How Capacity Markets Are Reflecting Climate Mandates

In many industries, a business failing to earn targeted rates of return may choose to shut down and exit the market. If this happens in the electricity sector, however, we risk not having enough generation available to meet peak demand, for example, during a heatwave or other extreme weather event. This is where the NYISO’s capacity market comes in, providing economic incentives to generators for the reliability benefit they provide.

Electricity needs and consumer demand fluctuate throughout the year and across seasons in response to changes in the weather, economic conditions, and the use of emerging technologies. Put simply, while typical system conditions may not require drawing power from certain units, the capacity market seeks to ensure sufficient generating capability is available if those conditions suddenly change causing an increase in consumer demand.

Installed Capacity in the Wholesale Electricity Market

Unlike other markets where production can be ramped up readily to meet demand, power plants take a great deal of time to permit and construct. They also have technical specifications and limitations that determine something called “installed capacity,” or the amount of electricity a unit can produce. If the overall total of installed capacity on the grid is less than peak electricity demand, we risk outages on the electric system when demand outstrips supply.

The NYISO Capacity Market compensates resources for being available to produce energy, even if they aren’t regularly selected in the day-to-day energy market auctions. Seasonal capacity auctions establish a price for installed capacity based on the expected demand for electricity and the amount of capacity available to the system to meet that demand. The capacity market price seeks to ensure resources are available (or on “stand by”) when they are needed. In this way, the NYISO-administered markets support grid reliability during peak demand.

Capacity Markets and Public Policies

In New York’s pursuit of its nation-leading climate goals, lawmakers and regulatory agencies have instituted policies to reduce our reliance on fossil fuels. These policies are directly influencing the Capacity Market. Here’s an explanation of how:

Electrification

Historically, much of our infrastructure was built with a reliance on fossil fuels, like gas-powered cars for transportation and natural gas-powered home heating systems. Electrification policies aim to replace gas-powered cars for transportation and natural gas-powered home heating systems with electric cars and heat pumps for heating and cooling.

State policy mandates aim to reduce New York’s reliance on fossil fuels but will also increase the demand for electricity, as more people rely on electricity for things they didn’t before. Historically, winter season demand for electricity in New York has been lower than the summer, as people turn off their air conditioning and switch on their gas or oil burning heating systems. However, electrification will alter this pattern, increasing electricity demand year-round as consumers switch to electric heat.

The challenge and risk of moving too fast with this transition, however, is that if the rate of electrification increases electric demand faster than the addition of new installed capacity, the likelihood of a supply shortage increases. While a heat pump can be installed in a day, it can take a new generating facility years to come online and connect to the grid. That’s why a coordinated, careful transition of the electric system is so important. Additionally, clean energy that supplies the grid, like wind and solar, are also weather dependent, so building additional capacity above the installed capacity of fossil resources and building other types of resources will be required to maintain reliability. Let’s look more closely at this challenge.

Decarbonization and Renewable Energy

Fossil-fuel generators produce something called dispatchable energy, or a source of electricity that can adjust power output supplied to the grid on demand. This is helpful to serve reliability in response to quickly changing conditions on the grid. Renewable generation, on the other hand, is intermittent, and dependent on weather conditions. Changing weather conditions may prevent intermittent energy sources from reaching their full output. Consequently, a renewable energy grid means that more installed capacity and other types of dispatchable generation are necessary to keep the grid reliable.

Retiring “Peaker” Plants

Some policies such as the NYS Department of Environmental Conservation’s (DEC) “Peaker Rule” seek to help decarbonize the grid and improve air quality by introducing stricter environmental standards for fossil-fuel burning power plants. A majority of the year, peaker plants sit idle – not burning fuels, and not emitting pollutants. However, they are also compensated through the Capacity Market to remain available to the grid for periods of high demand, extreme weather days, and to keep the lights and air conditioning running for New Yorkers.

Per the DEC’s stricter standards, many peaker plants have determined that compliance with the rule is too costly or infeasible and have indicated their intent to shut down. As they do, the grid will see additional decreases in the supply of installed capacity. This may result in the need for more generation to maintain reliability, especially in areas such as New York City where a shortage of transmission infrastructure can challenge deliverability of supply on days of peak demand to meet demand.

For additional information and discussion on next steps if a reliability need is found on the system, please read our Short-Term Assessment of Reliability (STAR) report for the first calendar quarter of 2023, released in April 2023.