To: Power Advisory LLC Clients
From: Travis Lusney, Director of Power Systems, Michael Killeavy, Commercial Director, Brady Yauch, Manager of Markets and Regulatory
The pending capacity crunch facing Ontario’s electricity grid is becoming increasingly clearer and more severe. On April 4th, the IESO released its second Annual Acquisition Report (AAR), which presents the Independent Electricity System Operator’s (IESO’s) plans to address future power supply system needs.
The AAR continues a growing trend of the last two years, highlighting a potential – and increasingly likely– supply crunch in the back half of 2020s. With the capacity need continuing to grow from the last AAR and the previous Annual Planning Outlooks (APO), so too has the IESO’s plans for procuring new capacity and ensuring existing assets remain in operation.
The IESO notes that while some of the capacity needs for 2025 and 2026 that were laid out in the last APO will be met through the combination of the annual capacity auction and the recently launched medium and long-term RFPs, additional actions will likely be necessary. These additional actions may include adjustments to nuclear outages, increased energy efficiency programs, re-contracting of biomass facilities, a broader capacity auction and additional procurements. The IESO is also considering procuring capacity expansions at current facilities and “expedited” procurements. The IESO may also launch a “multi-year” capacity auction for a “medium-term” commitment.
The AAR describes changes to the amount expected to be procured from both the medium and long-term RFPs.
The amount of capacity procured from first medium-term RFP – which allows for up to a five-year commitment between 2024 and 2031 – has now been reduced from 750 MW to 475 MW. The IESO states that the reason for the reduction was to maintain “robust competition”.
The long-term RFP – which was expected to procure 1,000 MW of capacity to be in service by 2026 to 2028 –will now procure up to 2,500 MW of capacity to be in service by 2027. A second long-term RFP will procure an additional 1,500 MW of capacity to be in service by 2030. In total, the IESO may now procure up to 4,000 MW of capacity on a long-term basis.
The IESO has also increased its firm guidance for capacity it expects to procure through the annual capacity auction on a UCAP basis – whereas previously the capacity auction procured on an ICAP basis. The firm guidance for the summer 2023 auction has increased to 1,200 MW from 950 MW. The winter firm guidance amount for 2023 and 2024 has increased to 750 MW and 850 MW, respectively, from the previous forecast of 500 MW for both years. Given the procurement will be using UCAP, the actual MWs procured through the capacity auction will be materially higher than previous auctions.
And finally, the AAR states that while competitive means for procurement are the preferred approach – whether through the annual capacity auction or medium- and long-term RFPs – to meeting future capacity needs, other options will be considered. The IESO notes that “some mechanisms can be adapted” to address needs over the next one to four years and could include changes to the capacity auction, responses to government programs or bilateral contracts with certain assets. The IESO recently signed a bilateral contract with the Lennox Generating Station until 2029 and is currently in negotiations with the Brighton Beach Generating Station and Calstock Generating Station.
Power Advisory Commentary
The supply gap has widened considerably from the last AAR. This is not surprising given the changes outlined in the 2021 APO compared to the 2020 APO. By 2030, the IESO now expects a capacity need of between 4,000 MW and 6,000 MW. Ontario is facing a pending supply crunch the likes of which the province has not seen for nearly two decades.
The time frame to bring on additional generation resources is becoming increasingly compressed. The growing need and compressed time frame make closing the capacity gap very challenging – to say the least – while limiting the types of resources that can participate in procurements will further diminish competition. Compounding the challenge facing the IESO is the expectation that siting, community engagement, and managing global supply chain disruptions will be more difficult now than a decade ago when Ontario last built significant new supply resources.
The IESO spent a great deal of time and effort on an Incremental Capacity Auction (ICA) as part of the Market Renewal Program (MRP) that the sector – both suppliers and buyers – overwhelming rejected from the outset. The result of delays from pursuing the ICA at the expense of other procurement options is part of the reason for the current situation. Further, significant resources and capital has been concentrated on MRP, which has reduced the ability of the IESO to adjust to post-pandemic demand growth and supply need issues that are now a near-term concern.
We do not see a need to run a Request for Qualifications (RFQ) where there already is a pool of experienced and capable developers that can be vetted through the Request for Proposal (RFP) process (Hydro Quebec, for example, does not see a need for such obstacles in its current procurement processes). Furthermore, the IESO has not fully engaged with the broader sector to prepare for the huge wave of development that will require coordination among LDCs, Hydro One, municipalities, and approvals-granting ministries (e.g., ministry of natural resources, ministry of environment). Finally, the IESO has focused on standardized contract terms and restrictive eligibility requirements. To support their innovation mandate, the IESO should consider greater flexibility in the proposal evaluations to allow proponents to submit different contractual arrangements, project designs and solutions. Rigid procurement and contract design restricts the pace of development of needed resources.
Six years ago, the IESO embarked on MRP, which if implemented, will fundamentally change Ontario’s wholesale electricity market. While some of these changes will improve the economic efficiency of the market by reducing out-of-market payments, the impending changes also create significant uncertainty for developers, which may deter investment when it is most needed. To encourage investment in new supply resources, the IESO will likely need to provide certainty to investors through long-term contracting. The contractual certainty will likely diminish the stated benefits of the MRP changes. MRP will also continue to consume resources that may need to be deployed elsewhere to acquire the needed supply resources.
Closing the capacity gap will require the IESO to make fundamental choices about the future. Tough decisions will be required including the reprioritization of major deliverables. Given the amount of capacity need and potential difficulty in development of new supply resources in today’s environment; the Ontario electricity system may experience a similar resource adequacy and reliability situation of 2002-2004 when Ontario was importing around 4,000 MW in peak demand hours. In the words of IESO’s own contracts “time is of the essence”; action and adaptability is required.
Installed Capacity (ICAP) represents a generators installed capacity adjusted for ambient weather conditions. Unforced Capacity (UCAP) represents the percentage of ICAP available after a unit’s forced outage rate is considered