ONTARIO NEWS

By George Vegh, McCarthy Tetrault

The main argument in favour of capacity markets is that they can be more transparent and technologically neutral than government directed procurement processes.^[1] If capacity markets are likely to achieve these goals, they would provide a valuable change to the current system where resource needs are chosen largely on anecdotal and political grounds. However, if capacity markets are not capable of doing this, then they could be just one more policy instrument used by the government to replicate and expand upon the current approach. As a result, the situation before us is whether capacity markets are the cure to what ails us or will they be just one more complicating symptom.

          In other words, while it may be a plausible hypothesis to claim that capacity markets can make Ontario’s resource procurement process more coherent and efficient, that hypothesis needs to be tested. It is necessary to ask why our province conducts procurements in the way it does and whether instituting capacity markets is likely to provide any improvement.

          In evaluating this, the key thing to keep in mind is that capacity markets are a means, not an end. Also, capacity markets may take many forms and are continually evolving. There is therefore no single capacity market design that is right for each jurisdiction or for each point in time. Evaluating the proposal to develop capacity markets therefore should involve a clear understanding of what goals an Ontario capacity market are meant to achieve, how capacity markets compare to other means to achieve them, and the process by which capacity markets will evolve to meet changing needs as they arise.

          Capacity markets are typically understood as mechanisms to meet resource adequacy requirements. There are other mechanisms that are designed to achieve the same goal, whether procurement contracts (as is the practice in Ontario), regulatory oversight, or more developed energy or operating reserve markets.^[2]

          The immediate question is thus whether there is any reason to think that we will see greater transparency or technological neutrality under capacity markets than under the current procurement processes. In considering this, it is important to bear in mind that procurement processes can also be transparent and technologically neutral. If they have not been, then the question is why that is and whether capacity markets are likely to fare any better.

          The criticism of the current procurement process as it has operated in Ontario is that there has been regular and direct government intervention that has led to a lack of transparency and the government choosing technological winners and losers based on anecdotal evidence and political lobbying.^[3]

          No doubt, the government certainly has been a “black box” issuing directions to the Ontario Power Authority. So it is hard to argue that procurement processes have been transparent. But is there any reason to believe that the government will be more transparent in its dealings with the IESO than it has been with the OPA? It does not appear so.

          The recently passed legislation that will merge the OPA and the IESO clearly maintained all of the government’s directive powers for the new agency. So the government’s oversight over the new IESO will mirror the oversight it exercised over the OPA. As far as I am aware, no one has provided any assurance that the government will be any more hands-off capacity markets than it has been for procurement contracts.

          Further, there is no effective check on the Government’s power to direct the IESO in the same way it directed the OPA. It is helpful to compare this governmental power to the role of government in other capacity markets – PJM, NYISO and NEISO.

          Each of these ISOs is governed by Boards who are elected and accountable to members and stakeholder representatives (including consumer groups). State ISOs are also subject to independent regulatory oversight by the FERC, which has extensive power to approve all market rules – including capacity market rules – by reference to a just and reasonable standard. None of these ISOs are created by or accountable to governments or legislatures.^[4]

          The process of reviewing proposed rules is particularly important because all capacity markets have proceeded by trial and error. There is no single end-state that will work for all markets: “Each of the U.S. capacity markets has undergone substantial reforms in their market design over the years, with redesign efforts often driven by unanticipated challenges or changes in underlying market fundamentals.”^[5] It is therefore crucial to have a process by which the strengths and weaknesses of market proposals and experiences can be tested under open and transparent processes.

          We simply do not have that in Ontario. The IESO is entirely appointed by the government. There are no statutory requirements respecting expertise or representation. IESO market rule amendments are subject to a nominal review by the OEB, which has only 60 days to make a decision on a market rule amendment and must do so by very limited criteria – whether the amendment unjustly discriminates against market participants or is inconsistent with the purposes of the Electricity Act, 1998. As a practical matter, the IESO is only really accountable to the government. It may not be too much of an exaggeration to say that the governance and oversight of the IESO resembles a government agency much more than it does an American-style ISO.

          As a result, the capacity markets in various the United States have been developed following in a process that is completely different than the Ontario system. While the US processes may lead to more transparent decision making the Ontario process almost certainly will not.

          The case for transparency is therefore very hard to make for an IESO capacity market.

What about technological neutrality? Again, the government’s record with the OPA has been to dictate technology by setting out technology specific energy and capacity targets for both supply and conservation.^[6] But here as well, there is no basis for believing that the government will be more technology neutral in the treatment of the IESO.

          For the last few years, the government has published its technology targets through the Long Term Energy Plan (“LTEP”). The LTEP has no legal status or authority – it sets government direction and the OPA has voluntarily treated itself as bound by it. Will the IESO be any different? One does not have to look too far to find the answer.

          The most recent LTEP set targets for energy storage for both the OPA and the IESO; it also contains demand response targets for the IESO. The IESO did not hesitate to design programs to achieve these targets. Further, the IESO’s designs are not technologically neutral – it did not say, for example, that it sought system flexibility or operational capacity that can be met through storage or demand response. Rather, it is designing services aimed at achieving the government’s goals.

          What is particularly striking in these cases was that the government did not even have the authority to direct the IESO to carry out a storage procurement or demand response initiatives, yet the IESO was fully prepared to defer to the government over which technologies and other resource types should be procured. It stretches credulity to believe that the IESO would be more effective at resisting this control after the government acquires its new directive power than it was when the government lacked this power.

          So the case for capacity markets on the basis of transparency and technological neutrality cannot be made out simply by substituting one government agency for another or one policy instrument for another. Rather, if there is going to be a path towards a transparent and technologically neutral approach to procurement, it is necessary to address more fundamental governance issues in the sector.

          Good governance examples are not hard to find. As mentioned, all other North American ISO’s are subject to effective oversight by independent regulatory agencies. Imposing the same obligation on the IESO would at least bring it in line with the status quo.

          Bringing the IESO in alignment with other North American ISOs would involve a fairly simple change to the current legislative framework. As indicated, the OEB’s authority to review market rule amendments is currently limited both in terms of the criteria that the OEB can apply and the time limit to make a decision. Removing those restrictions would be an important step to achieving greater transparency and accountability to IESO procurement decisions. With this type of oversight, transparency and technological neutrality, will at least have a fighting chance. Under the existing structure, it is hard to have any confidence that this would be possible.

Footnotes

1.  See: http://www.ieso.ca/Pages/Ontario%27s-Power-System/Evolving-the-Markets/Ensuring-Reliability-Through-Markets.aspx

2.  See: http://www.ieso.ca/Pages/Ontario%27s-Power-System/Evolving-the-Markets/Ensuring-Reliability-Through-Markets.aspx

3.        For a generalized critique of how lack of independent regulatory oversight leads to decisions on the basis of anecdotal evidence and political lobbying of interest groups see: Cass Sunstein, “Simpler: The Future of Government” (Simon & Shuster, 2013), especially Chapter 7, “Regulatory Moneyball”.

4.        See: Dworkin and Goldwasser, “RTO Governance and Accountability 8,” Energy Law Journal (2007), 543 at 556.

5.        Kathleen Spees, Samuel Newell and Johannes P. Pfeiifenberger, “Capacity Markets – Lessons Learned from the First Decade” in Economics of Energy & Environmental Policy, Vol 2, No. 2 (2013) 1, at p. 20.

6.        For a critique, see: George Vegh, “Energy Planning: The Case for a Less Prescriptive Approach (2013),” http://www.mccarthy.ca/pubs/George_Vegh_Sept23_2013.pdf