Alberta’s electricity market is set to join the capacity markets club.

In a November 23, 2016 announcement, the Alberta government committed to restructuring its power market by 2021 to provide for so-called "capacity payments" to generators on top of spot power prices—an approach taken in the UK, Russia, parts of the US. and Australia, and currently being explored in Ontario.

The capacity market plan and plugging the supply gap

As in those jurisdictions, generators will competitively bid for periodic payments to make their generation capacity available (through a new "capacity market"). They will also continue to receive spot prices for their actual energy deliveries (through the existing energy market). In effect, generators will recoup costs through two revenue streams rather than one.

This development answers the question we posed in a bulletin earlier this month about the future of Alberta’s "energy-only" market. In the current structure, spot prices alone are relied upon as a signal for needed future investment. The province’s recently-announced Renewable Electricity Program (REP) guarantees revenue certainty for one category of generator: the owners of new wind, solar, biomass and other renewable projects. It posed no solutions to the supply gap left by the government’s coal phase-out plan, which will require adding thousands of megawatts of replacement gas-fired generation by 2030.

More specifically, the compounded impacts of a provincial economic downturn and policy changes have created a challenged environment for existing generators and prospective non-renewable investors. Further, as acknowledged by the Alberta Electric System Operator (AESO), "adding high volumes of intermittent renewable generation to Alberta’s market through the [REP] will decrease the revenue available for all generators."

A capacity market may provide a modicum of financial certainty while retaining Alberta’s distinctive (in Canada) reliance on market-based incentives. According to the government, a parallel capacity market will both help to incent needed generation and "ensure that existing investments, including existing renewables, are treated fairly and that there is a level playing field for competition."

As with the REP, the government's capacity market plans substantially adopt a recommendation report of the AESO. In its 100-page report, the AESO takes the view that the energy-only structure "delivered on the original objectives set for it," but would not likely incent required non-renewable investment in Alberta’s REP era—thereby putting reliability at risk. The AESO rejected the model of long-term contracts embraced during Ontario’s mid-2000s market restructuring, stating that either contracts or traditional cost-of-service regulation "would likely result in higher long-term costs to consumers as competitive forces are minimized and they [consumers] are exposed to the risk of poor long-term decisions." Nevertheless, it appears likely that the REP will lock in such cost increases for at least part of Alberta’s supply mix.

Alberta’s capacity market will take years to plan and implement—perhaps the most significant challenge before the government. The AESO’s report estimates 2024 to be the "earliest date" capacity market–procured generation will energize. Practically, this will tighten the government’s window for replacing, by 2030, the coal-fired generation supplying half of Alberta’s power today. Acknowledging this, the AESO indicates that some form of “bridging mechanism” may be required during the transition, including, but not limited to, interim supply contracts with new generators.

The immense task of planning, approving and administering the contracts associated with an Alberta capacity market will fall to the AESO. Along with the AESO’s expansive REP mandate, this confirms the agency’s much-enlarged status in a coal-shedding Alberta. Some risk follows this responsibility: it remains to be seen whether the AESO becomes the political target the former Ontario Power Authority did after being appointed the policy agent of that province’s dramatic renewables shift.

Similarly, it is unclear whether the capacity market proposal (set for a 2021 launch) will survive the next provincial election (in 2019). The REP and associated changes are almost certain to generate fierce opposition in the province’s Legislature. A capacity market, for its part, was rejected by the preceding Progressive Conservative government in a 2005 review that noted "strong opposition" from stakeholders to the concept. This time around, however, industry opposition may have softened with the spot price itself.

While acknowledging the spot price’s "historic lows," the Alberta government on November 22 also announced a four-year price ceiling of 6.8¢/kWh for residential and business customers paying Alberta’s existing “Regulated Rate Option” (RRO). Customers can currently choose between RRO and competing non-RRO plans offered by retail companies. Cited as a mechanism to “protect families, farms and businesses from electricity price volatility,” the 6.8¢ ceiling is near current long-term retail prices, but well above 2016 prices hovering around 4¢/kWh. Should prices breach the cap, Alberta will compensate RRO providers for the difference—a taxpayer-to-ratepayer subsidy non-RRO competitors may be hard-pressed to compete against.