Capacity Markets & Resource Adequacy

Foreword

Foreword

This professional reference is one of a series Energy Compliance, Inc. publishes for registered entities and the people who run their compliance programs.

I’ve spent more than thirty years on every side of the bulk electric system. I’ve operated control centers as a Reliability Coordinator, Transmission Operator, and Power System Operator. I’ve audited grid facilities and signed off on findings as a senior compliance auditor. I’ve worked enforcement matters from inside the regulator’s process. For the last several years I’ve advised registered entities directly through the firm I founded.

The entities that do reliability well share a common habit. They take the standards seriously without confusing them with reliability itself. They know that a NERC Reliability Standard is a floor, not a ceiling. They know that compliance is something an auditor evaluates, but reliability is something a system either delivers or doesn’t. They prepare for audits by building programs that survive real questions, not binders that look thick.

That’s the perspective these references try to share. Each one focuses on a single topic. A standard family, an operational function, a regulatory framework, or an emerging industry challenge. Each one walks through how the topic actually works.

These references are written for the compliance manager who wants to understand the system, not just memorize requirements. For the legal counsel who has to brief a board honestly. For the senior operator who’s been told that compliance and reliability are the same thing and suspects they aren’t. And for the new compliance hire who got handed a binder and told good luck.

These references aren’t marketing material disguised as content. They’re the result of three decades of doing this work and watching it succeed and fail. I’ve written them in the same voice I use in a control room or in front of a Regional Entity audit team. Direct, evidence-grounded, honest about what the standards do and do not require.

Energy Compliance exists because most of the consulting offered to registered entities today is structured for billable hours rather than for outcomes. Every engagement is led by one senior practitioner. We don’t bring five people to a meeting that needs one. We automate the work that should be automated. We apply senior judgment to the work that requires it. If that approach matches what you’re looking for in a compliance partner, the back of this reference has our contact information.

If not, the reference still belongs to you. Take what’s useful. Apply it well. And remember the only test that ultimately matters: when the system needs to perform, does it?

Rob Smith, Founder, Energy Compliance, Inc.

EC-WP-402 Capacity Markets and Resource Adequacy Governance

Chapter 1

Statutory Authority and the Emergence of Capacity Constructs Capacity Markets: Governance This volume considers capacity markets from a governance perspective

as opposed to an instrumentation perspective. It covers issues of statutory authority, tariff design, accreditation processes, the scope of regulatory oversight, and the design of market pricing mechanisms and reliability risk. It explores the impact of market constructs on capacity, and the subsequent impact on grid reliability, investment, and the governance of the electricity system.

Resource adequacy is not just a planning metric, it is a reliability requirement that is enforced through regulation and operation practices. Capacity markets are one mechanism to ensure the resource adequacy requirement is met in organized wholesale market environments.

The statutory basis for capacity markets is found in the Federal Power Act. Under sections 205 and 206 of the FPA, the Federal Energy Regulatory Commission (Commission) has jurisdiction over wholesale rates, terms and conditions of service involved in the sale of energy in interstate commerce. The organized wholesale markets are operated under Commission-approved tariffs that are just and reasonable and not unduly discriminatory.

Resource adequacy is a function of reliability obligations rather than rate making. The mandatory and enforceable nature of Reliability Standards under Section 215 of the FPA means that resources must be maintained in sufficient quantities to meet projected peak load and planning operating reserve requirements (POR) to support their designation as reliable resources. The planning and operating reserve standards define the minimum amount of resources that must be available in order to provide reliable service.

The interaction of the various market pricing mechanisms caused structural difficulties in the early development of market structures. Energy-only market designs tried to use prices and incentives derived from energy revenues and scarcity prices to spur investment. Market designers who took demand response and high volatility into account were concerned about the potentially large distortion caused by price caps, by the inelastic nature of demand at high prices, and the wild swings in revenues caused by their mechanisms.

Capacity markets were created within portions of Regional Transmission Organization (RTO) and Independent System Operator (ISO) markets as a forward procurement tool. In these markets, periodic multi-year auctions are held and bidders such as Load Serving Entities (LSEs) and other market participants compete for awarded positions that obligate the winner to provide sufficient megawatts of capacity to satisfy the projected peak demand as well as associated capacity reserves.

The Commission has endorsed a number of construct propositions that relied on the commission’s findings in relation to structured forward capacity procurement reducing the risk of periods of low electricity supply and promoting price discovery in the wholesale market. The tariff has rules in relation to what constitutes a qualified resource under the forward capacity market, the operational standards that are required to be met in relation to participation in the forward capacity market, the penalties that apply in the event of non compliance, and rules for settlement of the forward capacity market.

Capacity markets are structured differently in various organized markets. Some use a centralised forward auction with upward-sloping demand curves, while others have mainly bilateral contracts with a central catch-all procurement mechanism. The institutional details differ, but the underlying principle in all cases is to provide incentives for generation capacity that will deliver the right level of supply to the power system to meet reliability needs.

With the introduction of capacity markets came formalized methods of accreditation. Accreditation involves determining the capacity of the resource that will be attributed to a unit for purposes of providing reliable capacity during peak hours. The early accreditation methods for determining a unit’s reliable capacity were based on past performance and technology class. As base resource mixes begin to evolve and become more diverse, these initial methods will also need to be modified.

Our research discusses the implications of different capacity concepts for governance. While the investment theory focuses on the signalling aspect, our analysis extends to the post-investment phase, focusing on the governance aspects related to market design. Indeed, market design determines the specific obligations that generators have to comply with under various emergency situations and determines associated penalties in case of non-compliance and generators’ incentives for want of congestion. Such provisions are likely to interact with governance and design aspects related to Reliability musts regulating Balancing Authorities and resources adequacy.

Capacity markets are a regulatory response to a perceived adequacy risk in the competitive market. They operate on top of Commission-approved tariffs and are superimposed over the reliability requirements established by the Electric Reliability Organization.

Capacity constructs exist because energy markets do not do an adequate job of managing long-term adequacy risk. Organized markets attempt to separate capacity from real-time energy pricing in order to provide forward-looking price certainty for capacity and provide resource providers with forward-looking price certainty as to the availability of their resources.

The structure of this system has changed over time. Parameters for auctions, the demand curve, locational capacity release constraints, and rules for network capacity accreditation have all been changed in response to developments on the market, in court proceedings and as a result of Commission decisions. Capacity governance is a dynamic process, not a static concept.

The legitimacy of capacity markets is a subject of considerable debate and scrutiny in relation to just and reasonable rates and adequate reserves. The capacity market has evolved in a dynamic process of negotiation between price, prudence and politics.

End-of-Chapter Summary

Capacity markets are the forward procurement mechanisms established under the Federal Power Act to address concerns regarding resource adequacy in organized wholesale markets. They are established pursuant to Commission-approved tariffs and are designed to ensure that appropriate reserve margins are maintained in accordance with reliability standards. The accreditation methods and performance requirements contained in the capacity constructs thereby tie market design to reliability governance.

Chapter 2

Resource Adequacy Obligations and Planning Reserve Constructs

Resource adequacy is a reliability obligation, not a market creation. Utilities have long had the planning and operational responsibility to provide sufficient capacity to meet peak hour forecast loads, plus a margin for reliability, or reserve margin. These obligations remain for all registered resources. For the purposes of reliability, Planning Coordinators and Balancing Authorities must be able to show that the system has sufficient peak load and spinning reserve to meet the anticipated demand and required reserve under all conditions defined in the reliability criteria. The planning reserve margin is composed of several components to provide sufficient reserve to mitigate forced outages, forecast errors and uncertainty of load and generation. These margins are not set arbitrarily. Rather they are based on a determination of the risk that a utility or system is willing to accept, defined by the Loss-of-Load Expectation (LOLE) metric. Loss-of-load expectation (LOLE) frameworks determine the average frequency or duration of possible outages over some planning horizon. Originally, planners generally based their planning on a one-dayin-ten-years expectation, which was often interpreted as an average rather than a minimum standard of service quality. The capacity market is designed to meet this adequacy expectation. Capacity Market – Organized Market Capacity Constructs The capacity markets transform the reliability planning requirement into a financial obligation to pay for capacity. Loads are covered under tariffs, which mandate that Load Serving Entities (LSEs) procure enough capacity to cover peak forecast loads, plus any additional reserve requirement. If an LSE fails to secure adequate capacity, they may be subject to penalty rates for congestion or must have their load curtailed or substituted by the market operator to prevent deficiencies. Reliability standard and capacity market obligations are structurally linked but not the same. The reliability standard obligations cover the resources that must be retained in order to meet the reliability requirements. The capacity market is the tariff based mechanism that is used to exercise the supply side choices in a competitive market environment. The obligations under the reliability standard do not

change because the supply side choices are made through a capacity market. The Planning Coordinator still has the responsibility for assuring that the total portfolio of resources is sufficient to meet the reliability requirements of the grid. Reliability Margin calculations are based on a set of assumptions regarding forced outage rates, planned and unplanned outages, load forecast errors and correlated weather events. These assumptions need to be reviewed and revised as the generation mix changes. The

integration of renewable resources, with their inherent spatial and temporal characteristics, adds additional complexity to the adequacy assessment. Energy storage systems (ESS) like battery energy storage systems (BESS) add another level of complexity. Reliability contribution factors for energy storage systems will vary depending on the time period considered, the state of charge (SOC) assumptions and the dispatch strategy under stressed system conditions. Nameplate rated capacity of these systems does not adequately describe their operational characteristics. Therefore, adequacy modelling of energy storage systems must include probabilistic performance factors. The capacity market operations embody these assumptions in the accreditation process. The capacity resources are cleared for forward capacity markets based on an estimated capacity value, which is a measure of the resource’s contribution to meeting peak demand during high-cost, reliability-constrained hours. Transmission constraints are also an important factor in the resource adequacy framework. In many organized markets, locational capacity requirements are used to ensure that sufficient generation capacity is available to meet the needs of load pockets that are constrained. Zonal or locational minimum capacity requirements acknowledge that even though the RMT may determine that the grid has sufficient aggregate interconnection-wide capacity to meet demand, that does not necessarily mean that the capacity is available in a particular location to support local needs. Prices in certain high-voltage zones could diverge from prices elsewhere in the system due to local transmission constraints and resource adequacy issues. Typically, high clearing prices occur in heavily constrained areas (capacity-constrained zones) due to physical constraints inherent in the high-voltage transmission network and the confluence of planning and market models. Historically, Weather Volatility issues related to the Adequacy Frameworks, Extreme Cold and Hot weather related Correlated Outage risk by fuel type and geography and Peak Demand Related Reliability and Availability Performance issues have not been major concerns. In light of more frequent and severe extreme cold and heat weather events all of these issues are becoming much more important. Recent power grid disruptions and blackouts have driven significant

changes in RTO/ISO procedures for determining accreditation, calculating the reserve margin, and defining RRC performance criteria. The RTO/ISO’s focus on ensuring grid resilience for stressed conditions is a departure from past practice that was largely focused on RRC average performance. Balancing Authorities are still the entities that are on the ground directing real time supply and demand management. Capacity that is contracted forward to help manage supply and demand must also be available to prevent a potential emergency from occurring. The key challenge on the grid under stress is separating contracted capacity from real time operational capacity. Resource Adequacy governance thus implies layered accountability. Planning entities determine the adequacy of resources with a probabilistic approach. Market operators conduct the real time forward supply management activity. Balancing Authorities perform the real time reliability management service. Oversight bodies supervise the respect of the RRM and the rates approved by the regulatory commission. Capacity markets serve a governance purpose. Their effectiveness is heavily dependent on the forecasts of system parameters used for their

design, the accuracy of the accreditation procedures, and the enforceability of the obligations they create.

End-of-Chapter Summary

Resource adequacy is a reliability obligation based on planning reserve margins and probabilistic risk criteria. Capacity markets transform this obligation into an organized wholesale market context by translating the resulting planning needs into a forward purchasing commitment. The processes for accreditation, the locational analysis and the calculation of the reserve all imply a series of reliability assumptions which are then transferred into the market pricing mechanisms to ensure grid reliability.

FROM THE FIELD

Resource adequacy is not a market construct. It's a reliability standard. The market is a method for paying for it, not a substitute for the obligation.

Planning Reserve Margins were calibrated for a different generation mix. With IBR penetration rising and storage variable, the historical reserve calculations are increasingly stale.

A reserve margin that looks adequate on paper can fail in practice when the contingency hits during a tail event. The math has to model the tails, not just the mean.

Chapter 3

Accreditation Methodologies and Effective Load Carrying Capability

Capacity accreditation is the measure of the amount of capacity that a resource can provide or be credited with supplying and vending within the forward capacity markets. It is the metric that is derived from translating the physical and probabilistic characteristics of resource performance into a quantifiable measure of reliability contribution, which can be used as the basis for capacity accreditation and marketing within the market. As the energy production mix continues to change, capacity accreditation remains a key factor in the determination of market outcomes and capacity market governance. Traditional methods of defining the rating of an accredited resource were based upon the installed nameplate capacity adjusted for the forced outage factor. Conventional synchronous generating units were typically assigned a rating equal to their nameplate rating with reference to historical availability factors. This approach was based on the fact that it had been proven over many years of operating experience that synchronous generating units could be depended upon to provide close to their nameplate rating capacity on a reliability basis during periods of peak load demand. The high voltage transmission grid reliability regime was established under conditions where the supply resources were mostly traditional. The variable energy resources such as wind and solar pose significant challenges to this regime. The output variability of wind and solar plants is caused by weather rather than any changes in the grid load or the command signal to the plant. The wind and solar plants may be generating little power during the peak demand periods and their rated capacity may not accurately reflect their actual contribution towards improving grid reliability. Effective Load Carrying Capability (ELCC) is a probabilistic approach that measures the marginal contribution of a resource to the supply reliability of the system. The marginal value of the resource is defined as the additional load that can be supplied with the same level of reliability. The approach characterizes the reliability contribution in terms of the reduction in the expectation of loss-of-load-duration and not by a fixed value of capacity. ELCC is portfolio-sensitive. The marginal reliability

ELCC of a resource is contingent to the existing portfolio. The marginal ELCC of additional solar capacity, for example, will be higher in one portfolio than in another. The effect of increased penetration and in particular evening peaks will further change over time the ELCC criteria for accreditation. Energy storage systems like batteries are ELCC (Energy-Limited Critical Criteria) for duration that is longer than the duration of short peak period. An example is a 4 hour energy storage system that can provide useful

margin of resources during a short peak period but has no marginal capacity to supply energy during a long stress period. These criteria considers the duration of the discharge, along with assumptions of state of charge and the dispatch strategy. Accreditation frameworks should address correlated performance risk. For example, extreme weather could potentially affect all plants in a region or depress output from a number of different fuel sources at the same time. In some cases the assumption of forced outage may be less appropriate given the potential for resource availability to be weather dependent or that plant geography and climate may be correlated. ELCC modeling attempts to account for these broader systemic risk elements. The approach to ELCC in organised markets is also not uniform. Some markets have chosen to apply a class average accreditation factor derived from modelling of the whole system, while others are applying resource specific ELCCs derived from measurements and modelling specific to that resource. These choices represent trade-offs between ease of administration and detailed analysis. The Accreditation method affects the Market Clearing outcome. A lower accredited capacity means that the resource can offer less energy into the forward auctions, and this may have an effect on the revenue the resource can earn and on investment signals. Over-accreditation can introduce latent reliability risks as the expected performance is over-estimated. Recent activities: Compliance with accreditation methods and processes is under increased scrutiny by regulatory bodies. Market operators may be called upon by regulatory bodies to provide rationale for assumptions in their models, datasets used, estimated components such as outage rates and correlation coefficients for the ELCC calculation. The balance between being overly conservative vs. enabling economic activity within the rules is a common theme in stakeholder engagements. Accreditation governance is related to more than just market design. Planning Coordinators, and reliability bodies may also monitor the delivery of capacity by accredited resources to ensure it is delivered in-line with the contracted capacity and as modeled by the resource owner. Should significant deviations from the accredited capacity level be observed, during stress events in particular, this may trigger changes to the methodology used to determine what capacity should be accredited. Extended Low Capacity Factor (ELCC) is not a static measurement and can change as patterns of electricity use and load change over time with increasing electrification and more penetration of distributed resources (DR). Peak periods, for example, may change seasonally or during the day. New accreditation assumptions must be made to account for the new stress conditions on the power system. Static assumptions may lead to incorrect reliability analysis and/or pricing for capacity services. This item links capacity governance and the application of accreditation methods with probabilistic scheduling and tariff based procurement. ELCC is an attempt to bridge the discrepancies between the actual variability of resource supply and the pre-planned nature of the forward market. Decisions that relate to the accreditation of new capacity therefore contain elements of both technical and governance nature. These decisions will impact the levels of the reliability margin, the levels of the investment incentives, and the rules and models for the cost of consumption. A large share of the credibility of capacity markets is also associated to the framework of the accreditation procedure.

End-of-Chapter Summary

Capacity accreditation converts resource characteristics into reliability contributions in a forward looking procurement environment. Effective Load Carrying Capability (ELCC) is a probabilistic method to calculate the additional value of a resource, mostly for variable and energy constrained resources. The assumptions behind the capacity accreditation have a material impact on the prices that are paid in the market and on the reliability margins. These assumptions will need to be revised a number of times during the life of a resource commitment, as the system composition and load shapes change over time.

FROM THE FIELD

ELCC is not a number. It's a function of the portfolio. The same solar resource accredits differently in MISO than in PJM, and the difference is not a calculation error.

Storage accreditation depends on duration, dispatch, and the rest of the portfolio. A four-hour battery in a portfolio dominated by other four-hour batteries clears differently than the first one in.

Accreditation methodologies are revising in real time. A development project signed under last year's methodology may not clear under this year's. The risk lives with the developer, not the market.

Chapter 4

Performance Obligations, Non- Performance Risk, and Reliability Accountability

The Capacity Accreditation Step in Resource Planning Capacity accreditation relates to the capacity of a resource that can be brought into the forward procurement constructs. The Performance Obligation Step follows from that and details the exact requirements that need to be fulfilled by that resource in periods of high system stress. The credibility of a capacity market is not only based on the forward procurement commitments that it is able to create, but also in the degree to which the providers and users of capacity are able to meet enforceable obligations during peak demand periods. Organized capacity constructs define performance assessment hours associated with emergency declarations, scarcity conditions or defined reserve shortfalls. During such periods, a resource is expected to provide generation or capacity in accordance with its contracted level of commitment and/or the system requirement. Non performance may result in penalty payments or deficiency charges. Performance concepts are used to align prices with the needs of reliability. If capacity prices are paid regardless of real time availability, then the impact of forward contracting on reliability preservation will not be internalised. Price penalties aim to make resource internalise reliability risks. On Feb 2, 2018, grid operators implemented a new design for non-performance penalties (NPPs) to address recent stress events. Severe weather events have highlighted the gap between Gen & capacity contract wording and actual Gen & capacity delivered. Some markets have also increased the level of penalties following discoveries of low levels of penalties being insufficient to align generation and capacity market incentives with grid reliability needs. Performance risk varies by resource type. The volatility of VG is more closely tied to weather events which are largely outside of operational control. Energy storage is only constrained by SOCH management on a periodic basis within predefined look-ahead intervals. Fuel supply to thermal plants may also pose an issue in extreme weather conditions. Capacity governance as proposed attempts to account for these variances in resource type performance

risk through accreditation, metering and penalty adjustment. The interaction between Capacity Performance Obligations and Reliability Standards is generally indirect but still material. System operations, including by Balancing Authorities for providing real time supply/demand balance and related reserves, proceed largely as before. If capacity resources perform poorly during stress periods,

the consequence to grids may be marginally worse, potentially requiring the exercise of emergency response measures such as demand response or calling for emergency power or implementing controlled load shedding. These types of actions would likely result in disturbance reporting obligations and could show the vulnerability in resource adequacy planning. The performance of capacity resources has reliability implications that extend beyond economic determination of winners and losers. In market designs, force majeure or performance exemptions are often built into market constructs. The scope of excusable non-performance determines the allocation of market risk and the exposure to reliability risks. Broad exemptions can reduce performance accountability, while narrow exemptions can also impact investment in certain types of resources. Performance evaluation methodologies are generally based on measured output performance data, demand response baseline calculations and defined reference periods. Measurement and settlement processes are an integral part of the trading market. Performance evaluation disputes can impact the regulatory assessment of the reliability of building structure construction. The increasing occurrence of extreme weather events is bringing correlated outage risk into sharper focus. Existing capacity market designs, including relevant FRR designs, generally assume that thermal resource outages are relatively uncorrelated. This assumption is based on the fact that the market designs were initially developed without an acknowledgement of the potential for correlated thermal resource outages, with the occurrence of such events being relatively rare. The occurrence of outages like Polar Vortex and Storm Uri, which resulted in the simultaneous disruption to the fuel supply of multiple generators, is an event that has caused market participants and regulators to reassess design assumptions. Initial governance responses have included the imposition of winterization requirements on resources, a detailed fuel assurance analysis for the coldest regions, and modifications to the penalty structure to address potential correlated thermal resource outages. The boundaries between financial penalties and reliability consequences need to be understood. Financial penalties replace the energy that was not delivered due to non-performance but do not make good the lost MW during system stress conditions. Capacity governance may be aimed at reducing

the likelihood of potential shortage but the guarantee of reliability is still with the generator, transmission system operator and the system planner. Performance constructs that affect investment behavior include the following: - Resources that can sustain high levels of output over the most stressful periods of the year are generally worth more than those that do not. - Technologies that provide a short duration or that are highly weather dependent may be subject to reduction in accreditation and/or increased performance risk. With increasing electrification, the variability and shape of the load curve is changing, which may affect the Performance Assessment Interval (PAI). The concept of capacity and the definition of stress periods may need to evolve in order to ensure that reliability-critical conditions are adequately captured, rather than simply peak load conditions from historical periods. The validity of the capacity market concept essentially depends on the enforceability of the performance obligations and the penalty design. If the performance risk is not properly internalized, the forward purchase only offers

the illusion of sufficiency. Therefore, the governance framework must ensure that the incentives are reasonably distributed among generators, that fairness is maintained for the different types of resources and that operational reliability requirements are taken into account.

End-of-Chapter Summary

This topic is defined as one of the Performance obligations embedded in capacity market constructs to turn forward obligations into binding binding contractual obligation during stressed conditions.Non performance penalties are used to tie the economic incentives to the reliability needs although they cannot replace operational availability and in practice are only used at times of ample supply and low demand: This and the accumulation of performance design, the initial set of accreditation assumptions and the lessons learned from a small number of past extreme events altogether amount to a dynamic policy on resource adequacy within an organized market.

FROM THE FIELD

Selling capacity in the forward auction is not the end of the obligation. It's the beginning of one. The performance hurdle comes during the stress event the market was paid to insure against.

Non-performance penalties under capacity performance constructs are designed to hurt. PJM, ISO-NE, and others have refined the penalty structure precisely because earlier versions didn't.

The capacity payment is in the rear-view mirror by the time the system is tested. The performance penalty is what determines whether the participation was profitable.

Chapter 5

Locational Capacity Requirements and Transmission Constraints

Region-wide aggregate adequacy does not guarantee reliability at individual locations. Transmission constraints, stability limits and deliverability restrictions can all impact the reliability of an individual location, even when the region as a whole is considered adequately reserved, as indicated by the aggregate margin analysis. Therefore, the capacity market must also address locational needs in order to ensure that sufficient supply is available to meet demand at points of transmission constraint. Locational capacity zones are determined by Planning Coordinators and Market Operator through transmission system studies. These studies assess the ability of the transmission system to deliver energy from distant high-voltage resources to load pockets during peak and contingency conditions. Where there are transmission constraints, thePlanning Coordinators and Market Operator may determine a minimum capacity required for a given zone. Reliability justification for locational constructs This argument denies an economic purpose for locational constructs, attributing the necessity for locational constructs to the needs of reliability rather than redistribution. The argument is that a constrained urban load center cannot afford to lack backup resources during peak demand. The constrained urban load center will either have its own reserve capacity of generators, or it must know, a priori, that it will be able to secure sufficient resources from local demand response programs. If the latter is true then capacity governance should be included in the rate structure as part of the assurance provided to the load serving entity. Locational capacity pricing can be quite different than system-wide clearing prices due to scarcity in individual zones that can lead to much higher clearing prices due to the constrained supply of energy available in that zone. The price differential represents risk, and opportunity, for generators to invest in higher margin capacity. Within this governance model, Transmission Planning and Capacity Procurement are inextricably linked. Improved transmission will enable the reduction of constraints and zone to zone capacity enhancements/pricing. Without adequate transmission upgrades, the market will be required to use more expensive local resources for a longer period of time. Deliverability testing is used to determine if a resource is considered capacity within a constrained zone. This testing evaluates the ability of the grid to move energy from the resource to the load under various contingency conditions. Resources that fail deliverability in a particular zone will receive zero or reduced capacity credit in that zone. Distributed energy resources and demand response have further complicated the locational issue. Resources located within constrained load pockets may provide reliability value out of proportion to their size, because their reduction in net load during periods of high peak can have a substantial impact

on grid stability. Capacity markets attempt to price this value in through the use of zonal participation rules. WG01 discussed many of the issues highlighted in the report and particularly the interface with locational governance, environmental/siting policy. Capacity constraints may be exacerbated by limitations on building new capacity in high population density areas and vice versa. Capacity markets address the reliability requirement while navigating the multiple issues associated with environmental and land-use policy. Transmission constraints are not always static. Outages, maintenance schedules, or changes in power flow levels may require revisions to deliverability estimates. Capacity resources rely on dynamic forward-looking transmission models, but it may not reflect system conditions during a stress event. Severe weather conditions will continue to stress transmission resources. Warm temperature constraints, storms causing damage to transmission facilities and stability concerns may all impact the ability to move generation to where it is needed. Locational capacity requirements are a mechanism to address these potential impacts. The main governance challenge is to get the boundaries and minimum capacity values of zones right. In other words to balance too much detail (and thus administrative burden, potential for price distortions and opportunity for rent seeking in boundary negotiations) with enough granularity (too large areas tend to disguise local constraints such as unique topography). Much of the stakeholder dialogue will likely focus on refining zonal boundaries and capacity thresholds. The locational capacity constructs in FRESCO also play a role in retirement decisions. Resources with high value resources in constrained locations are paid higher capacity revenues, which can make continuing operation more attractive. The retirement of a major local generator can also cause significant zonal price effects that call for regional reliability studies and possible out-of-market management measures. This topic addresses the relationship between locational adequacy and reliability standards in a somewhat roundabout fashion. Reliability standards require determination of transmission capacity and contingency performance. Capacity market zonal constructs translate the results of those planning analyses into procurement arrangements that span the forward looking planning horizon. Locational capacity governance thus acknowledges that reliable resources exist in particular places, that reliability is a spatial and quantity metric, and that adequacy is needed in specific locations where loads are served, not just overall in an interconnection. Locational capacity governance recognizes the physical aspect of the grid and acknowledges that what matters to one load may not matter to others in a different location.

End-of-Chapter Summary

Locational capacity requirements address transmission issues that cause reliability concerns on a localized basis even though overall system wide reserves are available above the required amount. The use of zones in capacity markets ensures that deliverable capacity is purchased in the locations where a lack of system transfer capacity creates high reliability concerns and incorporates the results of transmission planning studies into the market process on a forward looking basis. Proper calibration of

the locational requirements is critical to achieving an alignment of market conditions and their corresponding effects on the high voltage transmission system.

FROM THE FIELD

Aggregate capacity adequacy doesn't guarantee local adequacy. Transmission constraints can leave a region short even when the system as a whole is long.

Locational Capacity Requirements exist because the grid is not a copper plate. Capacity in the wrong location is, for reliability purposes, capacity that isn't there.

A development project sited for capacity revenue without studying the locational constraint is a project at risk of stranded capacity. The constraint analysis isn't optional; it's the underwriting.

Chapter 6

Market Design Tension and Reliability Risk Allocation

Capacity markets are a market design mechanism that seeks to combine competition with mandatory reliability requirements. They inevitably lead to structural trade-offs between efficiency and risk aversion when designing the electricity market, which is reflected in the policy choices embodied in the capacity market constructs. These choices determine how adequacy risk is distributed between individual market players, end-users and system operators. In energy-only markets, scarcity pricing serves as the price signal to encourage generators to build new capacity. Capacity markets add a forward-looking component – in the form of contracts – to help stabilize and reduce the uncertainty of investment decisions. The decision to opt for a centralised capacity auction is driven by the policy-maker’s concern that energy prices may not adequately reflect the long-term risks of adequacy. Risk Allocation in Capacity Models is Multifaceted The FCA models include a number of risk components related to capacity. • The Loads and Reserves component relates to the LSEs’ procurement obligations for the anticipated loads and reserves as defined in the RFOAs. • The Generator Stress Risk component relates to the generators’ performance risk during stress periods. • The Auction and Settlement component relates to the market operators’ roles in running the auctions and providing the mechanisms for the buying and selling of capacity in the market. • The Tariffs component relates to the RA’s review of the tariff provisions in relation to the statutory just and reasonable (J&R) test. Ultimately, consumers pay for the capacity market through their retail rates. The size of those payments will depend on the clearing price, the rules governing who is eligible to earn the payments and other market design factors. There needs to be a balance between ensuring reliability and keeping costs in check. Too much excess capacity can lower the reliability risk to customers, but at a higher cost. Conversely, not enough extra capacity may keep prices low in the present, but will then increase the likelihood of a power outage when a major event occurs. Determining optimal reserve margin is an exercise in risk and probability, requiring human judgment and possibly regulation. The interaction of state policy and capacity factors further complicates the governance of this issue. Generation connected to the grid receiving state subsidies, and receiving out of-market payments for their capacity, are included in the capacity market alongside their mitigation reserve capacity. This interaction was the subject of significant hearing proceedings focusing on price suppression, competitive neutrality and state jurisdiction. Where capacity is thought of as a tariffbased FPA regulatory construct, the RA debate necessarily introduces state law generation planning and retail rate-making authority. There is a lot of institutional detail to manage between federal power marketing

function control and state energy policy. Reliability risk allocation is a component of the accreditation assumptions. Conservative accreditation results in less capacity being credited to intermittent or energy limited resources, potentially requiring more and more expensive supply purchases. More aggressive accreditation may preclude the need for supply purchases but increases the risk associated with adequacy if the underlying assumptions are overly optimistic. After recent extreme weather events highlighted the risk of correlated outages across fuel types and geography, markets have quickly responded by adjusting market design rules to enhance incentives and changing the accreditation process to reflect the likelihood that historic outage assumptions are no longer valid. Capacity market constructs that are not related to meeting peak demand also play a role in the retirement and investment decisions made by generators. In the context of forward price signals and the economic viability of aging thermal plants, the capacity market also affects decisions related to the retirement of such plants. The recent reductions to certain technology accreditations could also disincentivize new investment, absent of alternative revenue streams. The governance objective remains the same and the responsibility of both the wholesale and retail market providers. The governance objective is to have sufficient and deliverable resources to meet the reliability criteria. Market design is a tool to meet this objective and nothing more. When the capacity assets fail to achieve adequate commitment of resources in the wholesale market, then additional solutions, similar to current reliability must run (RMR) or administrative solutions like a central procurement program need to be considered. This points to the continued importance of reliability over purity of the market. The reliability metric does not allow for the temporary or permanent lack of available energy reserves in the name of market efficiency and any deviation from the adequacy criteria will have to be addressed by regulatory or market-driven measures. Capacity governance works within a dynamic policy environment. Economic theory, regulatory

language, state energy policy, and reliability standards will all influence the design and modification of the capacity constructs in place at any given time and the endurance of those constructs.

End-of-Chapter Summary

The debate over capacity market design is a manifestation of the broader struggle for how to achieve reliability in the face of what some characterize as radical change. Issues of risk allocation between all load resources, including consumers and utilities, are disguised within the reserve demand response standards, the auction clearing rules, and the performance requirements of the market design. The market design has to be dynamic enough to reflect changing resource portfolios, state policies, and reality (i.e. facts) of stress events so that pre-contingency forward looking resource planning reflects what is needed to provide reliability.

Chapter 7

Extreme Events, Correlated Risk, and Adequacy Recalibration

Historically, constructs for resource adequacy have been based on probabilistic models derived from decades of operating experience. Forced outage rates have been modeled as nearly independent occurrences for different types of resources and locations. However, experience with severe weather has indicated that, at times, there can be a high degree of correlation among outages affecting different types of resources and different subsystems. Recent cold weather and heat waves have highlighted the vulnerabilities and issues associated with the resource fleet including fuel supply constraints, equipment failures due to cold weather and heat stress and thermal performance issues that can impact large portions of the resource fleet at the same time. Heat waves are also putting additional pressure on power system generation, transmission capacity and forecasting. These events are impacting reserve margins in more dramatic fashion than has been considered in traditional reliability models. Correlated risk affects adequacy assessment. If outage probabilities are no longer independent, a larger loss-of-load expectation will be experienced even with adequate capacity under current statistical assumptions. Therefore, more vigilant capacity governance that accounts for worst-case scenarios under correlated conditions is necessary. Current Challenges in the Changing Grid Market Climate Following changes to market design rules and regulations, market operators and Planning Coordinators have been re-assessing their approaches to grid accreditation, setting reserve margin levels and setting performance standards for resources. Utilities that rely on ELCC models are shifting from static forced outage rates based on historical climate conditions to using outage correlations based on real-time weather. Seasonal adjustments to grid accreditation are also being implemented in select regions where winter and summer provide different risk profiles to grid reliability. Fuel security has become a key focus area in the adequacy governance. Thermal plants operating on interruptible fuels may experience increased risk of forced outage during high demand periods when the fuel is not available. Performance standards for capacity resources have

been modified in some markets with increased penalties for non-performance or to address fuel security concerns. The revision to the adequacy standards extends into the field of reserve margin targets and the perceived reliability reserves available to the system. Assessing potential system stress may be considered when determining appropriate reserve margin levels, while increasing the planning reserve margin provides greater reliability margin, but at greater cost. Understanding an operator’s risk tolerance

is a key factor in setting these margins. Demand Forecasting in an Electrified Grid Is More Challenging A changing load profile could be in the cards. With electric vehicles and heat pumps replacing gaspowered cars and heating systems, the peak could move to a different part of the day. The system could also react more strongly to severe weather swings in temperatures. Current load shapes used in adequacy planning may not always adequately describe the most stressful parts of the system’s operating period. Extreme event experience has also highlighted the importance of operational readiness above the installed capacity. Winterization, maintenance reliability and operational coordination become material factors impacting the capacity realization during stress events and therefore need to be incorporated into capacity governance performance metrics. Market monitoring has identified a number of instances where capacity contracts have been reviewed in relation to the events that caused their non performance. Generally these reviews have been driven by the need for resource adequacy to be clearly related to actual availability of resources. In instances where non-performance was identified despite the resource having been procured ahead of time the Market Surveillance Panel has examined whether the assumptions that were made in relation to capacity contracts and penalties adequately reflect the risks associated with the potential for non-performance. Interconnection-wide learning supports the process of grid-wide recalibration. Investigations of disturbances which have identified correlated failures are used to adjust the adequacy planning models. The loop between the observed system performance and the probabilistic assessments of the grid will likely expand as climate related variability increases. Correlated renewable output risk has also been analyzed. Low wind during extended periods and cloud cover during peak hours can lead to decreased variable generation output. ELCC methodologies consider this type of risk through weather data selection and stochastic modeling. The adequacy governance framework has been reformed in line with a changing risk management framework where past records alone are not considered sufficient to cover likely future stress situations. As past climate, power system composition, or demand conditions may not be adequate for covering the unpredictability introduced by climate change, it is essential to use more dynamic and forward-looking analyses and models for determining power system adequacy. Capacity markets need to be dynamic. Static measures such as capacity accreditation factors and reserve margin targets do not reflect the changing nature of risk. Dynamic analysis must evolve and provide assurance that the supply contracts put in place to meet forward looking reliability needs continue to adequately respond to current operating conditions. As nothing has changed in terms of objectives: it is still about providing sufficient and deliverable quantities of energy sources and materials in a credible extreme scenarios context. It is the route that must be adapted based on what is learned from operational experience and experimental analyses in relation to system vulnerabilities.

End-of-Chapter Summary

Correlated Performance Risk Exposure from Extreme Weather Events is a topic that has been a central theme to many discussions within capacity markets over the last several years. Exposure of consumers to extreme weather has brought to light the real and present risk of correlated outages across different resource types. This experience invalidates many assumptions underlying traditional notions of adequacy in electric power systems. These issues have been addressed in capacity markets by adjustments to procedures for accreditation of new resources, by adjustments to reserve margins and through modification of performance criteria. Accounting for correlated risk and looking forward to incorporate anticipated effects of climate change remain key issues to ensure that probabilistic planning and operational reliability are maintained in sync.

FROM THE FIELD

Forced outage rates were modeled as independent. Winter Storm Uri proved they aren't. Capacity adequacy assumptions built on independence assumptions produced inadequate capacity in correlated stress events.

Correlation is the underestimated variable in capacity adequacy. Two units of the same fuel type, in the same weather, often fail together. The reserve margin calculation has to model that.

Extreme events have rewritten capacity market assumptions in every region they hit. The lesson travels: model the tails, then model them again.

Chapter 8

Institutional Boundaries and the Future of Capacity Governance

Capacity markets are established within a layered institutional framework that interacts at the intersection of federal, ERO regulatory authority, regional grid tariff provisions, and state energy policy. The stability of capacity market constructs depends on the interaction within these boundaries. FERC has jurisdiction over wholesale market tariffs, including capacity market designs, under FPA Sections 205 and 206. At the same time, states retain jurisdiction over matters such as generation resource planning, siting and retail rates. Resource adequacy is thus a matter of regulatory overlap or jurisdictional overlap, rather than being fully within the jurisdiction of a single regulatory authority. The federal capacity market rules have been the subject of extensive judicial review litigation focused on the balance between the federal tariff authority and state resource policies. The market mitigation rules, minimum offer price requirements, and participation eligibility provisions all reflect the efforts to preserve competitive market processes while accommodating state policies. This area of litigation also highlights the institutional sensitivities associated with adequacy governance. The Reliability Standards under Section 215 establish rules, or prescriptions, for sufficient resource planning and real-time reserve management. Capacity markets are required to operate within the framework of these prescribed reliability standards. Should the constructs of the tariffs failed to secure adequate resources to meet the reliability standards, the reliability standards are still in place and must be addressed through remedial action. Accountability is built into layers of the Market. Forward Auctions, and the associated market rules, are managed by the market operators. The assessment of the future sufficient margin of the power system resources is carried out by the Planning Coordinators. The real-time reliability running of the power system is managed by the Balancing Authorities. The compliance with the grid reliability criteria by all market participants is ensured by the Regional Entities. The reliability is finally safeguarded at a European level by the Commission with respect to the security of the tariffs applied by the Transmission System Operators. Tension

Arising from Complex Systems When the electrical system undergoes a significant change in generation and load, this change occurs in a world with complex institutional structures that are not always compatible with the speed of change. Changes in the retirement of thermal resources, changes in modeling of inverter-based resources, and growth of distributed resources all have a material impact on adequacy assumptions. The market rules and practices are not always evolved to the level needed to

accommodate new system conditions and the process of stakeholder proceedings and FERC filings to change procedures for accreditation and performance standards may be a material one. Decarbonization policy is increasingly impacting capacity governance. State-level policies, such as renewable portfolio standards, carbon reduction goals and electrification policies are changing the way resources are dispatched and consumption patterns evolve. New capacity market designs will need to balance these policy requirements with adequate reserve resources to ensure reliability. Long-term adequacy planning may have to look beyond the standard three-year forward auction horizon. The development of transmission and large-scale generation projects can be longer than procurement periods in the market. Therefore, the capacity market and transmission planning processes will have to be closely interlinked to avoid any structural mismatch. New resource technologies are a creating a whole host of governance issues. The introduction of hybrid power technologies that provide both generation and energy storage functions mean that assets have to be re-classified in various regulatory frameworks. Demand response aggregation services also blur the distinction between a load and a source. This must be addressed in market design or otherwise in a way that doesn’t compromise reliability functions. Possible capacity governance options and how they may interact with each other in the future include greater planning and operational analytics interplay, improved accuracy of accreditation and reserve targets using advanced probabilistic modeling, high resolution weather and scenario based risk analysis. A possible challenge in this context is to incorporate these analytical components into tariffs with accompanying explanations and communications to consumers. Infrastructure credibility requires consistency between future assurances and current performance. If capacity-based infrastructure continues to fail to deliver expected reliability benefits during stress events, despite initial political assurances, the credibility of the broader framework will be undermined and changes will need to be made to the reform design to restore credibility. Capacity governance development will proceed in an evolutionary fashion with small adjustments made in succession. It is likely that the procedures of accreditation, the

magnitude of performance penalties and the zonal boundaries will all be subject to revision in an iterative fashion. Resource adequacy is still a material reliability obligation. Capacity markets remain one of the mechanisms to secure resource adequacy in organized wholesale markets, and their ongoing efficacy will be a matter of ensuring that Commission regulations, FERC reliability standards, pricing signals and system operations remain in sync with changing FERC regulations and evolving system conditions.

End-of-Chapter Summary

Capacity governance is carried out within a complex institutional setting of layered federal, regional, and state institutions. It requires that tariff-based procurement mechanisms are accompanied by enforceable reliability obligations. Additionally, as resource portfolio and policy objectives change over time, the rules

governing accreditation, performance, and planning coordination must be adapted to ensure that sufficient capacity is maintained and regulatory assurance is preserved.

Glossary

Glossary

In generation and transmission electricity systems a Balancing Authority (BA) is a body responsible for operating the network (i.e., combining each utility’s resource plans ahead of time, providing load interchange and generation balancing services within the region in real time and contributing to Interconnection frequency regulation).

Capacity Market – A tariff-based forward procurement mechanism used by Load Serving Entities (LSEs) and market participants to secure from the resources the capacity required to meet forecasted peak demand and associated reserve requirements.

ELCC – A probabilistic measure of the incremental load that can be supplied by the resource in such a way that it meets the ELCC metric for the associated risk of power loss.

Electric Reliability Organization (ERO) A utility entity that has been designated and certified by the FERC under Section 215 of the Federal Power Act to develop and enforce Reliability Standards for the Bulk Electric System.

Federal Power Act (FPA) The federal statute providing jurisdiction over interstate wholesale electricity markets and establishing mandatory Reliability Standards under Section 215.

Firm Load – Electric demand that is served under normal conditions and is not interruptible except under emergency circumstances.

Load Serving Entity (LSE) The utility that serves the retail load of customers and provides sufficient generation and transmission/distribution capacity to meet the forecasted peak load and reserve requirements called for in the rate tariff.

Loss-of-Load Expectation (LOLE) – A probabilistic metric that indicates the expected number of hours per year that a power system is expected to experience a capacity shortfall over a given planning horizon.

Planning Coordinator (PC) – An entity that performs the function of coordinating and integrating transmission planning and resource adequacy assessments within a Planning Coordinator Area.

Regional Transmission Organization (RTO) – An independent entity that operates the transmission system, manages an organized wholesale market and imposes Commission-approved rates and terms on sellers transmitting power over RTO transmission lines.

Reliability Standard – A requirement that has been approved by FERC as a rule under Section 215 of the Federal Power Act, enforceable and applicable to Reliability Councils and Region electricity organizations that are registered with FERC.

Reserve Margin – The excess of planned available generation capacity above the maximum forecast peak demand level; typically measured as a percentage of demand.

Transmission Constraint : A physical limit of the transmission system that restricts the power transmission between two locations.

About the Author

About the Author

Rob Smith is a senior electric industry professional with over thirty years of experience across every major function of the North American Bulk Electric System. His work spans reliability coordination, transmission operations, regulatory compliance, and cybersecurity reliability.

Rob has worked directly in real-time grid operations as a Reliability Coordinator, Transmission Operator, and Power System Operator within RTO/ISO and utility control center environments. He has also held senior regulatory and oversight roles, including senior compliance auditor and subject matter expert for NERC Reliability Standards. In those roles he audited grid facilities for compliance with applicable standards, evaluated the adequacy of mitigation actions, supported the development of violation notifications and settlements as part of FERC-directed enforcement actions, and participated in risk based oversight of utility mitigation activities.

Rob founded Energy Compliance, Inc. to bring senior, regulator-side compliance authority to registered entities directly, without the layered staffing, billable-hour overhead, and generalist advice typical of larger consulting firms. Every Energy Compliance engagement is led by Rob personally.

About Energy Compliance, Inc.

About Energy Compliance, Inc.

Energy Compliance, Inc. is an independent consulting and advisory firm focused exclusively on electric reliability, cybersecurity reliability, and regulatory compliance for organizations connected to the North American Bulk Electric System.

Our work supports registered entities, including Generator Owners and Operators, Transmission Owners and Operators, Reliability Coordinators, Balancing Authorities, and Distribution Providers. We work across NERC Reliability Standards, FERC orders, RTO/ISO market participation rules, Regional Entity oversight, and state regulatory frameworks.

We do this work differently than larger consulting firms. Engagements are led by a single senior practitioner with regulator-side experience. We don’t staff for billable hours. We staff for outcomes. Our deliverables are written to be operationally executable and audit-defensible, not to manufacture activity. Where automation can replace manual work, we build the automation. Where senior judgment is required, the senior is in the room.

Energy Compliance is not affiliated with, sponsored by, or endorsed by the North American Electric Reliability Corporation, the Federal Energy Regulatory Commission, or any Regional Entity.

Services Provided

Our services are written to be clearly defensible. Operationally executable in real time. Audit-defensible at compliance review. Every deliverable is structured for the auditor’s question, not the consultant’s binder.

Energy Compliance services include, but are not limited to:

• NERC reliability and compliance advisory support
• Reliability governance and program assessments
• Registration and applicability analysis
• Operational and engineering reliability alignment
• Compliance program design and improvement
• Audit and enforcement support (non-advocacy)
• Mitigation planning and Self-Report development
• Training and executive briefings on reliability frameworks
• Regulator-perspective program reviews

Each engagement is scoped to the entity’s role, function, and bulk system impact.

ENERGY COMPLIANCE PROFESSIONAL REFERENCE

Rigorous Compliance. Defensible Programs. Energy Compliance, Inc. partners with registered entities on the institutional and technical questions that define strong reliability and cybersecurity programs, from classification through audit through enforcement response.

N ERC CO MP LIANC E S ENIO R ADV ISO RY Program support, interpretation, and audit Direct engagement on complex reliability preparation. questions.

I ND USTRY ENGAGEMENT AUD IT D EFENSE Standards development and working-group Notice of Penalty response and settlement participation. posture.

CONNECT WITH US Scan to visit

E N E RGY COMPL IAN CE , IN C. · EC-WP-402 · © 2026 · AL L RIGHTS RES E RV E D