IEEE Power & Energy Magazine - January/February 2021 - 33

suppliers are willing to offer at or below the offer cap. This
outcome implies that the system operator must be forced to
either abandon the market mechanism or curtail load until
the available supply offered at or below the offer cap equals
the reduced level of demand, as occurred several times in
California between January 2001 and April 2001 and most
recently on 14-15 August 2020.
Because random curtailments of supply, also known as
" rolling blackouts, " are used to make demand equal to the
available supply at or below the offer cap under these system
conditions, this mechanism creates a " reliability externality "
because no retailer bears the full cost of failing to procure
adequate amounts of energy in advance of the delivery. A
retailer that has purchased sufficient supply in the forward
market to meet its actual demand is equally likely to be randomly curtailed as another retailer of the same size that has
not procured adequate energy in the forward market. For
this reason, all retailers have an incentive to underprocure
their expected energy needs in the forward market.
The lower the offer cap, the greater the likelihood that
the retailer will delay its electricity purchases to the shortterm market. Delaying more purchases to the short-term
market increases the likelihood of insufficient supply in
the short-term market at or below the offer cap. Because
retailers do not bear the full cost of failing to procure sufficient energy in the forward market to meet their future
demand, there is a missing market for long-term contracts
for long enough delivery horizons into the future to allow
new generation units to be financed and constructed to
serve demand under all future conditions in the shortterm market. Therefore, a regulator-mandated, long-term
resource-adequacy mechanism is necessary to replace this
missing market.
Some form of regulatory intervention is necessary to
internalize the resulting reliability externality unless the
regulator is willing to eliminate or substantially increase the
offer cap so that the short-term price can be used to equate
available supply to demand under all possible future system
conditions. This approach is taken by the Electricity Reliability Council of Texas, which has a US$9,000/MWh offer
cap, and the National Electricity Market in Australia, which
has an AUD$15,000 per MWh offer cap. If customers do not
have interval meters that can record their consumption on
an hourly basis, then they have a very limited ability to benefit from shifting their consumption away from high-priced
hours. All that can be recorded for these customers is their
total consumption between two successive meter readings
so they can only be billed based on an average wholesale
price during the billing cycle. Therefore, raising or having
no offer cap on the short-term market would not be advisable
in a region where few customers have interval meters. Even
in regions with interval meters, there would be substantial
political backlash from charging hourly wholesale prices that
cause real-time demand to equal available supply under all
possible future system conditions.
january/february 2021

Currently, the most popular approach to addressing this
reliability externality is a capacity payment mechanism that
assigns a firm capacity value to each generation unit based
on the amount of energy it can provide under stressed system
conditions. Sufficient firm capacity procurement obligations
are then assigned to retailers to ensure that annual system
demand peaks can be met.
Capacity-based approaches to long-term resource adequacy rely on the credibility of the firm capacity measures
assigned to generation units. This is a relatively straightforward process for thermal units. The nameplate capacity of the
generation unit times its annual availability factor is a reasonable estimate of the amount of energy the unit can provide
under stressed system conditions. In the case of hydroelectric facilities, this process is less straightforward. The typical
approach uses percentiles of the distribution of past hydrological conditions for that generation unit to determine its firm
capacity value.
Assigning a firm capacity value to a wind or solar generation unit is extremely challenging for several reasons.
First, these units only produce when the underlying resource
is available. If stressed system conditions occur when the
sun is not shining or the wind is not blowing, these units
should be assigned little, if any, firm capacity value. Second,
because there is a high degree of contemporaneous correlation between the energy produced by solar and wind facilities within the same region, the usual approach to determining the firm capacity of a wind or solar unit assigns a
smaller value to that unit as the total megawatts of wind or
solar capacity in the region increases. These facts imply that
a capacity-based, long-term resource-adequacy mechanism
is poorly suited to a zero-marginal-cost, intermittent renewable feature.

Supplier Incentives With Fixed-Price Forward
Contract Obligations for Energy
The standardized fixed-price forward contract (SFPFC)
approach to long-term resource adequacy recognizes that
a supplier with the ability to serve demand at a reasonable
price may not do so if it can exercise unilateral market power.
A supplier with the ability to exercise unilateral market
power with a fixed-price forward contract obligation finds
it expected profit maximizing to minimize the cost of supplying this forward contract quantity of energy. The SFPFC
long-term resource adequacy mechanism takes advantage
of this incentive by requiring retailers to hold hourly fixedprice forward contract obligations for energy that sum to the
hourly value of system demand. This implies that all suppliers find it expected profit maximizing to minimize the cost
of meeting their hourly fixed-price forward contract obligations, the sum of which equals the hourly system demand for
all hours of the year.
To understand the logic behind the SFPFC mechanism,
consider the example of a supplier who owns 150 MW of generation capacity who has sold 100 MWh in a fixed-forward
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IEEE Power & Energy Magazine - January/February 2021

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