Gowling WLG lawyers Paul Harricks and Tom Timmins, along with Michael Killeavy, Executive Advisor at Power Advisory LLC and AJ Goulding, President of London Economics International LLC, hosted a live webinar on May 23, 2019 as a follow up to the Canadian Power Finance Conference. This webinar explores aspects of the procurement model in Canada and narrows down on the ongoing consultation in Ontario around capacity markets and alternatives to capacity markets.
Paul: Good afternoon everyone, or good morning, or wherever you may be. I'd like to welcome you to Gowling WLG's live webinar on examining risks and opportunities in Canada's procurement models. My name is Paul Harricks. I'm a partner of the firm here in our Toronto office and I'm the head of our energy practice. We have an interesting hour ahead of us looking at some of the aspects of the procurement models here in Canada. To get started I'd like to introduce you to the people around the table here with me in Toronto who will be addressing the topics of the day.
We have Michael Killeavy, who is well known in the energy sector here in Ontario. He was Director of Contract Management at the Independent Electricity System Operator and is free to [take us] through the Ontario Power Authority from 2009 until 2018. For the past year he's been an Executive Advisor here in Toronto at Power Advisory LLC where he's responsible for providing advice on commercial, contractual and market related matters to clients in the Province in the electricity sector.
We also have A.J. Goulding, who is the President of London Economics International, also based here in Toronto. A.J. began his career providing Natural Gas Market Analysis and subsequently he lived in India for a couple of years advising the US Agency for International Development, "USAID". His experience has taken him all over the world. Every continent is in his CV, except Antarctica. At London Economics he has taken on responsibilities that include project management, marketing and budgeting and financial control. He also serves as an adjunct to the associate professor at Columbia University, from which he has an MA, where he teaches a course on electricity market design and regulatory economics.
And finally my partner, Tom Timmins, who leads our new energy team here in Toronto and across Canada. Tom has been involved in new and renewable energy since the conception of the Ontario electricity market, 20 years ago. He's also Chair of the Canadian Solar Industries Association and has led a number of our firm's largest transactions in the power sector.
Just to set the scene, today's webinar is entitled Examining Risks and Opportunity in Canada's Procurement Models. It's a very broad topic and we only have an hour. So we decided to narrow our scope a little bit to permit a more in-depth discussion. Our principal focus will be on the ongoing consultation in Ontario around capacity markets and alternatives to capacity markets. For those of you who are familiar with Ontario, you recognize that Ontario makes a challenging place in which to move ahead with the procurement of electricity. Observers of the market will recognize that although the Province currently enjoys a surplus of electricity capacity, that situation is going to change over the next few years. One of the principal drivers of that change will be the upcoming shut-down and decommissioning of Ontario Power Generation Pickering Nuclear Plant which provides, at any given day, about 15% of the electricity in the Province and that shutdown is scheduled to begin in 2023. In addition, we have a course of projected increase in the electrification of transportation, which will have an impact. We're also confirming the fact that over the coming years many of the fully contracted assets in Ontario will come off contract. The Ontario market has, for many years, been dubbed a hybrid market, in which a large amount of the generation is government owned and regulated and there've been very few opportunities for the development of a true bilateral contract market. We also have a situation in which the Provincial government has played a very significant role in market design, governance and procurement. Over the past 2 years, the independent electricity system operator has been working with space holders to develop a comprehensive incremental capacity option which is a fundamental component of its market renewal project. In the IESO field, the ICA will provide, in the long term, the most reliable and efficient solution to meet Ontario's future capacity needs by targeting a late 2022 option to address Ontario's coming capacity needs. So with that background I'm going to turn it over to Tom Timmins to help moderate our discussion. Tom.
Tom: Thank you Paul and welcome everyone. Without much further ado we're certainly in a time of change in the Ontario energy market. A.J. Goulding has put a lot of thought into capacity markets, in particular, so I'm going to turn the floor over to A.J.
A.J., I know you have a few slides to show us, so I'll let you take it from here.
A.J.: Great. Thanks so much. In terms of capacity mechanisms we've been deeply involved in the development of the economics in Alberta, as well as in terms of critiquing the evolution of thinking here in Ontario. We've also done a fair amount of economic modeling of the proposals both here and in Alberta. There are a few things that it's important to understand about capacity markets and mechanisms, in general, and also specific to Ontario. Sitting back a minute, what is a capacity mechanism, and why are we considering it here in Ontario? If we think about electricity market designs, we can have a range of alternatives. We can have an energy only market but that requires us to have a high degree of tolerance for price volatility and the ability of prices to go up to value of loss load in certain hours. Or, we can try and constrain these energy market outcomes in ways that are more acceptable to policy makers. But when we do that, we run the risk of there being insufficient money for market participants. The role of capacity mechanisms is often viewed as replacing that missing money. I sometimes think of a capacity mechanism as being a payment for existence, or what you might think of as an insurance premium, in that it's particularly targeted at low load tractor plants that are required for reliability purposes. Now, why are talking about this here in Ontario? Well, Ontario has cycled through a number of procurement models, we started with a wholesale market design, [but] got cold feet with regards to that market design. Moved to central procurement mechanism. We later, simultaneously, had a feed-in tariff mechanism that was in place for several years. As we moved away from fidelity to the long term plan we started to see some over-supply, started to have an understanding that our procurement mechanisms were producing uneconomic results and there was a desire to think about whether there is another way to do this. Given the prevalence of capacity mechanisms in neighbouring jurisdictions, one school of thought has been that the capacity mechanisms will help to avoid stranded costs in the future, help to manage the risk of over-procurement and will ultimately provide for a diversity of resources and technologies that might not otherwise arise in a large-scale competitive procurement model.
What are a few things that are important to understand about capacity mechanisms? Well, first, they are regulatory constructs. They are traditional market in the sense that we're looking at the market determining the optimum level of supply and demand, that we're having unconstrained pricing. In fact these are tightly controlled regulatory mechanisms which set both maximum and minimum prices, in some cases, which set the amounts procured based on policy initiatives. Capacity mechanisms are not a free revenue stream to generators and they are increasingly coming with performance standards that derive penalties if the plant is not available during the period of greatest need. Ontario has released a high level design. There's nothing set in stone about that high level design but there are a few aspects of it which are interesting. The first is that unlike in other jurisdictions the mechanism focuses primarily on incremental capacities. So it is an incremental capacity option and only that incremental amount that's required to serve future projected load is being procured.
Tom: A.J., can you just break that down a little bit for our listeners. What do they mean by incremental capacity? And just before you do, if folks are interested in asking questions, you can click on the top left of your screen. There's a dialogue box there to post any questions. But A.J., we always hear this term, what do they mean by incremental? What are we referring to?
A.J.: Over 90% of current supply is under either a contractual or regulatory model which provides for a high degree of predictability with regards to top line revenues subject to production. What this means is that the market designers have taken a view that these folks are already covered. They don't need anything and their plants are going to continue through the end of their contract or through the end of their regulatory arrangement. Therefore, the plants that are likely to have missing money are those that are needed for future supply. So therefore, the idea is that for new plants, or for upgrades to plants that are off-contract or just to continue operating, they will achieve their target revenue through a mix of energy and capacity revenues. Because of the hybrid market that Paul talked about the hourly Ontario electricity price is certainly insufficient to prompt new investment on its own. So the capacity mechanism is an intent to, when we look at all sources of revenue, provide a signal for new participants. But existing participants that are under contract, or under regulatory arrangements, will not be eligible for capacity payments and will not participate. Now, over time the incremental, in theory, should get larger as contracts fall off and if the government is sufficiently disciplined to force all participants, including those it controls, to finance new capacity off of the capacity mechanism. I'll return to that point in a minute.
Another aspect that's unique about what Ontario is currently proposing, a high level design, is the seasonal aspect in terms of separating the mechanism into summer and winter, and having separate demand curves, that will produce different results. This is interesting but may be more complex to implement. Another thing that is worth following carefully, as the design evolves, is the potential for a multi-year commitment. We see large differences across North America and around the world with regards to potential for a multi-year commitment. My personal view is that getting this right is essential in terms of providing the appropriate signals for new investment. In North America we see New England with the potential for up to a 7 year lock-in, PGM for 3 years. Other mechanisms have no multi-year provisions. The Alberta design does not. UK was much longer. This is a key feature to be watching as the mechanism design evolves.
Tom: Sorry, A.J. Help me understand that. Let's say we have another plant that's come off contract and where do our interests lie there? Just from a private sector perspective, are we looking for a multi-year contract so that we have certainty? Or are we looking for shorter? How do you think that plays out?
A.J.: Well, you raise an interesting question. One of things that the IESO has alluded to in the design documents is the possibility, which would be quite unique, of allowing folks to specify how long they want and then figuring out how to clear an option that has different preferences for life. It's very interesting theoretically. Whether you could make it work is another question. But the trade-off from the standpoint of a policy maker is that you want to avoid locking yourself in for longer terms, if you can help it, because of the potential for changes in cost. But at the same time you're talking about large scale investments, potentially, that need to be financed. Now, if I'm an uncontracted coming off contract I have a few advantages. I've got a site. I have some remaining useful life. I may want to take a strategy of run it until it breaks, until I can't possibly fix it again and so I may be happy with a little bit less length on my contract. Especially if that gives me an advantage over others. In fact, as a … coming off I might actually like the 1 year commitment design because it's going to be a bit of a barrier for new entry. That said, when we look at PGM, for example, which only offers a very limited set of circumstances for a 3 year lock-in, they've seen significant investment. Your view on this question is going to very much depend on the assets that you have and the capabilities that you see.
I do want to note that this is a Province in which we have seen, I'm trying to think of polite ways to put this, policy makers be rather hands-on with regards to the evolution of the sector. For these mechanisms to work you have to have everybody running in the same boat in the same direction. The challenges that we're facing in the US are really because not everybody is facing the same incentives and a significant number of resources are receiving out of market payments. The question for us in Ontario is going to be, as the market tightens is the government going to have sufficient confidence in the market mechanism not to issue directives, to OPG to build, or to otherwise enter into arrangements that occur outside of the mechanism. Because that's going to have an impact on investment signals. I'm not going to do through the deck. I think I have 3 more minutes or so.
Tom: The deck is amazing folks.
A.J.: I'm just going to highlight. If we go to slide 5 because I think that these questions are the ones that anybody should be thinking about as you look at capacity mechanism. We need to know how much to procure. Who buys it? How it's allocated. For what period are the prices known? How far in advance? How are accounts settled? How are other electricity product markets affected? I think that this is a very important point in that each individual generator needs to reach their target through a set of product markets. Those are energy ancillary services, capacity, and possibily environmental attributes. Each generator is going to be different. The market doesn't exist to guarantee every single generator a profit. The market design is not necessarily a failure if one or two or three generators don't make money as a result. It is a failure if it doesn't provide the investment that's required at the time that it's needed to maintain the specified degree of reliability. The challenge that is really facing markets today is what happens as we move to a higher share of intermittent resources in the market. We have some slides here that discuss this but I'm not going to present them in any great detail. Instead what I think we all need to be aware of is that capacity mechanism designs have evolved substantially over the past 15 years. We went through a number of phases where we started to do things like increasing participation of demand response. Thinking about we're buying this capacity, but what do we actually want folks to be obligated to do? Each of these iterations result of new rules. If we're moving towards a world where we have significant zero marginal cost resources, significant batteries, then we have to question what the role of the energy market is going to be, and in turn, where that leaves the capacity mechanism. Because it's possible that a larger, larger proportion of resources will be relying on capacity mechanisms for a greater and greater proportion of their required revenues. Are the market and mechanism designs that we are considering today consistent with what we need for the future, or not? I think that's probably a good segue into your presentation.
Tom: Maybe just before we leave you, A.J., thinking about Ontario's incredible Hydro assets, many of which are coming off contract, is this a possible kind of route forward to them? Many of our contracts aren't ending for 5, 10, 15 years, or are those assets just too big to benefit from something like this? They're basically batteries at the end of the day
A.J.: Yes. So, this has been a topic of interest recently. I think that there's a theoretical and practical response. The theoretical response is, yes. This can work. In order to continue to keep those resources available, these resources they have revenue through ancillary services, they've got revenues from the energy market. The amount that they need in the incremental capacity option is certainly smaller than what a new build would require. Now, if I'm sitting on the other side of the fence and I'm the owner of this portfolio and assets, when they come off contract I'm going to say to the government, "These are unique assets. The capacity mechanism doesn't really reflect the unique value that I provide to the system and I'm deserving of a longer term contract." Now, the government could say, "Look. You know what? We've designed this capacity mechanism to give you that option. Go forth and if you win, great. If you don't, we don't care." There has been no evidence to date of governments being willing to do that for strategic assets.
Tom: I've got a ton more questions and I know that some of our listeners do as well. Before we come back to you, A.J., I'm going to let Michael take the floor. Ladies and gentlemen, Michael Killeavy with Power Advisory. Michael's got some really great perspective on this as well. So, Michael, you take it away.
Michael: Thanks Tom. A.J., you're a tough act to follow. I'll do my best. I don't want you to think that I'm anti-capacity market. I'm just trying to point out that there are some issues. I think that short terms and voluntary capacity, market capacity, however you want to term it, they can help meet some power system needs. But I think the work capacity markets have [presents] some challenges and that is in terms of bringing on new generation. Another particularly, I think, acute here in Ontario, and there's a couple of reasons I'm saying that. The first one, A.J., you were really nice talking about policy makers being hands on. I'll be a little more blunt and just call it regulatory and political riffs. There's a lot of that in Ontario. A unique feature of Ontario is you have a large proportional generation in Ontario about government owned and also regulated. Which you don't have in a lot of other jurisdictions. There's a lack of bilateral contracting opportunities in Ontario. You basically have the IESO, the only game in town. Governing the electricity sector has been an issue for a while. I think it's being brought to the fore more now that the … market renewal project, but I think that this actually accentuates a lot of the risk that generators face. I think also there will be some challenges in financing projects in a capacity market. I'll talk about this a little bit more, more detail. Yeah, there are slides. I'm going to slide 4.
In terms of regulatory and political risk there was a changein government almost a year ago. One of the first things they did was cancel 758 … contracts and now our peak contracts. They haven't achieved a certain milestone in terms of the development of facilities and then I think most strikingly, you haven't heard a lot about this, but I think this is something is actually a little bit more chilling. They actually passed legislation to terminate a contract that they didn't have a right to terminate. That's the White Pines Project in East Ontario. That was pretty dramatic. Having been at the Ontario Power Authority when the Liberals were the last government in power, I was involved in the relocation of the two gas plants because of the hands-on nature of some of the policy makers which cost rate payers, if you listen to the auditor general, around a billion dollars. Political involvement in the sector creates a great deal of policy infidelity and uncertainty for investors. This creates a risk for investors that they really can't control or mitigate anyway. Lenders may be unwilling to lend to projects, or will only do so at an increased risk premium, which will raise the costs of projects for everybody and it may actually defeat the purpose of having a capacity market in the first place.
The second big aspect that I see that creates an issue for capacity markets in Ontario is the fact that there's been, you know, Ontario's largest generator is OPG, that accounts for about 17,000 megawatts of capacity which is about 46% of the capacity in the Province. It's all predominantly rate regulated. There's also an issue I pointed out. When I was there, the OPG board and the IESO board are both appointed by the Minister of Energy, so I believe you could make an argument [that] they're actually affiliates. They're affiliated in some fashion. You have a unique situation where you've got the largest generator of a Province being affiliated with the entity that's actually running it. I think investors might look on this negatively when it comes to making the decision as to whether or not to invest in new generation in Ontario.
Tom: Truly. This is almost ...
Michael: Yes. It would be … Exactly. Half of your capacity is owned by the government. Who else will appoint the board of directors but the guys running the capacity option? There's also a lack of contracting opportunities. Unlike the United States where you've got load serving entities, in Ontario you've really only got the IESO. They are really the main contracting counterparty.... So you don't really have a lot of … opportunities here in Ontario. Those opportunities, they give generators, basically, a way of hedging the risk associated with capacity markets. We really don't have that here. Governance, in terms of the market rules that will need to be implemented in order to create a capacity market eventually, they will be passed by the IESO. The IESO board of directors has had sole authority over capacity market rules. In the US the Federal Energy Regulatory Commission has regulatory oversight over IESO's in US jurisdictions and especially for capacity markets, design change rule amendments, they're all ultimately subject to the FERC review. They have really no transparent and exclusive regulatory proceeding. The government of Alberta has adopted a similar type of process for the capacity markets, the rule changes that are being implemented there right now. In fact I have a colleague that's sitting there taking notes.
Paul: Michael, it's Paul. Do you have a view on whether the ongoing governance review at the OAB is going to have a beneficial effect on what you've just been talking about?
Michael: I think it could if they give the OAB's some kind of regulatory oversight in terms of the market rules. Right now you can charge market rules on some fairly narrow grounds. It can't be discriminatory on some market participants. It can't be contrary to the principles of the Electricity Act and I think, being legislation, the OAB's got 60 days, I think, to make a decision if somebody were to challenge a market rule. I think if they were to broaden the criteria that they couldn't use market rules and also relax that 60-day time period that would be very, very great point, I think that would be seen positively by …
The next slide. Just a short overview of sort of decision making is done with the IESO compared to, say, three US IESO's that have capacity markets. They have a much broader participation. You can see it's in the 100's. Whereas in the IESO you've got a typical panel of 13 where everybody does get a vote, to some extent, the vote really, I would argue with the IESO, it's meaningful but at the end of the day the panel is basically providing advice to the board of directors. The board of directors are the ones actually calling all the shots. Then the three US IESO's, IESO New England, IESO New York and PJM, they are subject to, again, that FERC, Federal Energy Regulatory Commission, oversight in terms of the reviewing the market rules. You do not really have that in Ontario. You do have an ability to challenge market rules but then again the time period is quite compressed and there's only two main criteria which can be used to do that. Next slide.
The last thing that I want to talk about here in terms of the issues. The challenges that I think generators will face with investing in the capacity markets in Ontario. In order to make a project bankable you need stable and predictable cash flow. I just want to go to the next slide, briefly. I asked some of the clearing questions [about] capacity markets in USA and the UK. You can see that they're sort of up and down like a roller coaster. That I think could be a potential problem for anybody wanting to invest in a project in Ontario. There's also an issue with falsified resources primarily in the United States. We've seen recently, with PJM, falsified resources suppressing capacity prices. It's been an issue with PJM. They have a minimum offer price rule, MOPR, which they have applied to new resources. They tried last year to apply to existing resources of all different fuel types. There was a lot of uproar about that and my understanding is that FERC … didn't actually come to a decision. I believe it was last month PJM decided they were just going to conduct the auction this coming August using the existing rules. Another issue with capacity markets is there can be some rather large penalties for non-performance which negatively impacts the believability of these cash flows that these lenders are probably going to want to have reserves set aside to cover off any potential penalties that might crop up.
Capacity markets typically have a shorter time commitment period on the order of a year and that may not be enough time to actually earn enough to pay back your debt and for equity investors. There's also a risk. I was dealing with a client late last year who was thinking about some battery installation for the upcoming ICA and we had to point out to them that you kind of have to clear each year in order to be getting a capacity payment, or even if your capacity is included in the market as being there, you'll end up being a price taker. There's a lot of invincibility in terms of what that revenue is going to be like and is it going to be sufficient to actually pay back your debt and provide something at the end of the day for equity investors. Those are the potential issues that I see.
Next slide. Again, I talked about the suppression of prices, the minimum offer price rule. They offer a cap, I think, in most of the jurisdictions in terms of the maximum price that they are willing to pay for capacity.
Next slide. Terms of procurement alternatives. The majority of Canadian/US jurisdictions ensure resources having to feed through contracts and regulatory regs. ERCOT, a California IESO, MISO, I don't believe have capacity markets.
A.J.: We tend to say that Cal IESO and MISO have different mechanisms that serve the function but they are quite different. We do model a capacity like a product for mid-continent IESO. Both of them have much more, mid-continent, most of the members are under regulated rates. It produces very different outcomes and Cal IESO is a completely different mechanism.
Michael: So the contracts are typically used in all jurisdictions. I think the unique challenge we have in Ontario is that, really, the IESO is the only buyer. There's not a lot of active buyers in Ontario. In many ways wholesale electricity markets are coming full circle. They were originally … dispatched … [for] mainly fossil fuel generation. Then to see money problems partially justified capacity market. As finances change, you're seeing more renewals, more distributed energy resources. Capacity markets, I think, we've seen are fundamentally being challenged. For this reason we think that Ontario should be taking a pragmatic approach to ensure resource adequacy.
Tom: Michael, do you think, you've talked a couple times about load serving entities and that as a model which we have not adopted in Ontario but we certainly talk about from time to time. We talked about LLC's as serving entities, for example. Is there any traction? Do you think there's any momentum at all around moving to load serving entity model in Ontario?
Michael: There has been some talk about it but I think most of the focus now is on the market renewal project. I think it's probably attracted a lot of attention away from that. But in future I think there is probably going to be a push to make the LLC load serving entities. A whole lot of issues around that. But I think it's eventually stop going to …
Tom: A part of it is the government's issue or the ownership issue, the LLC's. That's where I sense challenges.
Michael: In terms of procurement from potential objectives for existing resources I've got a whole long list of these but I don't want to take up too much time. Fairness. We want the ability to compete with other resources. Utilization. You want to maximize utilization of the resources. Revenue certainty. For sure. If you're an investor or a lender or an equity investor you want some revenue certainty. Flexibility. You recognize your resources by fuel types, technologies, vintages, in terms of revenue certainty. You'll probably be commensurate. And also liability. In terms of objectives for new entry resources, again, fairness, revenue certainty, timeliness, you want to make sure they have enough time to actually develop their project. That can be an issue. There's a 3-½ year building period right now. If you're building a new gas plant, I don't know if 3-½ years would actually do it. If you're building a hydroelectric facility, 3-½ years would be a little bit close in terms of that. Risk allocation. Options. And enable project development should be appropriately allocated between the developer and customers and the other entities like the IESO. Bank abilities are the big thing for new entry resources. We already talked about that. Again, reliability. I've got 4 main options for consideration. The energy only markets, which is the situation here in Ontario, Alberta, sub-West Power Pool and I think ERCOT, energy only market. Capacity markets, PJM and NY-IESO, …, …Alberta, … contract from the … regulation. On the next slide I did a bit of a matrix here. It may be hard to read but I went through the various criteria. In terms of energy only markets they are efficient. They do ensure competition. They are transparent. I think where they fall down is when it comes to certain year revenues because that is a big problem in the energy only market. In terms of the capacity markets, they're probably the second best in terms of efficiency. They do promote competition. There is a certainty because you do have commitment period where you do have a fixed amount of money being paid for your price for existing, as A.J. points out. They are transparent. I think contract, they can check all the boxes, in terms of efficiency, competition, implementability, certainly transparency. People may question about competition but I would go back to the days of … … … contracts.
Tom: I think they worked fairly well. So what you're going to be coming off of terms in the next 5 years.
Michael: That's right. And in terms of rate regulation, I mean, re-regulation can deliver all these things. I guess the problem with rate regulation is there is no … Next slide. In terms of fairness, utilization, revenue certainty, flexibility, liability, timeliness, risk allocation and bankability, I think when it comes to energy markets there really is no resource adequacy requirement, in energy only markets. There's a timeliness issue as well, in terms of uncertainty about the availability of the resources, because they're not locked in. 5 minutes to 5 minutes dispatch. Capacity markets, again, they can tick all the boxes. Contract can tick all the boxes. In terms of fairness and rate regulations there are issues there because there is no competition. In terms of utilization utility incentives towards its own assets. There is an incentive there because it's great for rate regulation so they'll have more stuff. That's a bit of an issue. End of the day, this is the last slide, I think that contracts tick all the boxes and I think capacity markets are rate defined.
Tom: Very interesting.
Michael: That's my …
Tom: Thank you Michael. A couple of questions. Who are the stakeholders here in Ontario? Who's calling their minister or calling the IESO? Who's out there that you are seeing who's saying, "Okay. We're interested in this but we want to make sure we …" And A.J., maybe you've seen others in other jurisdictions, who are the players here?
Michael: I haven't really heard that a lot of people are contacting the government. There's a lot of reluctance to contact the government because the government seems to be, I don't know if it's true or not, but they seem to be very much anti-energy right now. They've passed a lot of legislation. They're really trying to discourage people from developing projects. I think people are pretty much sitting back waiting to see what comes out of the detailed … for the IESO, I think next year.
A.J.: I would argue that they're probably sitting back a little bit too much.
Tom: Who should be contacting the IESO?
Michael: I think if you've got a good project at a potentially good capacity price you'd certainly want to make sure that you've got your foot in the door. For sure.
Paul: I sort of get the sense, I'll betray my, I won't say prejudice, but my other hat I sometimes wear as I sit on the board of directors of the Association of Power Producers and we sat around, without telling tales out of school, we sat around the directors table and talked a lot about capacity payments and capacity options and where the alpha members fit into it and I think it's fair to say there's a variety of points of view. I won't betray any sort of cabinet solidarity by suggesting what those points of view necessarily are or attributing them to anybody. But I think there's the real sense that this government, despite some of the things it may have been doing around cancelling contracts, big ones that are legislated cancellations, but they are sort of open for business in a sense that there is a bit of an open door for people to go up with good ideas and good proposals. Although the train hasn't left the station in terms of capacity markets, I'm not sure that it's hurtling down a track that is unstoppable. All of which is to say I think I agree with you A.J. I think there should be more direct engagement. It doesn't mean some of the stakeholders in the industry … …
Tom: I'm thinking of the industry, the Class A customers, particularly on the demand response side. This is a terrific potential resource for them, income for them, it also gives them a chance to potentially [have] batteries on site. I know a lot of those battery projects are planning on that "revenue stack" and this forms part of it.
A.J.: I think that then you have to think carefully. We've talked about the capacity market here in a little bit of isolation without talking about the implications that goes with adjustment, the ICI.
Michael: I was going to mention that. In terms of the reviews. A lot of this is going to come out of the reviews that's going around in terms of investor rates, in terms of how is … adjustment going to be allocated in the future? Are you going to be able to avoid all of it or a portion of it or however it's going to pan out? I think a lot of that will turn on that position that gets made.
Paul: Should we open it up so that participants outside of the Province can participate in our market? Is there any reason why we shouldn't do that?
A.J.: My view is that any capacity mechanism should be technology neutral, location neutral. What you care about, of course, is whether the resource that you're procuring can actually deliver. Can it show up? Is there any double counting? What we don't want is a resource come in from New York, serve as capacity resource and then be subject to an override by IESO. Because if that's the case it should be selling capacity in New York, not here in Ontario. But this is also reciprocal in the sense that there will be resources in Ontario that may be paying for what happens to the Lake Erie connector, for example, want to sell products, and whether that's capacity or renewable products, crosses an interconnection, so I think Ontario needs to think about optimal participation of imports as well as positioning the market rules so that folks in Ontario can take advantage of opportunities across the interconnects.
Paul: Very interesting. Where does our climate change mitigation layer in a capacity market world?
A.J.: Well, these are policy decisions that ultimately affect the prices. Any of these mechanisms can work within the bounds and constraints that are offered. Whether you've got carbon pricing or not, what we're seeing in New York for example, is a goal of moving towards incorporating carbon pricing in dispatch so it shows up really in the energy market. Less in the capacity mechanism. I think that all that can be absorbed, if you will, by the market design.
Michael: Probably lend itself to showing up in the energy markets. Commissions are directly attached to how much you want. Probably makes more sense to incorporate that way.
Tom: Very interesting. Just going back to the seasonal aspect you mentioned in your presentation, A.J., can you just break that down a little bit in terms of Ontario's energy demand and is there anything unique about Ontario that players coming into Ontario need to be aware of?
A.J.: In some ways having seasonal product would facilitate greater participation because when we look at various kinds of resources, various kinds of demand response products, some have a greater ability to provide in one or the other season. We don't want to say, as some of the markets have done, "Okay. We're not going to consider you unless you go out and pair with somebody that's available we know this season." I think we're going to get more participation by having these seasonal products. We've also seen an evolution from winter peaking to dual peaking and back and forth that I think will allow for a more economically efficient set of procurement by looking at these as separate seasons. That said, we also need to balance the administrative complexity against the perceived economic efficiency. It's a bit unique here. I like it in theory. Whether it works in practice is going to be something else.
Tom: Any thoughts on that Michael?
Michael: I would have to agree.
Paul: Michael, question for you. I don't want to speak out of turn but I was seeing our existing government might be happy if they could cancel some additional contracts.
Michael: No comment.
Paul: Is this a potential way to provide a path for a negotiated out on those contracts, theoretically? I think we're a long way from that but do you think that's possible?
Michael: You mean bringing a generator to the table and say, "Either you agree to renegotiate it or withdrawal or termination of your contract or we're going to pass legislation to kill it."? Is that what you mean?
Paul: No. No. Here's this shiny new carrot.
Michael: Oh. I get it.
Paul: We'll take away your … for the next 12 years but on the other hand we've got this new capacity market you might want to participate.
Michael: I don't think so. Most of the contracts are only … they're not going to make …
Paul: If you think of it, we're doing a little spin into the capacity market. Intermittent renewals.
Michael: I think that would come down to the detailed designed consultation when it starts. Again, as A.J. points out you're being paid a fee to exist and be there and provide the capacity that is needed.
Paul: But I guess solar and wind, by definition, are not necessarily as dispatchable. Hydro was … from the course. It's available too but you can
Michael: Combine it with storage or
Paul: Storage is not quite there yet. They … … the support renewables in a capacity market situation. Maybe I'm wrong.
A.J.: I think the technology is there. The economics. It depends on who you talk to but I think the approach that IESO is taking so far is consistent with what's done in other jurisdictions in the sense, essentially you are saying, "What's the historical peak coincidence of these resources." and then "We're going to valuate them. You'll only get a fraction of the payment because you're really only providing a fraction of the reliability and on top of that we're not going to exempt you. We don't care whether the wind's blowing or the sun's out or the water is there, if you're not there when we really need you, you're still subject to the penalty structure." I think in a way the capacity mechanism does incorporate the lower value that intermittency provides from a liability perspective. I think there's still an argument to be made that intermittent resources should not get a capacity payment. But generally speaking if we're looking at this from a system-wide perspective we could look at the probabilities and we can be reasonably confident of how these things are going to play out.
Tom: They can hedge on their end. Especially if you've got multiple jurisdictions, like a very large area, and come up with technical solutions to provide better solar or better capabilities. Very interesting. In terms of the trend that we're seeing, and Michael this is more a question for you, the installation of batteries, in particular the … sector and the … how do you see that fitting in here?
Michael: I'm told we have some uncertainty of terms of investor rates are … I can't really comment on it. When I've looked at some business cases, the economics of strong storage, global, … it's a huge benefit and that gets diminished because of … global adjustment. The economics may get turned upside down for all I know.
Tom: The demand response community, where do they come in here? They've become quite strong. They've really done a lot in Ontario in the past number of years.
Michael: They have a demand response option. I'm not aware that they've ever actually called on the resources to actually, I think they actually have though.
Tom: Off the top of my head I'm not sure but I think that the capacity mechanism is one piece of the overall market renewal. I think that for the main response providers they need to be following all of those. Ancillary services, in particular, but because of the unique services they provide I think it's important to make sure that they have opportunities in the capacity mechanism. That they're subject to the same performance obligations and then potential penalties but also looking at the other product markets is very important for the demand response providers.
Tom: At this morning's breakfast, Paul brought up the idea that the demand responsible should be taken down to the Class B customers. A broader swath. Any thoughts on that world? When we're getting down to the consumer level in a capacity market or is that just so far down the road that it's not even conceivable?
A.J.: From my perspective I don't think the current mechanism prevents them from participating today.
Michael: Maybe not as fast … … There you could have potentially tens of thousands of solar systems or gas gensets. Not sure if we want to get into that world or not. Not our call to make.
Tom: Ready and standing by to provide power through the next 2004 blackout. Okay, we only have a few minutes left. Were there any questions?
Paul: Just one observation from one of the demand response people.
Tom: Really good point here being made by Rachel that there's a lot of organizations reaching out to the government on potential capacity. Which I would agree. There is a process underway so that's certainly true. Maybe before we sign off I'll leave with you just final question. Michael, maybe I'll let you start. If you could whisper in the ear of policy makers in relation to the capacity market, what are one or two points that you'd want to drive home.
Michael: I like what … said … keeping the politics out of it. State broad policy objectives in terms of what you want and let the IESO do their thing.
Tom: Okay. Great. A.J.
A.J.: I think that I would second that but, of course, this is something we've all been saying in Ontario for the past 20 years. As much as possible have the discipline for the government to stay out and secondly, from the IESO level, in my opinion having a multi-year commitment option is important for the … investment cycle.
Tom: Okay. Any final thoughts Paul?
Paul: No, I don't think so. I guess I'll just ask one quick question because we have 4 minutes to go.
Paul: We sort have identified the lay of the land now. If you had to predict where we're going to be in terms of capacity options 5 years down the road, where will we be if that's the option market in Ontario?
A.J.: In a way, and we'll know it less than 90 days what's going to happen, I think that clearly IESO is committed to market renewal. The government hasn't put forth any, "We've got 90 days and we're going to stop this or review it." They're letting that process unfold and I think there is a desire from some in the government to try and create mechanisms, institutional mechanisms, that go beyond the life of any individual government. There are some in the government that I think see the capacity mechanism and possibly … and other things as being a way to create facts on the ground that institutionalize market mechanisms.
Michael: Yeah. I think there's so much uncertainty that I don't really know where we are going to be in 5 years with capacity market. I think there's an even money chance that a lot of the same resources probably get re-contract. To be honest with you.
A.J.: I agree with that.
Paul: I think that to a lot of the power producers, that would be music to their ears.
Michael: I think it would be, yes.
Paul: I just want to conclude in the next minute by thanking our speakers. Tom, thank you for doing such a great job moderating. And of course, A.J. and Michael, thank you for joining us today. I just want to mention in closing that this webinar will be hosted on our website. I'm not quite sure when it will likely be posted but sometime in the next few days. For those of you who want to listen to it again, or commend it to colleagues or friends who might want to listen to it, you'll be able to find it through a link to our website in the next few days. With that I will bid you all a good day and thank you for joining us.
Tom: Thanks everyone.
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