In certain markets, suppliers/consumers need to independently ensure the scope of required reserves above their peak demand by either reducing demand in real time or signing agreements for purchasing capacity at the rate of the required reserve exceeding the peak demand (e.g. the Midcontinent Independent System Operator in the US). In France, this is known as a capacity certificate.

The scope of required reserves is derived from the probability of non-supply:

-In the US, one non-supply event in 10 years; In the UK, 3 hours a year; In Ireland, 8 hours a year.

There are two key methods for purchasing capacity:

The first is for extreme cases when the grid is in or close to shortage. This takes place in Sweden, Finland and a small number of other countries. The capacity purchased is defined as a strategic reserve and is acquired for a short term. Capacity payments to the units are the only source of funding for this capacity and it may not participate in the energy market.

The second method is applied for routine purposes when the unit receiving the payment (old or new) continues to participate in the energy market.

The grid operator holds a tender for purchasing capacity from new generating units, existing units and suppliers/consumers who can reduce consumption in real time according to the requirements of the grid operator and the required capacity amounts, response time to providing the service and type (new/existing).

The tender is similar to the day ahead market with the clearing price for capacity paid to all participants in the tender for the durations that were defined.

In some cases, a supplier can provide capacity services to itself by reducing consumption within the response times determined by the grid operator or by signing agreements with other producers for supplying the necessary reserve.

In some markets, the grid operator purchases the service and in others the supplier purchases the service or provides it to itself.

The supply of capacity through the dedicated payment mechanism affects the energy market and ancillary services as this capacity can participate in both the energy and ancillary services markets. Its funding outside of the energy market reduces the prices of energy and ancillary services in the market.

The assumption in markets that pay capacity payments to producers is that the energy market alone can’t cover their full fixed costs and that in the absence of capacity payments, the price in the spot market will be very high therefore these payments restrain these fluctuations.

The supplier is generally responsible for the scope of required capacity. The supplier must undertake a larger generating capacity than the consumption of his consumers at any given point. Failing to do so leads to the payment of fines and surplus capacity will be reflected in higher costs for suppliers. Placing the responsibility with the supplier offers an advantage because of its efficiency vis-à-vis the central dispatch or regulator, who will always prefer surplus reserves in order to avoid a shortage. Capacity purchases are carried out separately from the purchase of ancillary services.

Who can participate? Nearly anyone who can commit to provide capacity at the request of the central dispatch and reduce the probability of non-supply.

Availability can be for all hours of the day, for peak demand hours or with a 4 hour notice like in the UK.

Some countries impose fines for failing to meet the capacity when needed, other for failing to meet a day ahead.

The allocation among suppliers is based on either their relative consumption or their relative consumption during peak demand.

Country Transaction period for existing producers Transaction period for new producers
USA – PJM 1 year Up to 3 years
New England – ISO 1 year Up to 7 years including repowering
USA – NYSO 6 months seasonal with monthly updates 6 months seasonal with a yearly update
USA – MISO 1 year 1 year
UK 1 year Up to 3 years for repowering and up to 15 years for new facilities
Ireland 1 year Up to 10 years

When the suppliers aren’t obligated to the required availability amount, the responsibility to ensure the capacity passes on to the central dispatch, who will usually pay no more than the normative costs of a peaker station. The suppliers who did not buy the capacity themselves will buy it from the central dispatch.

Capacity purchases are usually for periods of 3-5 years in advance.

PJM model: suppliers commit to availability at the scope of their deals. The central dispatch commits to make up the missing capacity as part of a capacity transaction auction. Capacity purchase transactions are for a period of either 1 year or up to 5 years, including from new generating units. The auctions are geographically based because of grid constraints.

For producers, this encourages them to sign private deals with suppliers for as much capacity as possible otherwise they would have to provide the surplus capacity to the central dispatch as part of competitive bidding.

For suppliers, this hedges the price for capacity whose highest rate is the price in the central dispatcher’s auction for the purchase of new capacity. Suppliers prefer long-term capacity transactions in order to avoid price fluctuations in the event of trade in capacity (low reserves).

Gina Cohen
Natural Gas Expert