Capacity cleared: Meaning, Criticisms & Real-World Uses

What Is Capacity Cleared?

"Capacity cleared" refers to the amount of electric power generation or demand reduction resources that successfully secure commitments in a capacity market auction. Within the broader context of Energy Markets, these markets are designed to ensure long-term reliability of the electric grid. When capacity clears, it means that a certain megawatt (MW) quantity of resources, such as power plants or demand response programs, has committed to be available to produce or reduce electricity during a future period, typically several years in advance. These commitments receive a payment determined by the market's pricing mechanism. The primary goal of achieving cleared capacity is to maintain sufficient electric supply to meet peak demand and maintain grid stability, thereby preventing blackouts.

History and Origin

The concept of competitive capacity markets and the clearing of capacity emerged in the late 1990s and early 2000s as parts of the United States moved from traditional vertically integrated utilities to deregulated wholesale market structures. The Federal Energy Regulatory Commission (FERC) plays a crucial role in overseeing these organized wholesale electricity markets to ensure fair and reasonable prices and reliable service¹⁵, ¹⁶. Prior to this, resource adequacy was typically managed through long-term contracts or direct utility ownership.

One of the earliest and most influential models for a forward capacity market was the Reliability Pricing Model (RPM) established by PJM Interconnection (PJM), a regional grid operator serving parts of the Eastern and Midwestern U.S.¹⁴. PJM filed its Reliability Pricing Model with FERC in September 2006, and it became effective in June 2007, replacing an older, short-term capacity model that was deemed insufficient for encouraging necessary new generation¹³. Similarly, ISO New England (ISO-NE) implemented its Forward Capacity Market (FCM) in 2006 to ensure that the region would have adequate resources to meet future electricity demand¹². These markets evolved to provide financial incentives for both existing and new generators and demand-side resources to commit to future availability, moving away from a reliance on reactive measures.

Key Takeaways

Capacity cleared represents the volume of generation and demand-side resources successfully contracted in a forward capacity auction to ensure future electricity supply.
These auctions are held by independent system operators (ISOs) or regional transmission organizations (RTOs) several years in advance of the delivery period.
The primary purpose of clearing capacity is to promote long-term grid reliability and prevent energy shortages, paying for availability rather than actual energy produced.
The cleared price from these auctions is typically passed on to consumers as part of their electricity bills, influencing overall energy costs.
The mechanism encourages investment in new power infrastructure and retention of existing essential resources.

Interpreting the Capacity Cleared

The amount of capacity cleared in an auction reflects the market's collective assessment of the resources needed to meet future electricity demand and reliability targets. A high volume of capacity cleared suggests that the market successfully procured enough resources to fulfill projected needs. Conversely, a low amount of cleared capacity relative to targets could signal potential future reliability concerns or a lack of sufficient bidding from available resources.

The price at which capacity cleared is also a critical indicator. Higher cleared prices often suggest tighter market conditions, indicating that less supply is available or that the cost of bringing new resources online is increasing. Lower prices might indicate an abundance of available capacity. Grid operators use complex models that consider factors such as forecasted peak demand, reserve margins, and the geographical location of resources to determine the required amount of capacity to clear. This ensures that the system has adequate safeguards against unexpected outages or demand surges.

Hypothetical Example

Imagine the regional grid operator for the fictional "Green Valley" region, GreenGrid, conducts its annual forward capacity auction for the delivery year three years from now. GreenGrid has determined it needs 10,000 megawatts (MW) of available capacity to ensure reliability during peak summer demand.

Various participants, including solar farms, natural gas power plants, and companies offering demand response programs, submit bids to provide capacity. Each bid specifies a certain amount of MW and a price at which they are willing to commit that capacity. GreenGrid then ranks these offers from lowest price to highest.

The auction proceeds by accepting offers sequentially, starting with the cheapest, until the 10,000 MW target is met. If the 10,000 MW target is reached with the last accepted offer being a natural gas plant that bid $50/MW-day, then $50/MW-day becomes the "clearing price." All resources whose offers were at or below $50/MW-day are "capacity cleared," and they all receive $50/MW-day for their committed capacity during the future delivery year. This process ensures that GreenGrid has secured the necessary capacity at the lowest possible cost based on market competition.

Practical Applications

Capacity cleared is a fundamental outcome in organized wholesale electricity markets and has several practical applications across the energy sector:

Resource Adequacy Planning: For grid operators like PJM and ISO New England, knowing the amount of capacity cleared is central to long-term resource adequacy planning. It confirms that enough power resources are committed to meet projected demand and reserve requirements years into the future¹⁰, ¹¹.
Investment Signals: The clearing price established through the auction serves as a vital investment signal for developers of new generation and demand reduction projects. A high clearing price can incentivize the construction of new power plants or the expansion of demand response programs, while low prices might deter such investments⁹.
Utility Planning: Local utility companies, or load-serving entities, use the capacity cleared information to procure the necessary power for their customers. The costs associated with securing cleared capacity are typically passed through to consumers via their electricity bills⁸.
Regulatory Oversight: Regulators, such as FERC, monitor capacity cleared results and market mechanisms to ensure competitive outcomes and fair pricing for consumers. FERC has, for example, issued orders to enable distributed energy resources to participate more fully in these markets, influencing what types of capacity can be cleared⁶, ⁷.
Market Analysis: Analysts and participants in wholesale markets closely track capacity cleared results to understand market dynamics, evaluate supply and demand balances, and predict future energy costs. Recent reports have highlighted how surging demand, partly due to AI data centers, and delays in new power plant construction are impacting cleared capacity and driving up electricity costs in major markets⁵.

Limitations and Criticisms

While capacity markets aim to ensure grid reliability and incentivize long-term investment, they are not without limitations and criticisms. One significant concern revolves around the potential for market manipulation or the exercise of market power, which could lead to artificially high cleared prices. Regulators implement rules, such as offer caps, to mitigate this⁴.

Another critique centers on the challenge of accurately forecasting future electricity demand and resource availability several years in advance, which is crucial for setting the capacity target. Inaccurate forecasts can lead to either over-procurement (resulting in higher costs for consumers) or under-procurement (risking future blackouts). The complexity of integrating diverse and intermittent resources, such as solar and wind power, into traditional capacity markets can also pose challenges, requiring evolving market rules and regulation ³.

Furthermore, some critics argue that the design of certain capacity markets, such as PJM's, has inadvertently created barriers to entry for new generation or has not adequately incentivized timely construction of already cleared projects, leading to supply shortfalls and price volatility². The concept of "pay-for-performance" in some markets aims to mitigate risk management associated with non-delivery, penalizing underperforming resources and rewarding overperformers¹.

Capacity Cleared vs. Energy Market

While closely related, "capacity cleared" and "energy market" refer to distinct components within the electricity sector.

Capacity cleared specifically pertains to the successful commitment of resources in a forward capacity market auction. It represents an agreement to be available to produce or reduce electricity at a future date, typically three years ahead of time. The payment for capacity cleared is a readiness payment, compensating generators and other resources for their ability to deliver power, regardless of whether they actually produce it at a given moment. The goal is to ensure long-term resource adequacy and grid reliability.

An energy market, on the other hand, is where actual electricity is bought and sold for immediate or near-term delivery. These are typically "day-ahead" or "real-time" markets. Participants in the energy market are paid for the megawatt-hours (MWh) of electricity they actually produce and deliver to the grid. The energy market reflects the instantaneous supply and demand for electricity, and its prices can fluctuate rapidly based on factors like weather, generation availability, and transmission constraints.

The confusion arises because resources that clear capacity are often also participants in the energy market. However, a resource can clear capacity and receive a payment for its availability, yet not be dispatched or paid in the energy market if its actual power production isn't needed at that moment. Conversely, a generator might produce and sell energy without having cleared capacity in a forward auction if it's a smaller, merchant plant, or if its capacity commitment has expired.

FAQs

What does it mean for capacity to "clear" in an auction?

When capacity "clears" in an auction, it means that a specific amount of electricity generation or demand reduction has been successfully bid for and accepted by the grid operator to meet future energy needs. These resources commit to being available and receive a payment for that commitment.

Why do electricity markets have capacity auctions?

Electricity markets use capacity market auctions to ensure that there will be enough power resources available to meet demand years into the future, especially during peak periods. This provides long-term financial incentives for power providers to build, maintain, or update power-generating facilities and demand response programs, preventing shortages and maintaining grid stability.

Who pays for capacity cleared?

The costs associated with capacity cleared are typically recovered from consumers through their electricity bills. Load-serving entities, such as utility companies, procure the necessary capacity and pass those costs on to their customers.

How does "capacity cleared" affect my electricity bill?

The price at which capacity cleared in the wholesale auction is a component of your overall electricity bill. Higher cleared capacity prices can lead to increases in your retail electricity rates, as utilities factor these costs into what they charge consumers.

Is capacity cleared the same as actual electricity generation?

No, "capacity cleared" is not the same as actual electricity generation. Capacity cleared refers to the commitment of a resource to be available to provide power or reduce demand at a future time, for which it receives a payment. Actual electricity generation is the physical production of electricity that is then consumed by end-users, which is traded in the energy market.