Updated: Mar 26, 2020
What is the Forward Capacity Market?
The Forward Capacity Market is a competitive market that was designed to ensure that ISO-NE, the region’s power pool, has enough generation to meet expected demand 3 years in the future. Through a competitive auction, resources such as power plants, renewable generation, and demand-side resources bid to provide power or curtail demand when they are called upon to do so. For their end of the bargain, they are paid on a monthly basis as part of their participation in the program. The auction platform encourages competitive bids because those resources that do not clear the auction will not receive these monthly capacity payments.
How is Capacity Priced for a C&I Customer in New England?
There are 2 main components of a customer’s capacity costs. The first is the capacity tag itself which is set when ISO-NE registers its highest demand hour for the year. Historically this has occurred during the summer between 2:00 and 5:00 p.m. during a prolonged heat wave. For interval/hourly meters, once ISO-NE determines what the peak hour was for the year, they go back and look at each energy user’s usage during that hour. That value (adjusted for line loss) becomes the customer’s capacity tag effective June 1st of the following year. For profiled accounts, the capacity tag is based on the monthly consumption during the peak month and tend to be far less volatile than for interval accounts. Every energy user in New England has a capacity tag whether they are purchasing form the utility or a competitive supplier.
The second cost component is the auction clearing price which is released by ISO-NE 3 years in advance of the capacity period. Although this is oversimplifying, the capacity tag multiplied by the Clearing Price gives you a rough idea of what a customer’s capacity costs will be. In reality, calculating capacity has quite a few other factors and adjustments that make it difficult to predict, but these 2 main components make up the majority of the cost.
It is imperative that competitive suppliers understand a customer’s capacity costs because whenever they enroll a customer’s account, they become responsible for paying that customer’s capacity costs to ISO-NE. In a fixed price contract, suppliers include the cost of capacity in the price and rely on their estimates of the customer’s cost to be able to serve that account for the duration of the agreement profitably. However, capacity is typically the 2nd largest cost component and can make up 35% of a customer’s overall fixed price costs.
The other difficult part for suppliers is there can be significant volatility in a customer’s capacity tag from year to year. For example, if a manufacturer closed at 12:00 the day the capacity tag is set, they could have essentially 0 capacity costs. On the other side, if a customer is running full throttle and cranking their AC when the tag is set (which many businesses are), their costs could be higher than the supplier estimated.
As you can imagine, some businesses that have extremely predictable loads like hospitals are easy to predict from year to year. However, many businesses that operate more sporadically can be a much riskier proposition for a supplier to price from a capacity perspective. Every supplier has their own capacity calculations, appetite for risk, and contract language that can lead to drastically different price estimates for the same customer.
2023 Capacity Auction Results
 Figures available from ISO-NE Key Grid and Market Stats
How Significant is the Price Difference?
The Clearing Price has steadily declined from the 2019/2020 Capacity Period to an all-time low for the 2023-2024 period. This means that customers are seeing prices that decline steadily the longer the contract length. Based on pricing I have seen recently, a 12-month price with an April, 2020 start is typically about 5% more expensive than a 48-month term. When you factor in historic lows on the cost of the energy component itself (~3.6¢/kWh), customers are selecting longer term contracts and the average contract length has exceeded anything I have seen in my 9+ year career.
When you look at forward contract start dates in 2021, 2022, and 2023, the numbers appear even more attractive as they have already contracted for the higher priced 2020/2021 capacity period. On average, customers renewing in this time period are seeing prices between 8-12% less than current contracted rates. I would expect brokers with strong customer relationships to extend the majority of their customers until the end of 2022 at a minimum.
How Will This Impact Suppliers?
Although a reduction in capacity costs are a benefit for consumers, it presents unique challenges for retail suppliers. In a traditional fixed price contract, the customer is provided the same price over the entire duration, for example 48 months. However, if there is a 5% decrease from a 12-month term to a 48-month term as mentioned above, the contract may not be profitable for the first 24+ months during the higher capacity cost periods. The profitability on these contracts is significantly back weighted and will not be realized until the last 12 months of the agreement. I would expect this to reduce most supplier’s willingness to provide blend and extends which further push off their profitability.
The results of the 2023/2024 capacity auction will result in a much-needed reduction in electricity supply costs for customers throughout New England. With a lower clearing price, the risk for suppliers in estimating capacity costs in outer years should be reduced. I also believe that a significant percentage of Large C&I customers will sign long term extensions resulting in less activity for the second half of 2020 and in 2021. Finally, I believe that suppliers will expand margin on their long-term offerings to help them from a cash flow perspective during the early and possibly non-profitable portions of their contracts.
About Pursuit Energy
Pursuit Energy Solutions is a full-service Electricity and Natural Gas consulting firm that assists Commercial, Industrial, and Municipal customers to navigate New England’s complex deregulated energy markets. Pursuit works with customers to develop customized, long term purchasing solutions that fit within the client’s risk tolerance and budgetary needs.
The views expressed in this article are the author’s own and not those of ISO-NE or any supplier.
 “Updates - Finalized Auction Results Confirm Sufficient Capacity Resources and Historically-Low Prices for 2023–2024.” ISO Newswire, 18 Feb. 2020, isonewswire.com/updates/2020/2/18/finalized-auction-results-confirm-sufficient-capacity-resour.html.  Key Grid and Market Stats. ISO-NE, 2020, www.iso-ne.com/about/key-stats/markets#fcaresults.