Markets have a way of adapting to just about any situation and producing some kind of equilibrium. But when that equilibrium defies intuition, questions are bound to come up. Sustained episodes of negative and extremely low prices certainly play havoc with some participants’ balance sheets. Yet others might see them as the perfect remedy to a surplus generation situation. The key question at times like these is what’s best for the system as a whole.
Several related developments have converged on Ontario, forcing to the forefront a series of questions about market pricing. First, the decline of the manufacturing base has cut baseload consumption dramatically and helped to depress prices. Second, strong performances by exésting generators including renewables have contributed to a significant surplus of baseload generation, creating operating challenges for the grid, and a similar effect on prices. And third, the growth trend of the Global Adjustment has made it clear that hourly prices could be seriously compromised as a measure of value.
Adding to these conditions, the IESO anticipates nearly 3,800 MW of new and refurbished supply to come into service in the next 18 months. Ontario’s import/export capability is increasing over the same timeframe and conservation is expected to cut load further. Although the economy will recover, industry is becoming more energy efficient and some industries may never return. Other forces will continue to emerge as our world recovers from the recent recession, and many of these will be unforeseen. All of the price-depressing trends are likely to remain significant over the longer term and at least until the planned shut-down of the coal-fired generation. Together these factors are contributing to a serious decline in the average hourly power price, both now, and in all likelihood, for the near future.
The extremely low prices of recent months have highlighted concerns about surplus baseload generation and the increased maneuvering of nuclear units. Adjusting output from nuclear plants on short notice can challenge equipment performance and have long term implications for overall system reliability. The risk is that too much maneuvering of nuclear units has the potential to increase forced outage rates and potentially make them unavailable at the very times when they are needed most. Providing half of the energy for Ontario’s power system, nuclear units are fundamental to the operation of the grid. In the past, requests from the IESO to maneuver nuclear baseload plant have been very limited. However, more recently the number of maneuvering requests, and the duration of plant de-ratings, have expanded considerably, raising concerns over the long-term implications for plant and grid reliability.
The current dispatch rules used by the IESO could force merchant generators to reduce offer prices considerably in an attempt to avoid inadvisable maneuvers or being dispatched off line. While this reduces operational risk, it creates price risk, which could significantly impact both the merchant generators and the consumer. An open question remains: Would it be good for the market or for the Global Adjustment for a baseload operator to be forced to bid in at such prices just to reduce the number of dispatches?
In his remarks at the Ontario legislature’s recent committee hearings on the Green Energy Act, APPrO’s President Dave Butters noted that “Ontario’s bulk power system is designed for and must operate to meet customer demand in real time – meaning that supply and demand must be constantly and precisely balanced. The introduction of more green - and therefore variable - generation will change the existing paradigm” in which almost all generation is precisely controlled to make electricity when needed. Clearly the increased use of renewables holds a number of serious implications for maintaining the balance and reliability of the power system. This point was brought home for anyone watching the movement of the hourly price over the last few months: exceptionally good performance from wind and waterpower generation helped keep prices down, and affected the dispatch and returns available for many other generators. The growing output from renewables may have unanticipated repercussions in financial as well as operational arenas. For the full text of Mr. Butters remarks, please see “GEA bold, innovative but also ‘game-changing,’” on page 8.
As of the end of April the hourly prices for power in Ontario in 2009 were at historic lows - 3.9 cents per kWh on average. At the same time, total costs to consumers have been rising since 2006 and are likely to continue to do so. As a percentage of total wholesale costs, the hourly price has dropped dramatically, from 80% in 2003 to 50% in 2009, with the steepest decline being in the last few months. Once a rarity, negative prices have occurred during hundreds of hours this year, even as dramatic spikes have also been seen. These may be exceptional circumstances that will be mitigated over time, but the trend is a concern for many.
The health of the market is directly related to the accuracy of the price signal. And while the price signal in today’s market is arguably an excellent reflection of current conditions, the conditions that are factored into today’s price are loaded with imperfections and artificialities. From dispatch signals and the Regulated Price Plan to the imposition of ramp rates, administrative rules affect price in ways that a fully-competitive, properly functioning market never would. It has been widely accepted for some time now that Ontario’s market prices are generally insufficient to support investment in generation. They may also be blunted in their ability to communicate the degree of scarcity at certain times.
By assigning a market-based value to energy savings, prices are supposed to ensure that consumers are properly rewarded for investing in energy efficiency. Prices are also supposed to encourage generators to build the appropriate types and amounts of generating capacity. With power prices at today’s levels however, the system is in effect punishing those brave souls who installed energy saving technology, including smart meters, telling them to wait longer for their payback. It almost forces generators into fixed price procurement mechanisms that pay less attention to market signals, and which will have to rely heavily on administrative rules to determine when to operate. (Witness the curtailment provisions proposed for FIT contracts.) In fact, the problem magnifies itself because in many cases, given that investors can’t assume that market forces will fundamentally determine market conditions going forward, the only way to get significant amounts of new generation for a period of time will be with contracts that continue to insulate owners from certain types of price risk.
While the current price signal may be a reasonably accurate indication of the surplus of baseload generation, it’s probably not telling the whole story in terms of the system’s need for intermediate and peaking generation, particularly as coal is being phased out. In all likelihood non-baseload generation will need to be built for reliability and other purposes, even though current prices might indicate otherwise.
Consumers who think that current prices are OK because they seem relatively steady would benefit from taking a closer look. If the manageable part of the bill, the hourly energy charge, is becoming smaller in relative terms, they will have fewer options in the future when total bills rise.
The good news is that that the market continues to operate and actually adapts to just about any situation. In fact, the market remains fully capable of doing its job, to the extent that the province and consumers choose to rely on it. As it becomes clearer that recapitalization of the energy sector is one of the best ways to address climate change, the public seems increasingly prepared to accept certain kinds of adjustments to the price structure. Whether these changes will push the system further in the direction of competition or away from it, is one of the key questions to keep in mind as options are developed.
During the early years of Ontario’s competitive market for power there were great concerns about the potential for excess revenue. In response to this a system of revenue caps was introduced. Ironically, now that the market has been operating for several years, the net effect of various policies and measures has been to keep prices so low that revenue support rather than caps may be necessary.
Of course, some philosophically minded people will be tempted to ask what’s the purpose of maintaining a wholesale market for power if prices don’t reflect full costs and new supply is largely a result of policy-driven contracting. The fact is, the market still has important roles to play in productive efficiency, enabling efficient decisions about dispatch, outage planning, and a wide range of other operational behaviour. It may not be the fulsome system for delivering all the rewards and discipline that markets are best known for, but it remains a relatively precise and efficient tool for disseminating real time information about real time conditions and the relative value of alternative hour-by-hour operating options.
Getting from the present circumstances to a healthier market will be challenging, but feasible and worthwhile. There will be transitional issues of course. For example, whatever decisions are taken, they must be careful to reward those who respond to market signals in the future, without burdening market participants who for any number of reasons may be in arrangements without full sensitivity to the market now. It is untenable to retroactively impose price sensitivity on a long-term investment like generation if it was financed on the basis of being protected from such signals. Fortunately, the OPA has shown an admirable ability and willingness to design contracts that build in significant amounts of market responsiveness while also respecting the participant’s need to earn a reasonable rate of return commensurate with the associated degree of risk.
In previous issues of this magazine, we have cited a range of technical rules which have the effect of suppressing price. For example:
• Imports are over-scheduled from a cost perspective, and they are not factored into the wholesale energy price. Both the over-scheduling and the under-pricing lead to unnecessary inefficiencies in the market.
• Peak rather than average figures are used for the demand forecast in pre-dispatch, also leading to over-scheduling in advance and market inefficiency.
• The current market design ignores physical restrictions of the transmission system when determining the province-wide price
• A wide variety of wholesale services are paid for through uplift charges, rather than being factored into energy prices
• The 3x ramp rate adjustment artificially suppresses price without commensurate compensation to generators.
• The IESO sometimes takes out-of-market actions that have the effect of suppressing price such as Control Action Operating Reserve
• Setting an artificially low rate of return for OPG, significantly less than the standard commercial rate of return, when operating its facilities
• Absence of any requirement to retire accumulated debt on a fixed schedule. Even the old Power Corporation Act set statutory requirements for retiring minimum amounts of public electricity debt every year
• This remains to be resolved, but generator cost guarantees as currently designed could encourage generators to bid below their operating cost, to achieve dispatch and get side payments, further suppressing price.
As stakeholders think through the current price environment it may be helpful to keep in mind the benefits of accurate price formation:
• Ensuring there are efficient signals for real-time operation
• Distributing appropriate compensation for conservation and energy efficiency
• Minimizing the incidence of inefficient exports
• Improving predictability and “hedge-ability”
• Preventing unstable scenarios of sustained negative prices (especially given that all consumers are expected to pick up the tab for many generators who would be running when prices are negative or extremely low)
• Providing signals for investment in new generation, storage and technology development
• Accurately representing the true value of the commodity.
As Adele Malo of Direct Energy so aptly remarked, “If the price is wrong, nothing else is right.” Today’s low hourly prices may in fact be three things: part of the problem, part of the solution, and a strong indicator of other underlying problems that need to be addressed.
During its difficult childhood the market has been burdened with many artificial expectations. Some measures have been entirely sound and sensible, but rarely has attention been devoted to the cumulative effect of all the rules and regulations. It just might be that the many layers of band-aids on this patient have become their own kind of burden on the system. There’s no doubt that the attention of the hospital staff has been diverted to maintaining the bandages almost as much as caring for the patient.
There are dangers if the system is allowed to drift too far from market forces. Price behaviour will be particularly interesting to watch in this respect in the coming months. Generators, consumers and everyone else want to be responsible participants in the market for electricity. If they are to act responsibly, and rely on the tried and true technique of market pricing for assessing their options, significant repairs to the system will be necessary, beyond the typical band-aids. The specific improvements will take some work to develop, but pretty well everyone will be glad to see action taken to reduce the non-competitive portions of the bill and increase the attractiveness of being price-responsive, for both generators and consumers on the system.
Improving the health of the market, like improving any other kind of health, will require steady attention.
— Jake Brooks, Editor