The Distributed Energy Financial Group (DEFG), a specialized financial services firm, and the Center for the Advancement of Energy Markets (CAEM), a non-profit energy policy think tank, released a 80-page study last week entitled “Resource Adequacy and the Cost of Reliability: The Impact of Alternative Policy Approaches on Customers and Electric Market Participants.”

Many regions of the United States have enacted or are considering the imposition of “generating reserve” or “resource adequacy” requirements to ensure higher electric reliability levels. The study concludes that this regulatory approach: 1) results in considerable costs passed onto consumers over and beyond the current costs; 2) treats all consumers the same regardless of their preferences to pay for more or less reliability; 3) undermines other public policy goals, e.g., the creation of competitive markets and the ability for consumers to respond to changes in electric prices; and 4) disproportionately impacts market participants, providing subsidies to electric generators and potentially increasing costs to marketers and utilities that do not own generation.

“We conclude that both regulated and restructured electricity markets tend to maintain unnecessarily large reserve margins that impose net costs on customers,” stated Ronald Sutherland, one of the primary authors. “That is, the value of improved reliability due to reserve generating capacity is much less than the cost of providing this capacity.”

The study recommends that market-based approaches to improving reliability–-including market-based demand response initiatives, distributed energy and moving towards an energy only market (with limited or no extra capacity costs fixed for reliability)--be adopted or phased in to more closely link consumer preferences and consumption levels with costs. Specific recommendations include:

  • With regard to operational reliability, replace annual capacity obligations with a short-term capacity reserve margin, and match capacity reserves to expected peak generation plus a reserve margin, during a short planning period (months, not years). The expectation is that alternative, less costly means, e.g, energy efficiency, demand response and distributed energy, will develop to meet resource adequacy needs, at least in part, within shorter timeframes. Resource adequacy in the longer term will be come on line through market based pricing solutions that attract capital to build generation, transmission and distribution assets.
  • Link the marginal cost and marginal value of reliability to customers; do not set a reserve margin by “rule of thumb.”
  • Allow wholesale prices to float and to accurately reflect the marginal cost of supplying electricity.
  • Eliminate barriers to developing a price-demand response market.
  • If necessary, set larger capacity reserves during the transition to a competitive market (for example, when prices are capped) and reduce or eliminate the capacity reserve once the market is competitive and/ or the artificial caps have been removed.

“Economic efficiency and consumer benefits cannot be achieved if we attempt to build a competitive market on top of the foundation of an inefficient capacity market,” concluded Nat Treadway, the other principal author and a DEFG managing partner. “By relying more on market-based solutions, $19 billion in potential costs savings translates to putting back over $60 annually in every American’s pocket while maintaining high levels of electric reliability. That’s a goal worth pursuing.”