Our capacity payment definition will help you understand how capacity payments are beneficial to the grid and include several examples of markets.
What is Capacity Payment
Balancing electricity demand and supply is a daunting task and one way of making it possible involves the concept of capacity payments.
While calculating the capacity payments on a monthly basis, the electricity markets take into account the prevailing energy consumption and peak load demand in the future.
In other words, the supplier should produce surplus electricity whenever there is a demand. This is the area where capacity market kicks in and ensures sufficient generation of power to fulfill the energy needs.
When it comes to the capacity payment definition, it relates to a fixed revenue mechanism of payments. The amount is paid to the power plants, which pledges to increase the electricity generation in the coming years.
Capacity payment is a type of incentive to attract the attention of the investors. As a result, they enhance the generating capacity of the existing power plant or build new ones. The managing bodies that run the whole system are referred to as forwarding markets or capacity markets.
It helps to direct investment in the power sector prior to the actual rise in demand. This is essential, as it takes a long time to build power plants and requires a huge investment.
Furthermore, capacity payment helps to achieve the benefits of long-term planning.
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Breaking Down Capacity Payment
The basic theme behind the capacity payment is to compensate for the power generating companies for enhancing their capacity in the future. The process of awarding capacity payments requires the generators to take part in the auction.
One of the biggest auctions is known as the Base Residual Auction. It takes place every year, where it is essential for the winning party to deliver the project till the end of three year’s time.
There are numerous other incremental auctions where bidders seek the opportunity to sell or buy their commitments.
It usually happens when a power plant fails to fulfill the commitments made at the time of auction. This allows such generators to purchase a replacement capacity from any other plant.
The grid operator normally holds these auctions depending on the projected electricity demand regarding upcoming years.
To elaborate it further, let’s take a look at this example.
If the grid requires to meet the demand of 550 megawatts, the grid operator will hold an auction to find a power plant capable of offering this capacity in future and that too at the lowest cost.
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Benefits of Capacity Payment
The capacity market works in two ways. Apart from offering the production and delivery of electricity, this market also ensures to enhance the capacity of power plants. It pays the generator for making reliable and cheap electricity.
The capacity payment is awarded irrespective of the fact that how often a generator sells the electricity to a grid. The basic purpose of paying a capacity price is to have a surplus amount of energy to meet the demand.
Following are the benefits of capacity payment.
- Helps to keep the prices stable and affordable
- Allows to maintain the reliability factor
- Offers revenue certainty and generous incentives to the generators
- Works well to maintain a competitive market
- Assists the generators to maintain cost discipline through innovation
- Makes it possible to implement the plans to counter climate change by promoting the use of renewable energy sources
The capacity payment is usually made by the end consumer if there is no subsidy involved.
Now when you know who pays the capacity payment, it’s time to see how it works.
How Capacity Payment Works
Capacity markets in the US utilize various ways to create the capacity payment formula. However, all such methods serve a similar purpose, which is the generation of sufficient electricity.
It helps to ensure that the independent system operators (ISOs) or regional transmission organizations continue to meet the peak demand.
The price of capacity is calculated on $/kW per month basis. The prices may vary due to the amount of capacity generation bid. Apart from this, factors like plant maintenance, outages, and mothballing also affect the capacity bid.
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NYISO Capacity Payment Overview
With a view to determining this capacity price, NYISO holds monthly, six-month strip, and spot auctions. NYISO issues a demand curve regarding different energy needs for every capability period.
This ultimately affects the pricing for a particular period.
PJM Capacity Payment Overview
The amount of PJM capacity payment is determined through the Reliability Pricing Model. It depends on the procurement of projected capacity during a three-year period.
The peak load contribution of the user plays a key role when calculating the capacity price. It is the amount of capacity, which a supplier requires to produce and meet the expected peak demand.
The monitoring of the five Coincident Peak Hours takes place from June 1 to September 30 last year.
ISO-NE Capacity Payment Overview
ISO-NE relates to the Forward Capacity Market (FCM). It is a way to increase resources by attracting new investment.
In addition, ISO-NE also serves to maintain prevailing investments and use them when required.
The FCM tries to procure sufficient electricity to fulfill the projected demand for the next 3 years. It compensates the generators for the cost of import or demand resource, prevailing generation, and penalize those power plants who have failed to produce required electricity during peak demand.
What is Capacity In Electricity?
It is the ability of a generator to produce maximum electric energy during specific conditions. However, the capacity factor is relatively different, as it is the measure of electricity generation showing how often a generator operates.
For this purpose, the ratio of maximum possible output to the actual output is taken into account.
As a result, the grid can easily calculate future demand as well as the capacity payment.
Capacity payment is a method of bridging the gap between supply and demand. This serves as an incentive for the generators to produce more energy by enhancing the efficiency of their power plant or building new facilities.
The capacity price depends on the actual amount utilized by the consumer in prevailing circumstances and the projected peak demand.
The electricity demand varies during different months of the year. This means that the generators must maintain their power plants in working condition even if the demand is low.
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