analysis on energy markets, geopolitics, industry trends and strategy