The Capacity Market's Role in Grid Reliability: Frequently Asked Questions

New York State is making a historic move towards a zero-emissions grid by 2040. As the grid operator in New York, the New York Independent System Operator’s mission is to operate a reliable electric grid, even as it transitions to new clean energy technologies. But how are state policies like the Climate Leadership and Community Protection Act (CLCPA) and the Department of Environmental Conservation’s (DEC’s) “Peaker Rule” impacting markets? How is the NYISO adapting its markets for the grid of the future?

The NYISO’s Capacity Market, which is critical for maintaining reliability, is already beginning to reflect signs of the transition. Capacity is the amount of electricity a generator can produce. Strict reliability rules in New York State require utilities serving electricity consumers to procure enough capacity to meet peak demand plus a reserve margin. Utilities can procure capacity directly from suppliers or through the capacity market auctions administered by the NYISO.

The NYISO’s Capacity Market competitive auctions facilitate the purchase and sale of capacity between wholesale suppliers and utilities or other retail providers. These auctions enable utilities to procure the least-cost mix of capacity resources available to meet these reliability obligations. The capacity market compensates suppliers to be available to serve the grid when needed, meaning at times when energy demand is low, many of these generators may sit idle, not actively supplying energy to the grid. The capacity market enables NYISO’s market participants to provide and procure the capacity needed to meet reliability standards in a transparent and cost-effective manner.

The State’s climate and clean energy mandates are adding to the challenge of ensuring sufficient supply is available to the grid. With an increased reliance on intermittent resources such as solar or wind power, the system must maintain sufficient capacity to provide energy when the sun is not shining, or the wind is not blowing, which increases the reserve margin.

To learn more, read the following FAQ:

What is capacity? What is resource adequacy?

Capacity is a measurement of the electric output that a supplier can produce. Resource adequacy is a term used to describe the ability of the electric system to supply electrical demand while meeting all energy requirements, taking into account system capabilities and expected demand levels.

The New York State Reliability Council (NYSRC) establishes, on an annual basis, the level of capacity needed to preserve statewide resource adequacy. It establishes the system’s reserve margin that accounts for the performance of available supply resources, transmission capability, and expected demand. Utilities serving customers throughout the state then must procure the amount of capacity required to meet the peak demand plus the reserve margin. NYSRC’s IRM is submitted for review and approval by the Federal Regulatory Commission (FERC) and the New York State Public Service Commission (NYS PSC).

What is the NYISO-administered capacity market?

The capacity market is the means by which market participants purchase sufficient supply to meet expected peak demand plus the installed reserve margin established by the NYSRC. Capacity is bought and sold through auctions as well as individual contracts between utilities and suppliers.

NYISO capacity auctions are conducted on a seasonal and monthly basis, with seasonal auctions for the summer capability period (May through October) and winter capability period (November through April). Monthly auctions provide additional opportunities for capacity purchases and sales. Lastly, the NYISO’s monthly “Spot auctions” ensure that all capacity procurement obligations are adequately secured.

What is the role of capacity markets in supporting reliability on the energy grid?

Imagine a mild day in April. Temperatures are in the 60s, winds are calm, and the warmth and light of spring leave rooms naturally lit and comfortable. As a result, demand on the grid is relatively low, with power needed to supply everyday appliances and activities.

Now imagine a hot, humid day late in July. The grid still needs to supply those everyday appliances and activities. But as the temperatures rise throughout New York, air conditioners start humming, adding to that everyday demand. In fact, peak demand on days like these could be twice as much as what it was on that mild April day. The capacity market provides incentives for supply to be available to the grid to meet these higher-demand days even if they are not dispatched to supply the grid during the lower-demand days.

How do you know how much capacity is needed?

The amount of capacity needed is set every year by the NYSRC when it establishes the Installed Reserve Margin (IRM) for the system. The IRM is used to quantify the minimum capacity required to meet the “resource adequacy” reliability criterion set forth in the NYSRC’s reliability rules. The IRM represents the minimum level of capacity, beyond the forecasted peak demand, that utilities and other energy providers must procure to serve their customers.

The IRM for the 2023-2024 capability year is 20.0 percent of the forecasted NYCA peak load, an increase from 19.6 percent last year. Based on a projected summer 2023 peak demand of 32,048 MW, the IRM requirement for the summer capability period is 6,410 MW. The total installed capacity requirement for the summer capability period is 38,458 MW.

How does the capacity market work?

The NYISO’s capacity auctions select the efficient mix of capacity available to meet system reliability by maintaining resource adequacy. Auctions are held in an open and competitive process. The capacity market requires energy providers, such as utilities or other retail electricity providers, to purchase sufficient capacity to meet their peak demand reliably. In seasonal and monthly capacity auctions, suppliers submit offers to reflect the cost of their available capacity, and utilities and other retail providers submit bids to purchase it.

In these seasonal and monthly capacity auctions, these offers are ranked by cost from lowest to highest, selecting the least costly resources first, and then continuing to select supply resources until the total demand is met reliably. This means that demand also influences prices – lower demand levels result in selecting lower-cost resources in the rankings. Higher demand levels mean higher-cost resources need to be selected to meet demand reliably.

In monthly capacity spot auctions conducted by the NYISO, any unfulfilled utility capacity obligations are met through an auction process that employs administratively set, FERC-approved capacity demand curves. These auctions are conducted in a way that minimizes costs, supports cost transparency and predictability for supplies and consumers, and supports reliability.

Due to transmission limitations that restrict the amount of capacity that can be delivered into certain regions of the state, the NYISO also establishes locational capacity requirements (LCRs) for the Hudson Valley, New York City, and Long Island. That means a certain percentage of the capacity supplying these regions must be physically located within the region. Due to the limitations of the transmission system, these regions would face reliability concerns during periods of higher demand without sufficient local generating capacity.

For the 2023-24 capability year, the NYISO established LCRs of 85.4% in the Hudson Valley region, 81.7% in New York City, and 105.2% for Long Island. Given the reduced availability of generation in the New York City area due to generators’ compliance plans for the DEC’s Peaker Rule, capacity market prices are expected to be higher than in recent years, reflective of the tighter margins.

What kinds of resources does the capacity market support?

Capacity suppliers are often conventional generators but can also include demand response providers as well as clean energy technologies like battery storage, wind and solar generation. As the resource mix transitions towards more wind, solar, and storage, each technology’s contribution to reliability may change over time.

Historically, the performance of conventional generation meant that grid operators could rely on these generators to deliver most or all of their generating capacity when needed. Further, conventional generation provided grid operators with flexible tools to manage transmission constraints by adjusting generator output in response to changing system conditions. With renewable and storage resources, this relationship between a generator’s overall capacity and what amount of that capacity will be available on demand no longer exists.

Further, the value of these types of resources in meeting reliability needs is also very dependent on the diversity and performance of the resource mix. To function properly and retain the types of resources that provide greater certainty and flexibility, the capacity market must accurately reflect the reliability contribution of resources. For example, as more behind-the-meter solar generation is installed throughout the state it will suppress demand on the grid, shifting peak demand periods to non-daylight hours. One result of this shift will be that grid-connected solar will offer less value to resource adequacy needs.

What are the current factors influencing capacity prices?

The price of capacity in the NYISO’s market reflects the balance between the expected demand for electricity and the amount of capacity available to the system to meet that demand. Since last summer (2022), roughly 680 MW of fossil fuel-based generating capability retired or will be unavailable to meet summer demand in 2023. These deactivations are concentrated in the downstate region and largely driven by stricter emissions requirements for “peaker units,” or generators that are typically called upon to meet high-demand periods. At the same time, load forecasts suggest that demand for electricity in New York City will be greater than last year, due in part to ongoing economic recovery. The combination of reduced supply and increased demand contributes to higher capacity prices.

Will price impacts be felt outside of New York City?

Economic and geopolitical circumstances are placing upward pressure on global energy prices. But elevated capacity prices reflect more localized circumstances. The thinning margin between available capacity and expected demand is particularly acute in New York City due largely to compliance plans under the DEC’s Peaker Rule and transmission constraints that limit the ability to import resources.

How long might capacity prices be elevated?

In recent years the NYISO has observed that more generating capacity is exiting the system than is entering the system. This trend is likely to continue as additional peaker units exit the system due to stricter emissions limits taking effect in 2025. Further, these retirements and deactivations are concentrated in New York City and downstate regions where demand for electricity is the greatest and reliability rules limit how much the region can rely on capacity imported from elsewhere. In addition, policies promoting electric vehicles and the electrification of buildings will increase demand for electricity in the coming years. Until additional supply that can be dispatched to meet demand is available to the downstate region, capacity prices will continue to reflect the tight conditions.

What has the NYISO done to ensure its capacity market attracts clean energy resources?

To ensure rules intended to preserve competition in the capacity market do not interfere with the state’s clean energy policies, in 2021 and 2022 the NYISO engaged stakeholders and policymakers to revise its buyer-side capacity market mitigation (BSM) measures. If the BSM rules did not evolve, they were likely to interfere with CLCPA policies by mitigating new entrants necessary to achieve New York State’s policy objectives.

In conjunction with BSM reforms, the NYISO also pursued capacity accreditation market rules to reflect capacity market suppliers’ contributions more accurately to resource adequacy. These new market rules allow market compensation for capacity suppliers to be properly aligned with an individual resource’s expected reliability benefit to consumers while maintaining sufficient resources to meet resource adequacy requirements. The groundbreaking proposal was accepted by FERC in May 2022. These reforms serve as a new national model for wholesale electricity market design, addressing long-standing tensions between federal and state oversight of capacity markets while also strengthening reliability and economic efficiency.

The NYISO is currently looking into other ways to enhance our markets, and has outlined its approach through a recent report, entitled The Grid in Transition. The report details a comprehensive approach to redesigning flexible, competitive electricity markets, creating incentives that align with the changing needs of the grid.

How does New York's capacity market differ from those in other regions?

Different regions of the country have taken different approaches to resource adequacy and capacity markets. In fact, some regions, notably Texas and California, do not have capacity markets. Instead of providing capacity payments to secure supplier availability, the market in Texas relies heavily on revenues in the energy market to attract sufficient investment in capacity. Extreme weather in recent winters has driven demand in Texas to levels the grid was unable to supply.

California relies on contracts between utilities and suppliers to ensure enough power to meet demand. Like Texas, California has experienced extreme weather in recent years that resulted in insufficient generation available to meet demand.

And in other regions, including New England and the PJM states, three-year forward capacity markets are utilized in an attempt to procure sufficient capacity to meet demand. Relying on such forward forecasts can lead to risks of inaccuracies and uncertainties for both supply and demand due to unanticipated events such as changes in expected supply levels, and unexpected demand levels.

Is the NYISO preparing its capacity market for the transition envisioned by policymakers and the CLCPA?

An increased reliance on intermittent resources, such as solar or wind, will fundamentally change the manner in which the grid is supplied. It will require new flexible generation to maintain reliability and will require changes in how the NYISO manages the grid.

In conjunction with reforms implemented to facilitate participation in the capacity from clean energy resources, the NYISO also pursued market rules to reflect capacity market suppliers’ contributions to resource adequacy more accurately. These new market rules will align market compensation with an individual resource’s expected reliability benefit to consumers. The groundbreaking proposal was accepted by FERC in May 2022.

Is the role of the capacity market different now that the CLCPA is in place?

The capacity market historically served as a signal to generation owners and investors on whether to keep existing generation in the market and whether to invest in new generation. The CLCPA creates strong policy-based incentives to invest in new supply. With out-of-market incentives driving investment, the influence of the capacity market on these investment decisions is more limited. Increasingly, the importance of the capacity market is in its signal to retain existing generation that will be needed to balance intermittent resources and support reliability.

The pace of deactivations of existing, conventional supply resources is increasing in response to the DEC’s peaker rule, while investments in new supply are increasingly limited to non-emitting resources. This leaves potential investors in conventional supply technologies, even those with significantly lower emissions than generation currently on the grid, without a path forward to make such investments. The result is a risk that higher wholesale electricity market prices will be unheeded by asset owners and investors, leading to higher costs and further reductions in reliability margins.

When reliability margins shrink to the point where reliability cannot be maintained, the NYISO is obligated under its federally regulated tariffs to preserve reliability by preventing the retirement of existing generation until new supply is available to reliably serve customers. Those decisions can be costly and perpetuate the operation of older, higher-emitting resources that are the subject of environmental justice concerns.

In fact, the NYISO estimates that in 2030, when 70% of our electricity is expected to be renewable, the grid will still need more than 17,000 MW of fossil-fuel or other dispatchable generating capacity to reliably supply electricity on peak-demand days.