Discussion with the RCM Working Group 17 April Discussion outline • CAUSATION – T HE RCM AND OTHER DRIVERS – L OAD FORECAST UNCERTAINTY • HOW THE RCM INFLUENCES CAPACITY INVESTMENT CHOICES – T HE VALUE OF PURE CAPACITY – T HE MRCP REVIEW IN PERSPECTIVE • FURTHER DISCUSSION – C OMPLEXITY OF FULL MARKET - BASED APPROACH – RCP FORMULA - BASED APPROACH • The current RCP formulation and the option of a steeper “slope” The current RCP formulation and the option of a steeper slope • The relationship between the RCP and the MRCP • Picking values – Other Related Issues 1 The Lantau Group
Trend in excess reserve capacity 14 6% 14.6% 2 The Lantau Group Many “reasons”, but the RCM is always a factor Capacity Year Attributed Factor 2008 2009 2010 2011 2012 2013 Total Schedule 7 Schedule 7 536 536 536 536 Displacement tender 256 256 MRET 1 1 90 5 19 116 Government policies 220 220 Market outcomes 331 109 10 112 562 Demand-side resources 47 0 71 87 181 45 431 Total Capacity Addition 583 587 181 187 518 64 2120 Excess Reserve Capacity 278 527 113 302 495 775 The specifics are interesting, but the general point that the RCM is a s factor attracting or supporting investment remains 3 The Lantau Group
Demand uncertainty (1 of 2) Just SIX “lumpy” loads – represent very significant uncertainty – what commitment should be expected of loads to be commensurate with other resources? 4 The Lantau Group Demand uncertainty is inherent in the WEM (2 of 2) UPWARD REVISIONS DOWNWARD REVISIONS Probably any forecast can be made “better”, but you cannot eliminate fundamental uncertainty in a small, lumpy market – the RCM has to be sufficiently responsive so as not to ADD TO the problem 5 The Lantau Group
A capacity credit value is the value of “pure capacity” • Consider the choice between CC Annual CC Levelized Cost investing in an incremental MW of a Carrying Cost = “Gross CONE” pure peaking resource or an Annual Fuel Energy and incremental MW from a unit with a incremental MW from a unit with a AS Margins AS Margins Savings Savings lower marginal dispatch cost. Peaker Annual Peaker Levelized Carrying Cost Cost = “Gross • Both units would provide exactly the CONE” same reliability benefit. • In addition, the unit with the lower Shortfall = Capacity dispatch cost could displace higher- Net CONE = Value cost resources. Capacity Price • Accordingly, the unit with the lower dispatch cost has a second source of value. Combined Peaker Cycle It is the role of the RCM to produce the “red” portion, which is the same “value” no matter what technology or side of the equation (demand or supply) 6 The Lantau Group Before MRCP methodological and definitional adjustments, and after 200,000 ~9 % 180,000 160,000 23.4% 140,000 120,000 RCP 100,000 80,000 RCP (slope = -1) based on 85% OLD MRCP 60,000 40,000 RCP (slope = 1) based on 85% NEW MRCP RCP (slope = -1) based on 85% NEW MRCP 20,000 0 0% 3% 5% 8% 10% 13% 15% 18% 20% 23% 25% Percentage of Excess Reserve Capacity The MRCP has changed, but the RCP is no more sensitive to market conditions than before, and the lower MRCP has implications for longer-term investment incentives 7 The Lantau Group
Reduced investment in the WEM has already (apparently) begun 350 300 250 200 MW Demand ‐ side resources 150 Market outcomes 100 50 0 0 2008 2009 2010 2011 2012 2013 Capacity Year This is to be expected, and is good, given the current level of excess reserve capacity…but 8 The Lantau Group Market-based pricing of capacity credits is not simple • What is the value horizon (one year, multiple years)? • What is the reference point (today, next year, three year’s hence, longer term)? • How big is the market (thickness, level of competitive sourcing/dynamics)? H bi i th k t (thi k l l f titi i /d i )? • What is the starting point and how did it get there (transition, fairness, contracting, etc) • What is the role of forecasting and forecast uncertainty? (who bears?) • What is the level of accepted exposure to non-market risks? • The RCM currently bypasses or simplifies most of these, keeping it but imperfect Changing the formula of the RCP can make a significant “pro-market” improvement, even if it does not address every imperfection immediately 9 The Lantau Group
Current approach, varying slope Steeper – more responsive to p p 200,000 market conditions 180,000 Could be steeper still, as 160,000 current market value of a single 140,000 year credit is very very low 120,000 RCP 100,000 The steeper and lower the Credit price can go, the more 80,000 one has to worry about whether RCP (slope = -1) based on 85% OLD MRCP 60,000 the credit value can go “higher” RCP (slope = -1) based on 85% NEW MRCP 40,000 on the upside to create correct on the upside to create correct RCP (slope = -3.25) based on 85% NEW MRCP 20,000 expected values in the longer term 0 0% 3% 5% 8% 10% 13% 15% 18% 20% 23% 25% Percentage of Excess Reserve Capacity 10 The Lantau Group Capped by MRCP Steeper – more responsive to p p 200,000 market conditions 180,000 No 85% cap 160,000 140,000 But still limited to MRCP 120,000 RCP 100,000 What is the MRCP? It is the expected cost of pure peaking 80,000 RCP (slope = -1) based on 85% OLD MRCP capacity provided by a 160MW 60,000 OCGT RCP (slope = -1) based on 85% NEW MRCP 40,000 RCP (slope = -3.25) based on 100% NEW MRCP 20,000 It is not the estimated “maximum” cost of peaking capacity in 0 economics, but a price cap in the 0% 3% 5% 8% 10% 13% 15% 18% 20% 23% 25% Percentage of Excess Reserve Capacity WEM 11 The Lantau Group
Capped by 110% of MRCP Steeper – more responsive to p p 200,000 market conditions 180,000 110% of MRCP – is that enough? 160,000 140,000 The higher the cap above MRCP, 120,000 the more incentive to bilaterally RCP 100,000 contract around this exposure. 80,000 RCP (slope = -1) based on 85% OLD MRCP An “uncapped” and “unbottomed” 60,000 RCP would drive stakeholders into RCP (slope = -1) based on 85% NEW MRCP 40,000 more contracting to manage risk more contracting to manage risk RCP (slope = -3.25) based on 110% NEW MRCP 20,000 This principle is key to the bilateral 0 contracting incentive in modern 0% 3% 5% 8% 10% 13% 15% 18% 20% 23% 25% Percentage of Excess Reserve Capacity capacity markets 12 The Lantau Group Comment • Currently, the RCP is adjusted downward in proportion to the amount of excess reserve capacity that exists. • A straightforward change would focus on sharpening the administrative price adjustment mechanism to be more responsive to the amount of excess reserve capacity in the WEM. • An alternative of “spigot control” would go against market-based provision of capacity by new investors, though it would help protect existing generation investors from further potential reductions in CC value • Consequently, we favour a price-based adjustment either driven by more use of auctions (complex implementation and more volatile value impacts), or a sharpened RCP price adjustment formula • The risk to be avoided is one in which the adjustments to the RCP are so sufficiently and Th i k t b id d i i hi h th dj t t t th RCP ffi i tl d consistently downward without any chance of an offsetting upward adjustment that the expected value of a Capacity Credit over the life of a capacity investment is not sufficient to support that investment commercially. 13 The Lantau Group
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