The greatest debate in electric policy today concerns the incompatibility of two sets of policies:

1. A restructuring of the electric sector, introduced in some areas of the United States, where central planning of generation by state public utility commissions was supplanted by wholesale markets whose auction-set prices are meant to be the exclusive indicators of whether individual plants are economical and should be built or continue to operate; and,
2. A growing trend on the part of governments, especially state governments, to select energy-supply resources by fiat.

For the first time in years, FERC has offered its views on this debate, approving a significant modification to the New England Independent System Operator’s market for capacity late last week.

Those who hoped for an elegant, conclusive answer to this problem will probably have to keep looking. The ISO-NE proceeding suggests there may be a number of sub-optimal paths forward, mapped out through largely subjective administrative decisions, for those who lack the determination to fall conclusively on one side or the other of this debate.

How we got here

But let’s back up. What FERC approved is a modification to the market’s forward capacity auction. This auction is an annual process which clears supply resources’ offers against the ISO’s projection of regional needs three years into the future. New resources participating in this auction are subject to a Minimum Offer Price Rule (MOPR). The MOPR counts (certain, but not all) government support of a resource as a cost, the point of which is to allow the auction to arrive at a price that is the result of competition between “unsubsidized” bidders.

The price the auction clears at is the least-cost bid needed to serve the last megawatt of capacity the ISO believes will need to exist in order to reliably serve customers. The integrity of this price is important for those who believe at least three things: that capacity markets are an expression of “competition” in the first place, that capacity markets are necessary for maintaining a reliable system, and that capacity markets should send a meaningful signal for the deployment of capital by plant owners and investors.

The capacity-market MOPR’s obvious problem is that policymakers love to subsidize resources—now more than ever—and who are a bunch of technocrats to tell them they cannot? As a modest concession to this political reality, the ISO-NE MOPR rule previously included an exemption for 200 megawatts of new renewable resources per year: a kind of safe harbor after which the, ahem, real competition would fill out a price for remaining needs. Almost as soon as this concession was made, it was eclipsed by Massachusetts’ adoption of a law ordaining 2,800 megawatts of clean energy.

What just happened

ISO-NE’s new “Competitive Auctions with Sponsored Policy Resources,” or CASPR, which FERC approved Friday, eliminates the 200-MW annual carve-out. Instead, the new market design cordons off the forward capacity auction, so that only those new resources that have signed up to the let-the-market-make-us-whole theory of such markets are left as bidders.

Meanwhile, CASPR’s accommodation of state policy resides in a new “substitution” auction open to (some but not all) subsidized clean energy. (Some but not all) winning bidders of the first auction may offer to have their capacity obligations bought out by these subsidized resources.

If the prices bid by the “clean” and less-clean resources coincide, the less-clean energy resources are given a walk-away payment equal to the difference between the winning bids in the two auctions, and required to permanently close. This is a clever feature. By channeling government resource-sponsorship ambitions into a secondary auction, this reform prevents ISO-NE from becoming a market whose “competitive” status is only an ironic bon mot.

Consumers, however, pay for it all—either as consumers per se, or as taxpayers who foot the bill for public policies, or because they are as-yet-captive ratepayers of distribution monopolies on which state legislatures periodically shunt these clean-energy obligations, or through “side payments” the ISO-NE market design requires. Happily, this design does come closer than certain alternatives to ensuring that those jurisdictions that have chosen winners and losers will foot the bill for their choice.

Still, the reform can be understood as a kind of logrolling where enough moneyed stakeholders were satisfied with the design to have made it possible in the first place. There are notable exceptions, but in general, FERC’s order keeps the peace between the people whose earnings depend on “clean” versus less-clean energy. The latter receive a kind of bailout rather than rough justice; the former may sleep well knowing that FERC will not “MOPR” them entirely (or at least not most of them).

Winners and losers

The parenthetical caveats above are necessary, however, because the design of the new ISO-NE capacity market is predicated on largely subjective decisions about who gets to play in the new sandbox and who does not. Together, these infirmities of the market’s new design cast doubt on the reform’s durability and economic wisdom.

The wordy definition in the new ISO-NE tariff of “Sponsored Policy Resource”—those permitted to buy out other resources’ capacity obligations in the substitution auction—limits them to “renewable, clean or alternative energy” sources. Further, they must be “sponsored” under a policy that was law earlier than Jan. 1, 2018.

As a practical matter, this means that as-yet-unbuilt clean energy that qualifies under Massachusetts law will be favored in the new market over that which might qualify in Connecticut, which was in the midst of considering a similar policy. Once other states actually adopt these policies, it will be difficult for ISO-NE and FERC to rationalize a distinction that keeps the door closed on them.

The clean-energy definition of “Sponsored Policy Resource” also means that FERC’s intonations on resource neutrality—“We reiterate that the Commission’s policies are fuel-neutral”—should be understood as a sort of Stuart Smalley style–daily affirmation. Because you are fuel-neutral just until the point you are not.

Previously, FERC has employed euphemism as a literary device to avoid referring explicitly to clean energy when policies undertaken for that cause’s benefit have been adopted. Order 1000 used the coy phrase “public policy requirements” to describe the tacit clean-energy objectives of a more robust transmission planning and selection process. The agency thus retained a semblance of overt resource neutrality. The ISO-NE tariff FERC approved last Friday, meanwhile, creates a black-letter legal distinction between “renewable, clean or alternative” energy, and that which isn’t.

FERC also rejected the criticisms of ISO-NE’s market monitor, who argued that new capacity resources who win the “competitive” auction should be allowed to be bought out in the substitution auction. To do so would be more holistic, but FERC reasoned it could have warped the price in the first auction if bidders sought to strategically arbitrage its price for the “buy-out” bids in the substitution auction. Nevertheless, as FERC itself acknowledged in its order, its decision to keep new generation siloed means that more economic existing capacity resources may be bought out by renewables, even while less economic new ones come online. That is bizarre.

The capacity market house of cards

The market is looking like a rather odd style of “competition.” It is attenuated by the number of rules about who may compete and how. And of course in most markets, consumers don’t have to bail out one person vying for their business in order to let another have a go at it.

As capacity markets add additional points of bureaucratic decision-making, they eventually bear less and less resemblance to a genuine competition, and begin to look again like central-planning, which allocates revenues and responsibilities to regulated parties through serial decision-making by the regulator. This confines the choices of market actors, dampening the innovation that characterizes genuinely competitive markets. Think of it as the difference between going to the grocery store and being a guest at a dinner party. In the latter, someone else has set the table, served you the courses, and left to you the “competition” of whether you will use the fork or the spoon to eat the stuffing.

The ISO-NE decision adds layers of administrative complexity to a structure already suffering from a shaky foundation. Capacity markets owe their existence to the fact that politicians and technocrats are uncomfortable allowing energy-only markets to send price signals sufficient to ensure all necessary supply is available to meet demand willing to pay for it. In other words, capacity markets are a “competitive” market that was conceived because of a lack of confidence in its central proposition, which is that competition actually works.

In contrast to the world’s energy-only competitive markets, such as Texas’ ERCOT, capacity markets are based on forecasts of what technocrats at an ISO think demand will be. Indeed, because of the imposition of largely subjective reserve margins, it is more appropriate to say that the capacity market’s demand curve is a function of what an ISO thinks demand should be in the future.

Electricity is a “just-in-time” commodity, but capacity markets serve to diminish the volatility that would naturally be associated with such a product in a more “free” market. A freer market would rely on consumers to insure their energy-supply costs through a variety of products. Capacity markets, instead, are a space that a regulator and market operator have created for themselves, summoning into being a definition of, and a demand for, a regulatory product. Many of the follow-on regulatory problems such markets experience are born of this product’s lack of real-time physical traits actually demanded by consumers.

It is therefore all a bit rich when bromides about market purism are deployed in the context of capacity-market design. Are such markets more consistent with competition policy than, say, simply asking members of a state legislature which hip new energy project they would like their taxpayers to buy? Sure. But is it particularly more “competitive” than the demand forecasting that utilities used to do on their own? Not necessarily—either way, it’s a technocratic guess undertaken by a single point of administrative responsibility.

Likewise, if capacity-market rules become a sieve by which technocrats allow certain resources to participate, but not others, it is worth asking: Why is an ISO’s and FERC’s determination of this, in the name of competition, better for consumers or even more “competitive,” than the decisions of, say, a state public utility commission or consumer-owned utility?

Administrative tinkering with capacity markets makes markets as a whole less easy to defend. As Commissioner Rob Powelson noted in his dissent to the ISO-NE order, Secretary of Energy Rick Perry has criticized these markets as not particularly “free.” The secretary has a point now more than ever. Yet, even before FERC’s ruling, the design of capacity markets was not the kind of thing you could proudly write your Econ 101 teacher about.

No easy out the next time

Reading between the lines on FERC’s Order, it is clear ISO-NE gave FERC the option to open the pressure release valve, and the regulator did. To do otherwise would have meant either capitulating on FERC’s capacity-market ambitions, or rigorously enforcing the MOPR and extirpating any subsidy the agency could find from the market.

FERC will get another chance to be ambivalent or decisive very soon, when it rules on two conflicting proposals offered in a single filing by PJM, which evidently found this topic so confounding that it simply outsourced its decision to FERC. Whatever the outcome, let us hope that FERC addresses clearly some of the internal contradictions in its existing wholesale market regulation, before the reasoning behind it loses its center of gravity altogether.