Capacity Markets: Ensuring Energy Reliability in the Transition to Clean Power
As the generation fleet in deregulated and regulated power markets continues to move towards a higher percentage of renewable energy resources, the role of capacity markets continues to be debated. As a result, it’s essential to grasp of the concept of capacity markets, their role in ensuring a consistent supply of electricity to consumers, and how they fit into the energy market picture, if at all. In this blog post, we’ll explain what capacity markets are, including the purpose of capacity markets, their mechanics, and why some markets have or don’t have a capacity market.
Capacity Market Explained: Meeting Power Demands
Stated simply, a capacity market is a mechanism designed to guarantee that there’s enough electricity supply to meet the needs of consumers, even during periods of peak demand. Imagine a hot summer day in the south, let’s say in Louisana when everyone is cranking up their air conditions and lights after they get home from work at 5 PM. A capacity market ensures there’s sufficient electricity generation to keep our homes cool and lights on when demand on the electric grid increases. That’s where capacity markets come into play.
Different Markets: Energy vs. Capacity
To understand capacity markets, it’s important to differentiate capacity markets from energy markets. In energy markets, electricity is bought and sold in real-time or through forward contracts - it’s about making sure electricity gets to where it’s needed. On the flip side, capacity markets focus on future electricity needs. These markets ensure power plants are ready to generate electricity when called upon, even if these power plants don’t end up producing electricity every second of every day.
How Capacity Markets Work
One of the key concepts of capacity markets is to encourage power generators to commit to making their electricity available for consumers in the future. These generators receive payments for this future commitment, ensuring that their plants will be available in the future during peak demand events. Think of capacity markets as an insurance policy against future blackouts during peak demand on the grid, like when we all get home after work in the summer and turn on the AC and lights after sunset.
The Future of Capacity Markets
Incentives like the Inflation Reduction Act continue to push power markets to add more renewable energy resources, which puts increased emphasis on capacity markets. As we know, solar and wind are intermittent resources - they are unlikely to generate electricity at full output when the sun isn’t shining or the wind isn’t blowing. Capacity markets ensure the market has enough energy resources in the future, during times when the supply in the market can’t meet the demand. Note that deregulated non-capacity markets like ERCOT, which are called energy-only markets, use mechanisms like scarcity pricing that create price signals to call on expensive peaking power plants or demand response to meet the demand.
Navigating the Energy Transition
As the energy transition continues, capacity markets can be an important tool in the power market toolbox. Capacity markets can help bridge the supply gap created by retiring fossil generators and the addition of renewable energy resources. While one can argue that energy-only markets offer more pros than capacity markets, guaranteeing energy supply in the future is key to preventing disruptions. One way to incentivize future energy supply from power producers is to pay these producers for their future capacity to serve peak demand events for customers.
Wrapping Up
Capacity markets play a critical role in preserving energy supply during periods of peak demand. These markets ensure that power plants are available, ready to step up to the plate when needed, even as our power markets move to more renewable energy resources. So, the next time you read or hear about capacity markets, you’ll know these markets play a role in maintaining a reliable source of power as electricity markets continue to evolve.
