Assessment of Market Power Mitigation Measures in Alberta s CMD2 Reform

Transcription

1 Prepared for: Alberta Market Surveillance Administrator Avenue Southwest Calgary, AB T2P0L6 Assessment of Market Power Mitigation Measures in Alberta s CMD2 Reform Prepared by: 1201 F St. NW, Suite 700 Washington, DC Date: CRA Project No. D25754

2 Disclaimer The conclusions set forth herein are based on independent research and publicly available material. The views expressed herein are the views and opinions of the authors and do not reflect or represent the views of or any of the organizations with which the authors are affiliated. Any opinion expressed herein shall not amount to any form of guarantee that the authors or has determined or predicted future events or circumstances and no such reliance may be inferred or implied. The authors and accept no duty of care or liability of any kind whatsoever to any party, and no responsibility for damages, if any, suffered by any party as a result of decisions made, or not made, or actions taken, or not taken, based on this paper. Detailed information about, a registered trade name of CRA International, Inc., is available at Copyright 2018 Acknowledgements This report was authored by David Hunger, Jordan Kwok, Juliana Bruno, and Mark Noll. Page ii

3 Table of Contents 1. Introduction Background on CMD Report Objective and Structure Opening Commentary Review and Assessment of Market Power Mitigation Provisions Proposed for Alberta s Capacity Market Capacity Market Proposed Mitigation Measures Offer Requirements for Existing Capacity Resources Market Power Screens and Thresholds Default Offer Price Cap Allowance for Asset-specific Showings Applicability of Mitigation to Delist Bids (and Delist Bid Timing) Demand Curve Design Mitigation Provisions in Rebalancing Auctions Ex-Post Review of Results, Revisions to Market Rules and Parameters Review and Assessment of Market Power Mitigation Provisions Proposed for Alberta s Energy Market Offer Requirements for Participating Resources Market Power Screens and Thresholds Scarcity Test Reference Price and Asset-specific Showings Market Power Mitigation Considerations in Alberta s Ancillary Services Market Description of Market Rule Discussion and Alternatives Cross-market Considerations Role of Market Monitoring Entities Market Power Mitigation Considerations for Roadmap Design Elements Future Market Design Changes Following Ongoing Evaluation Future Market Design Changes Related to Dispatch and Flexibility Out-of-Scope Reforms Entity Roles in Market Power Monitoring and Mitigation Page iii

4 6.1 Considerations in Dividing Tasks Discussion of Proposed Dispute Process Appendix A: Market Power Concerns in Organized Electricity Markets A.1 Market Power in Capacity Markets Supply-Side Market Power Buyer-Side Market Power A.2 Market Power in Energy Markets Structural Approach Conduct and Impact Approach Reference Price Determination A.3 Cross-Market Considerations Establishment of net-cone Capacity Obligations and Resource Performance Appendix B: Market Power Mitigation in US ISOs with Centralized Capacity Markets B.1 PJM Supply-Side Mitigation Buyer-Side Mitigation B.2 ISO-NE Supply-Side Mitigation Buyer-Side Mitigation B.3 NYISO Supply-Side Mitigation Buyer-side Mitigation Appendix C: Market Power Mitigation Measures in US ISO Energy Markets C.1 PJM Reference Price Calculations in PJM C.1 ISO-NE Conduct Test Impact Test Reference Price Calculation in ISO-NE C.2 NYISO Conduct Test Impact Test Reference Price Calculation in NYISO Page iv

5 Table of Exhibits Exhibit 1: Economic Withholding Diagram... 8 Exhibit 2: Proposed Alberta Capacity Market Demand Curve Exhibit 3: Historical Frequency of Supply Cushion Events ( ) Page v

6 1. Introduction 1.1 Background on CMD2 The Government of Alberta has announced a policy decision, responding to a recommendation by the Alberta Electric System Operator ( AESO ), to transition to a capacity market as a supplement to existing wholesale electricity markets. A capacity market is intended to ensure reliable electricity supply by providing investors with a predictable revenue stream while preserving key benefits of energy markets, including economic signals that promote innovation and cost discipline, as well as risk shifting from ratepayers to investors. In the case of Alberta, a capacity market was further recommended to support reliability, through application of competitive market forces, as Alberta s electricity system evolves to be less dependent on coal and more dependent on wind, hydro, and gas resources. Currently, the AESO and its stakeholders have completed development of the second phase of the Comprehensive Market Design ( CMD2 ). Under the CMD2 proposal, the first capacity auction is anticipated to start in 2019 with the earliest delivery period in CMD2 is not the final stage of the reform process, and two more rounds of revision (CMD3 and CMD4) are expected before the CMD is finalized, notionally by Q Associated with the development of a capacity market, CMD2 includes reforms to the AESO administered energy and ancillary service markets ( EAS ). The overall structure of these markets will remain in place, but additional market power mitigation provisions are being proposed in light of the future implementation of a capacity market. Importantly, CMD2 also includes new rules for the energy market that continue the shift from Alberta s prior energy market paradigm, in which exercise of market power was explicitly allowed. The rents formerly allowed by above-marginal energy market price offers are to be replaced by capacity market revenue. The rationale for the new monitoring and mitigation rules proposed for the energy market are based on this theory. 1.2 Report Objective and Structure We have been asked by the Alberta Market Surveillance Administrator ( MSA ) to develop this report with the objective of identifying opportunities to exercise market in the proposed AESO CMD2 market design. Where we identify such opportunities, we present alternatives, including discussion of any associated trade-offs, for how to improve market rules to limit possibilities for the exercise of market power. We also provide a framework and recommendations related to the roles of the respective parties in implementing market power mitigation rules. That is, we discuss which responsibilities are best assigned to the MSA, which are best assigned to the AESO, and where they may be shared. Our review focuses primarily on the capacity market rules and proposed changes to the energy market rules. However, we also present a limited discussion of market power in the ancillary services market. Finally, we constrain our focus to market-power related issues; we do not address elements of the market rules that could expose the Alberta market to other types of manipulation or gaming. 1 Page 1

7 Our analysis is presented as follows: Section 2 provides CRA s review and assessment of market power mitigation proposals associated with the capacity market provisions of CMD2. For each element of the market power-related rules, we describe the proposed rules, provide a summary of the rationale presented in the AESO materials, and then present CRA s analysis and discussion of alternatives. Section 3 and Section 4 provide our review and assessment of market power mitigation proposals associated with the energy and ancillary services market provisions of CMD2, respectively, with presentation organized in the same manner as Section 2. Section 5 touches on future design elements described in the CMD2 roadmap reforms and out-of-scope reforms, those market changes that have been considered and may be reviewed and implemented as part of ongoing evaluation of the market and future reform efforts, as described in CMD2 Sections 10.8 and Section 6 presents a discussion of the division of market power monitoring and mitigation tasks associated with the proposed reforms, including a recommended framework of general principles that may be applied in dividing up tasks effectively. We review the literature on this topic and provide some context in the form of how market monitoring functions are divided in some US Independent System Operators ( ISOs ). This is the framework that is applied in each section entitled Role of Market Monitoring Entities that accompanies each market power monitoring and mitigation rule element assessed in the prior sections. This report also includes several appendixes. Appendix A provides a background on the types of market power issues that are generally of concern in wholesale electricity markets as well as some of the types of rules that are put in place to mitigate those concerns. Furthermore, it is our view that electricity market regulation and operation are complex processes that require significant levels of learning by doing. While every jurisdiction has unique considerations, sharing of experience and observation of more developed markets can provide insights to streamline the development of newer markets. Thus, Appendix B (capacity markets) and Appendix C (energy markets) provide a summary of market power mitigation procedures in PJM, ISO-NE, and NYISO, all US markets with significant experience in mitigating market power in the markets that they operate. 1.3 Opening Commentary Before moving to the body of our assessment, there are several overarching considerations that we believe are important to bear in mind during Alberta s market reform process. Above all, the proposed changes the addition of a capacity market and the shift to an energy market with mitigation of market power constitute a paradigm shift for Alberta s power sector. It should be expected that market economics in the new paradigm will drive outcomes that are different than in the prior paradigm. As a corollary, we point out that design decisions should not be justified based on the objective of achieving similar results as the pre-reform Alberta market. Relatedly, electricity markets are ultimately a tool by which to send signals to market participants and create incentives for those participants to act in an efficient manner. However, electricity markets are complex and each jurisdiction is unique. These factors make it difficult to predict how market participants will respond and ultimately how the market will behave. Thus, we recommend that the AESO and other entities associated with the Alberta Page 2

8 market (Alberta Energy, the AUC, and the MSA) move forward with the expectation that the new market will require close oversight and reactive rule modifications for at least the first several years of market operation. Finally, we acknowledge the important role that capacity markets can play in addressing shortcomings in electricity markets that lead to missing money. However, we caution against a policy of over-reliance on capacity markets to achieve long-term (or short-term) economic objectives. Capacity markets are fundamentally supplemental, administrative constructs. They are prone to political and regulatory capture and have proven controversial and difficult to administer. Thus, it should be a constant goal of market operators, market oversight entities, and market regulators to improve the efficiency of price signals from the energy and ancillary service markets to minimize the quantity of missing money, 2 thus shrinking necessary capacity payments and limiting reliance on the capacity market. The smaller the payments available, the less time and energy will be spent debating the effects of arcane market rules, and the less effort will be expended through constant rent seeking and rule changes. 2 All of the reforms listed in CMD2 Section are examples of future market reforms that hold considerable promise with respect to improving the efficiency of Alberta s energy and ancillary services markets. These include locational marginal pricing, security constrained unit commitment, security constrained economic dispatch, intertie dynamic scheduling, co-optimization of energy and ancillary services, and development of a day-ahead market. We might add to this list locational capacity pricing, multi-part bidding with cost recovery guarantees, and a scarcity pricing regime. Page 3

9 2. Review and Assessment of Market Power Mitigation Provisions Proposed for Alberta s Capacity Market The future Alberta capacity market is still under development and numerous details remain outstanding. However, per CMD2 documentation, the broad market design is in place. The high level elements include: Salable capacity is denominated in unforced capacity ( UCAP ) based on five years of historical data. Where not available, historical operating data will be supplemented by class averages or engineering estimates. Capacity resources take on a one-year obligation (Nov 1 Oct 31) and no seasonal options are available. The primary forward capacity auction will have a three-year forward period and be structured as a uniform price, sealed bid, single round auction. The auction objective is to maximize social surplus and minimize deadweight loss. Two rebalancing auctions will be held 18 and 3 months before the obligation period. During the rebalancing auctions, suppliers may offer buy-out bids and incremental sell offers. Rebalancing auctions will utilize the same demand curve shape and same auction mechanics as the base auction. The market has no explicit locational pricing. However, if transmission constraints require procurement of additional supply volumes offered at higher prices, such resources will receive uplift payments equal to the difference between the market clearing price and the resource offer price. Supply participation is available to resources greater than 1 MW, including generators within Alberta, storage resources, demand side assets, and external capacity assets. Energy efficiency resources and resources that received support through the Renewable Electricity Program ( REP, rounds 1, 2, 3) may not participate. The AESO will employ an administrative downward sloping demand curve denominated in Unforced Capacity ( UCAP ) and based on the results of a forward-looking probabilistic resource adequacy model. The resource adequacy standard will be specified by the Government of Alberta. System UCAP requirements will be adjusted for self-supplied volumes, unqualified imports, and ineligible volumes (e.g., REP resources). Cost of new entry ( CONE ) values will be based on a single cycle natural-gas fired reference generator. Resources may delist temporarily (economic or physical) or permanently, and must do so before ceasing participation in the capacity, energy, or ancillary services markets. Temporary economic delists are only allowed in the second rebalancing auction, are only allowed for two consecutive periods, and only economically delisted resources may withdraw from the energy and ancillary service markets. Page 4

10 Capacity resources, as with all resources 5 MW or greater, have the obligation to offer into the energy or ancillary services markets. Resources are subject to availability and performance payments, but also have the potential to earn bonus payments. 3 Capacity markets create the possibility, as with all markets, that dominant firms with large supply positions will have the ability and incentive to influence market outcomes through either physical or economic withholding. In this case, the AESO is focused on economic withholding: the ability of a firm to structure its capacity offers in such a way that by pricing some available supply above its cost, the auction clears at a higher price because it takes the next highest price for the quantity required to fill the supply gap caused by the withholding firm. This allows firms with market power to earn a relatively higher price on their cleared capacity than they would have had they offered their entire supply at competitive levels. Because of this concern, the AESO conducted analyses that evaluated the level of competitiveness in the Alberta market and ultimately determined that market power mitigation mechanisms are required for the capacity market. 4 In the sections that follow, CRA summarizes the supply-side mitigation measures that are being proposed by the AESO as part of CMD2 along with the rationale for design decisions. For each market mitigation measure proposed by the AESO, CRA has included a discussion and assessment of alternatives. The supply-side mitigation measures and their rationales included in the AESO s CMD2 proposal and summarized herein include: A must-offer requirement to mitigate physical withholding of capacity; A market power screen to determine which firms could potentially exercise market power; A default offer price cap that applies to all firms that fail the market power screen; and An asset-specific offer price cap for a firm that has failed the market power screen but can demonstrate that its qualified capacity asset s costs are higher than the default offer price cap. 5 We also discuss other elements of market design related to the exercise of market power, including the demand curve design and ex post review of market results and evaluation of market rules. There are presently no mechanisms proposed to mitigate net-short (buyer-side) market power. However, the AESO states that this may be reviewed in the triennial performance reviews of the capacity market and will make future reforms as appropriate. There are also no 3 Availability is assessed during the 100 hours of tightest supply cushion across each delivery period. During these hours, the AESO will charge resources that underperform approximately 0.5 percent of their annual capacity revenue, and provide that to over-performing resources as bonus payments. Similar provisions apply during performance events defined as EEA event levels 1, 2, and 3, and unit-specific performance is compared to pool average performance. Performance penalties equal 60 percent of capacity market revenue divided by the expected number of EEA hours (or 20). Stop loss provisions exist at 300 percent of monthly capacity revenue or 130 percent of annual capacity revenue. Exemptions are available for transmission limitations. 4 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 1. 5 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 2. Page 5

11 market power mitigation measures proposed for rebalancing auctions though the rebalancing auction will be included as part of the auction competitiveness assessment. If this assessment indicates that rebalancing auctions also require mitigation, the measures may be developed and applied to future rebalancing auctions Capacity Market Proposed Mitigation Measures Offer Requirements for Existing Capacity Resources Proposed Provisions in CMD2 Subject to rules associated with asset delisting, all firms must submit offers into the capacity auction for all supply resources above a threshold size. A firm must offer its entire qualified UCAP in each base auction. Offers must include a capacity asset ID, specify whether or not a block is flexible or inflexible, 7 the price for each block, and the quantity in UCAP MWs for each block. The offers are bound by a minimum of $0/kw-year and a maximum of the price cap established by the demand curve. The minimum block size will be one MW and the offer curve of each qualified capacity asset formed with price-quantity pairs must be monotonically increasing. 8 Rationale Must offer requirements are designed to prevent physical withholding in the capacity market. The AESO s rationale was that a must-offer requirement was employed by each jurisdiction it reviewed (PJM, ISO-NE, NYISO, UK and Ireland). It was decided that requiring all qualified capacity assets to offer into the capacity auction will facilitate competitive prices for all firms and rate-payers. 9 Discussion and Alternatives Must-offer requirements for all resources in the capacity market is an effective tool for mitigating the exercise of market power through physical withholding. Setting aside the possibility of exercising market power by physical withholding by temporary physical delists or retirement delists, both of which are addressed in a later section, this provision should eliminate concerns over physical withholding of existing capacity into the market. 6 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 3. 7 AESO. Comprehensive Market Design 2 Rationale Section 5 Base Auctions. April 24, p 33. Firms will be able to indicate whether blocks are flexible or inflexible. The AESO requires information on block flexibility for market clearing. Firms are allowed to identify an offer block as an inflexible block, which enables firms to prevent capacity assets that are under development from partial clearing and possibly requiring the firm to resize the asset. This option also allows firms to ensure that assets with a minimum stable generation level are able to ensure a minimum level of cleared capacity volume and the stable revenue associated therewith. To reduce computational complexity in the auction clearing algorithm, after a firm offers an inflexible block for an asset, all the higher priced offers for that asset have to be flexible. 8 AESO. Comprehensive Market Design 2 Rationale Section 5 Base Auctions. April 24, p 3. 9 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 3. Page 6

12 A related secondary concern is the possibility that incumbent generator asset owners in the Alberta market will decline to develop new capacity even if doing so would be indicated by the market economics. An existing firm would undertake such behaviour if it felt that developing and offering such capacity into the capacity market would lower prices in such a way that it would decrease overall margins. This is a form of physical withholding that is more complicated to detect and more difficult to remedy. Such behavior would only be possible if incumbent firms were able to raise barriers to entry for new competitors, otherwise these competitors would develop the economic capacity. Ex post review should consider this possibility when analyzing the competitiveness of market results. If it becomes apparent that new economic entry is not taking place when it should, the appropriate entities should assess barriers to entry either as raised by incumbent firms or known to be systematic to the marketplace and take corrective measures as appropriate (e.g., reforms targeted at reducing market concentration). Role of Market Monitoring Entities It should be straightforward to verify whether a resource has offered its capacity into the auction. This verification task is likely best done by the AESO, the market operator, as this entity has the most immediate visibility into both resource offers and the registered set of resources. However, the MSA is well-suited to monitor the overall direction of the market, including taking a role in identifying potential barriers to entry as described above. This could be done either as part of periodic reviews of the market, or through ad hoc analysis as necessary Market Power Screens and Thresholds Proposed Provisions in CMD2 The market power screen proposed by the AESO in CMD2 is a structural test that is designed to identify those firms that have a portfolio of UCAP large enough to profitably exercise market power. An ex ante market power screen will be applied by the AESO prior to each base auction in an attempt to identify which firms may have the ability to profit from a 10 percent increase in the capacity market clearing price by economically withholding capacity volumes. The AESO conducts the screen by calculating the minimum portfolio size in UCAP that is able to profit from an increase in the auction price of 10 percent or more achieved by economic withholding. The 10 percent change in price will be measured by taking an average of the change in market price above and below the demand curve inflection point. 10 The supply curve is not considered. If a firm fails the market power screen it will receive a notification from the AESO prior to the commencement of the auction. The failing firm(s) will be subject to market power mitigation measures, as described in the following sections. Per CMD2, the market power screen will not be applied to rebalancing auctions. 11 Exhibit 1 illustrates the impact of economic withholding on capacity clearing prices. 10 Capacity Market Design Working Group. Capacity Market Power Mitigation. AESO. May 2, AESO. Comprehensive Market Design 2 Proposal - Section 7 Capacity Market Monitoring and Mitigation. April 24, p 1. Page 7

13 Exhibit 1: Economic Withholding Diagram Rationale In order to develop the market power screen, the AESO, through a report commissioned from the Brattle Group, studied the level of market concentration that currently exists in the Alberta market. The study determined that five firms currently control over 70 percent of supply on a UCAP basis, with the top two firms controlling nearly 45 percent of total supply. 12 From there, the assessment determined the portfolio size at which a firm begins to have the incentive to withhold capacity to exercise market power. That assessment seeks to determine how large a firm would have to be to sufficiently drive up prices by withholding some owned capacity, all while having sufficient remaining capacity clearing in the market to create a net benefit from the increased price (despite the revenue reduction from un-cleared units). The study results are dictated by the shape of the demand curve, which determines how responsive price will be to a chance in supply caused by withheld capacity. Analysis to help determine the proposed provision was conducted using six different demand curve shapes that were each, at some point, under consideration for the capacity market. Table 2 in the AESO s CMD2 rationale document illustrates a series of different demand curves that were analyzed with price caps ranging from 1.6x net-cone to 1.9x net-cone. The analysis ultimately used to set the proposed threshold relied on the demand curve proposed in CMD2, which applies a price cap of 1.75x net-cone and a resource adequacy target of 400 MWh of expected unserved energy ( EUE ). In the example provided in the published rationale, a firm with 1,290 MW of UCAP in its portfolio could profitably withhold 110 MW from the capacity auction and increase the clearing price by 10 percent. In general, the results of the analysis showed that a firm with a portfolio size of 1,100 MW of UCAP or greater may have the incentive to withhold capacity from the capacity market. 13 The AESO determined that, though any price increase caused by withholding capacity would lead to price distortion and an increase in consumer costs, setting a lower threshold percentage may 12 Ibid. 13 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 2. Page 8

14 result in over-mitigation due to possible estimation errors of portfolio UCAP values. 14 Ten percent was viewed as an effective threshold that would account for the risk to the participant in employing a withholding strategy while also limiting price impacts to consumers. 15 Under this approach, the AESO s expectation is that firms with a portfolio size of 1,050 MW UCAP would be subject to mitigation. Note that the approach proposed in CMD2 relies on the assumption that the final demand curve shape, when expressed in UCAP, does not differ materially from the preliminary shape of the curve, when expressed in ICAP (as used in the preliminary analysis). 16 Discussion and Alternatives As a whole, the proposed capacity market power screen appears reasonable in its intent, but additional information would be valuable to improve transparency and better allow stakeholders to review the proposed screen and engage with respect to its likely effectiveness and areas for improvement. Furthermore, we are concerned that the test overly focuses on a firm s incentive to exercise market power and not its ability. As a whole, while more information is needed, the proposed screen may be more permissive and less conservative than it seems on first blush. First, the proposed screen assumes that a 10 percent shift in price is the acceptable threshold before withholding becomes a concern. We are not aware of specific quantitative support for this amount, which makes it difficult to completely assess the justification and efficacy of the proposed screen. Second, this approach requires an assumption about a 10 percent increase in price from what? It appears that the answer is 10 percent of the reference price, which is set to 87.5 percent of net-cone. With that in mind, in a year where the capacity auction clearing price would otherwise have been 20 percent of net-cone which, based on other capacity markets, is well within the realm of possibility a price increase of 10 percent of the reference price would be a more than 40 percent increase in the auction clearing price but for whatever market power was allowed. This is a far larger market power-driven price deviation than discussed in the rationale documentation. Thus, we conclude that the test and its rationale may be improved by increasing transparency and revisiting whether the proposed mechanism indeed accomplishes the AESO s stated goals. Finally, it appears to CRA that the test only address incentive to exercise market power, and does not address ability. Market power screens should, if possible, attempt to identify firms with the incentive and ability to exercise market power. At least, as part of their development, there should be consideration to whether the screen is expected to be overly conservative. In this case, it is possible that the proposed screen might mitigate firms that have the incentive to exercise market power, even though they may not have the ability to do so. Such a result would probably be considered over-mitigation. 14 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p Capacity Market Design Working Group. Capacity Market Power Mitigation. AESO. May 2, Ibid. Page 9

15 Though some allowance for a small amount of allowed ability to exercise market power might be warranted, we recommend revisiting the proposed screen. Particular attention should be paid in the screen design to limiting the allowable levels of market power (ability) in the context of the full range of possible market outcomes, while considering both ability and incentive to exercise market power. A more standardized screen, like a pivotal supplier test used in many markets, would increase transparency while making the rules more easily understood by market participants. A further note on the CMD2 proposal: the proposed screen was designed with both a particular demand curve and a particular mix of market participants (and ownership) in mind. Both of those things should be expected to change over time. As they change, the screen and its underlying justification should be re-examined to make sure they remain consistent with the prevailing supply portfolio and any revisions to the demand curve. An effective market design, supplemented with dynamic market monitoring, will ensure that the screens remain robust to changes in the market and market rules. The presence of jointly owned plants is also an issue that should be considered in the context of market power screens and the assessment of which firms have the ability and incentive to exercise market power. Practically, this determination will dictate which capacity should be attributed to which firms when running market power screens. While straightforward on its face, this is a problem that requires some judgement that is specific to the jurisdiction that is developing associated market rules. On the one hand, if a firm is responsible for offering the capacity it controls, 17 and if all communication rules are strictly obeyed, a firm can technically only exercise market power with generation that it controls, even if that generation is only a fraction of an individual plant s capacity. This reasoning would suggest allocating only controlled volumes of capacity to each firm when running a market power screen. However, a more conservative approach might take the view that a firm that owns all or part of a generator, regardless of its stated level of control, can manage to effect some level of control over that resource. This is probably particularly true in the context of capacity market participation, where it would be unlikely that long term decisions about an asset (e.g., delisting or retirement) would be made without all of the owners being involved. Should any of the firms that jointly own a plant have the ability and incentive to exercise market power, they may be able to do so with the whole plant. This alternative reasoning would suggest allocating the full MW of any partially owned generators to all firms that own a share of each generator. This approach is conservative and has the unusual outcome that, were one to use this approach to calculate market shares, the total market shares across all firms would sum to more than 100 percent. Ultimately, this is an Alberta-specific decision about how conservative a screen is warranted, taking into account perceptions about behavior by generator owners and operations, given the other rules and controls that are in place regarding generator operations for facilities with shared ownership. There is another market design issue that arises here, which is locational market power. As the CMD2 proposal is structured, there is no locational component in any market clearing algorithms or prices. If there were, locational market power would be a concern. Nonetheless, 17 Here, we distinguish between ownership and control. As long as a plant s owner fully relinquishes operational and economic decisions to the controller, it is the controlling entity that should be attributed the capacity of a plant for the purposes of market power screens. However, as we discuss, the division is not always this clear cut. Page 10

16 a similar issue remains. A resource that is aware that it is in a transmission constrained location may effectively be able to earn any price that it offers, regardless of how high, if it is needed to fulfill locational capacity requirements. That is a light form of market power. It does not have the negative ramifications of affecting prices for other generators, but it does allow a resource to receive any price it offers to the market, regardless of its underlying economics, and ultimately is a cost to load. Furthermore, and this is a weakness of the location-less market design, no price signal is sent to the rest of the market that additional generation is required within the transmission constrained area, nor is any award (in the form of higher prices) provided to other generators that are fulfilling capacity needs in that area, including higher price signals to prevent uneconomic retirement. Role of Market Monitoring Entities The final ISO rules should clearly lay out the process for conducting the market power screen and the threshold for applying mitigation and aim to reduce ambiguity or room for confusion. Because the market power screen is an important parameter that will impact outcomes for individual asset owners and for consumers, the agency that will conduct the screen may be less important than ensuring there is oversight of the process. And to the extent that the screen parameters are set in advance of the screening process, the primary focus would be expected to be on the assessing the effectiveness of the screen after the fact, and implementing any revisions as necessary. One option is to have only one entity (potentially the AESO) conduct the structural test and provide the results to the other entity (potentially the MSA), with supporting calculations and justification. This would provide necessary oversight while limiting duplication of effort. Another option is to have both entities apply the structural tests independently, and resolve any disagreements before notifying the market participant. Because the screen will likely be mechanical per a pre-established algorithm, this process should result in very few disagreements between the AESO and MSA, if any. It will also be important to consider the extent to which information is shared about participants that fail the market power screen. Providing too much information to participants, especially large ones, could facilitate collusion, but market participants will likely want to know the justification for their offers being mitigated Default Offer Price Cap Proposed Provisions in CMD2 A firm that fails the market power screen will be required to offer all of its existing capacity assets at or below the default offer price cap of 50 percent of net-cone in the base auction. The default offer price cap will apply to a capacity asset located inside Alberta, including demand response assets, as well as external assets under the control of firms who fail the market power screen AESO. Comprehensive Market Design 2 Proposal - Section 7 Capacity Market Monitoring and Mitigation. April 24, pp Page 11

17 Rationale The analysis by the AESO estimated those net going-forward costs that combined-cycle and simple-cycle gas-fired generation resources would need to recover in the capacity market. By making assumptions about how these resources would operate in the energy market and under different mitigation scenarios the AESO determined that a level of 50 percent of net- CONE was the level at which most technologies could recover their full net going-forward costs and reduce the need for assets to apply for an asset specific offer price cap. 19 Discussion and Alternatives The analytics behind the decision to set the offer price cap at 50 percent of net-cone, based on information we have been able to glean from our research, are insufficient to assess the quality of the analysis. If this is an area of significant concern, CRA would propose a deep dive into the supporting analysis after requesting more detail about what was done. 20 On its face, 50 percent seems like a conservative reference price cap. However, we are wary of forming conclusions without supporting evidence. For firms deemed to have market power that control significant amounts of low cost generation, 50 percent of net-cone could wind up being considerably higher than a competitive offer for many resources. Indeed, it may be more appropriate to establish more granular default offer price caps, perhaps with different caps for different types of generators. Setting the mitigated price cap at a higher level could allow for additional exercise of unmitigated market power by firms that have the ability (and incentive) to do so, were they to submit capacity offers at levels exceeding their avoidable costs but below the price cap. Setting the mitigation price cap at a lower level could reduce such risks, but also increase administrative burden as it is likely that more resources will need to make asset-specific showings for above-cap offers. Role of Market Monitoring Entities Presumably, the default price offer cap can be calculated in a simple manner. If this is the case, we believe it makes more sense for the AESO to determine and post this parameter prior to the auction. The MSA should monitor this parameter as part of its broader oversight duties Allowance for Asset-specific Showings Proposed Provisions in CMD2 Qualified capacity assets may have avoidable net going-forward costs higher than the default offer price cap. A firm that fails the market power screen may request an asset-specific offer price cap for a qualified capacity asset with costs higher than the default offer price cap. 21 Avoidable net going-forward costs are described by the AESO as those that can be otherwise 19 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p This is an area where CRA is available to perform additional analysis were MSA to determine that such analysis is required. 21 AESO. Comprehensive Market Design 2 Proposal - Section 7 Capacity Market Monitoring and Mitigation. April 24, p 2. Page 12

18 avoided by the owner of a capacity asset and are therefore dependent upon whether the capacity asset temporarily delists or continues to participate in the markets. 22 In order to qualify for this a firm must submit those avoidable net going-forward costs with supporting evidence to the AESO for review and approval. The AESO will implement measures to ensure submitted costs are valid and reflective of true costs. In the submission the legal owner of the asset must indicate if the cost submission is based on whether the asset would temporarily delist or continue participation in capacity market or energy and ancillary services markets. Depending on which scenario is selected the AESO will consider certain going forward costs where applicable. These costs include items such as labour expenses, admin expenses, fuel availability, etc. and the AESO expects that cost information represents an unbiased estimate of the actual cost to maintain and operate the asset over the obligation period in question. 23 There is a proposed dispute resolution process that follows if firms and the AESO are in disagreement regarding which costs have been considered applicable. 24 If the AESO does not approve the asset-specific offer price cap the offer price cap remains at the default offer price threshold, subject to the outcome of any active dispute. 25 Rationale The decision to use avoidable net going-forward costs as the basis for allowance for assetspecific offer price caps is, intended to more accurately reflect the price at which the legal owner of a qualified capacity asset, without market power, would be willing to offer into the capacity auction. It is an estimate of the marginal cost of making capacity available for the delivery period, taking into account expected margins from energy market operation. 26 Discussion and Alternatives The provisions that allow for asset-specific showings above the default offer price cap are appropriate to allow higher offer prices into the capacity market where justified. As long as there are sufficient controls on the accuracy of the information provided, as there appear to be (e.g., same information used to make internal decisions, validity attested to by corporate officer), the proposed rules should mitigate concerns over exercise of market power through the rules related to asset-specific justifications for economic offers. The elements of the going forward cost calculation included in section of CMD2 are appropriately detailed. We note several ways in which they could be improved. First, there should be allowances that other well-justified avoidable costs might be included that are not 22 AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, pp Capacity Market Design Working Group. Capacity Market Power Mitigation. AESO. May 2, AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p AESO. Comprehensive Market Design 2 Proposal - Section 7 Capacity Market Monitoring and Mitigation. April 24, pp AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 6. Page 13

19 specifically enumerated in the market rules. This provides some flexibility which may be valuable as it is hard to envision the financial circumstances of all plants when drafting a list of costs. Second, while it is referenced indirectly, going forward costs used to justify an asset-specific offer should be net of energy and ancillary services revenue as well as any generating expenses or revenue from associated emissions compliance or sale of environmental attributes (e.g., renewable credits) as appropriate to the asset in question. Finally, there is the issue of how to treat returns on capital. This applies in several ways. For existing capital, the capital carrying costs are not avoidable unless an asset is considering retirement. For resources that require incremental capital expenditures to continue operation, the cost of those capital expenditures and return on that capital is appropriately considered avoidable, at least in capacity auctions before capital is expended. Finally, resource owners may be allowed to demonstrate that there is opportunity cost associated with capital that is tied up in an asset that could otherwise be earning a higher rate of return through other investments. The incremental returns might be included as an opportunity cost in the avoidable cost calculation. Role of Market Monitoring Entities Asset-specific showings have been contentious in the US ISO markets, and rules vary with respect to how markets evaluate cost-based offers. In PJM, the market monitor reviews costbased information and bid justifications submitted by market participants, and the market monitor has contended that only one party, to avoid confusion, should be responsible for evaluating such offers. 27 The process works differently in other US ISOs, including ISO-NE and NYISO. In these markets, the internal market monitor develops cost-based offers, again based on information provided by the market participant. These asset-specific showings are also known as reference levels. In Alberta, the major question to answer is which party will determine the appropriate costbased offer cap, and the nature of the interaction between market participants and the entity responsible for developing the offer cap. Asset-specific showings will likely require communication between the entity and market participant that should be done well in advance of the capacity auction. We do not see an issue with this being done by a monitoring function within the AESO, but note that it could also be conducted by the MSA, and that having it done by the MSA is less likely to raise concerns over independence. Another option is to have the AESO and market participant work together to form an opinion, and notify the MSA of the supporting rationale, regardless of whether or not agreement is reached. This will help provide oversight for the process, and help the MSA ensure that both market participants and the AESO are complying with the ISO rules. If agreement is not reached, there is a question of whether the appeal should go to the MSA before reaching the AUC. There may not be the need for both the AESO and the MSA to develop an opinion on the matter if the market participant may ask for the AUC to review the assessments and make a final determination. 27 See, e.g.,, Jeffery Mayes, Howard Haas, and Joseph Bowring. Effective monitoring and mitigation in the organized wholesale electric power markets, January 5, pp Page 14

20 2.2 Applicability of Mitigation to Delist Bids (and Delist Bid Timing) Proposed Provisions in CMD2 There are three types of delist offers, each of which has its own rules: Temporary delist for economic reasons: Provided for resources that do not intend to retire but, depending on capacity market prices, may not be able to cover their net goingforward costs from AESO market revenues. Such offers may only be submitted in the second rebalancing auction. Economic delist offers required economic justification, presented to the AESO, of net going-forward cost. A resource cannot economically delist for more than two consecutive periods. Temporary delist for physical reasons: Generally for purposes of significant operational restrictions, like long repair outages. Such requests generally must include additional documentation justifying and affirming the need for the physical unavailability. These bids are not subject to market power mitigation provisions. Permanent delist: For the purposes of asset retirement. These bids are not subject to market power mitigation provisions and may not be placed in the final rebalancing auction ahead of an obligation period. Such bids are reviewed for reliability impacts and allowed to proceed if there are no reliability concerns found. Rationale Temporary economic delist bids require economic justification of costs on the basis that a firm should be required to show that it has valid economic reasons for delisting and is not seeking to remove an asset from the market to increase capacity prices for the purpose of benefiting the remainder of their portfolio. 28 Furthermore, more than two consecutive obligation periods of economic delisting are disallowed on the basis that quantities of temporarily delisted supply can distort investment signals by creating uncertainty about the capacity delisting duration and the timing of return to regular operation. Temporary physical delisting does not require economic reviews based on the understanding that such resources are being taken offline for necessary repairs or upgrades and will be returned to service when available. Permanent delist bids are also not subject to economic review. The AESO states that, following stakeholder consultations, it agrees that a legal owner of a capacity asset is entitled to make their own judgement about the economic viability of their assets and whether to retire them permanently. 29 Discussion of Alternatives We do not have any concerns about the market power implications of the temporary delist bid rules, either for economic or physical purposes. For economic delists, we agree that it makes sense to ensure that a resource is not bidding in such a manner as to benefit the balance of its portfolio. If market mitigation procedures are extended to the rebalancing auction, this 28 AESO. Comprehensive Market Design 2 Rationale Section 2 Supply Participation. April 24, p AESO. Comprehensive Market Design 2 Rationale Section 7 Capacity Market Monitoring and Mitigation. April 24, p 10 (section ). Page 15