September 2023 Ontario Electricity Market Update: CER Impact on the IESO-Administered Market

September 30, 2023
Brady Yauch

In August 2023, the federal government released a draft version of the Clean Electricity Regulations (CER) that introduce stringent operating restrictions for gas-fired generation beginning in 2035 – amounting to an effective prohibition on fossil-fueled electricity generation in its current form. Among other things, the CER establishes a strict emissions performance standard for gas-fired generating units with a capacity of more than 25 MW and which are connected to a NERC-compliant electricity grid. Per the draft regulations, the emissions threshold would come into force on January 1, 2035 for all units commissioned after January 1, 2025. For all units that have entered service prior to that date, the CER performance standard would apply once the unit reaches the end of its 20-year prescribed operating life (i.e., a unit that begins operation in 2024 will be exempt until 2044).

The proposed emission threshold for thermal generating units is 30 tonnes of carbon dioxide per GWh of electricity generated (or .03 tonnes per MWh). The emissions intensity of a generating unit depends on its “heat rate”, which is a measure of its efficiency in converting fuel into heat and electricity. In Ontario, the average heat rate of the natural-gas fleet is around 8 MMBTu/MWh (i.e. it takes 8 MMBTu of natural gas to provide 1 MWh of electricity). A natural gas-fired generator with a heat rate of 8 will emit around 416 tonnes of carbon dioxide per GWh of electricity generated – or more than 13 times the proposed threshold included in the CER. As such, gas-fired generation as it currently exists in Ontario, Alberta and elsewhere across the country will be prohibited from operating outside of the very limited hours prescribed by the CER.

The CER allows for gas-fired generators to emit up to 150 kilotonnes of carbon dioxide annually as long as they do not operate for more than 450 hours in a given year. The 450-hour limit works out to around 18 days of full operation for each unit (i.e., 5% annual capacity factor at full output). Based on the average heat rate of a gas-fired unit in Ontario (8 MMBTu/MWh), 450 hours of operation creates slightly more than 18 kilotonnes of emissions for a 100 MW facility – well below the prescribed limit. In essence, gas-fired generators will hit the 450-hour operating limit well before hitting the 150 kilotonne emissions allowance – meaning it will be the 450-hour limit that will become the de factor constraint on the operation of gas-fired units.

The proposed CER will have a significant impact on the operation and design of the province’s electricity grid. In Power Advisory’s view, it is difficult to see how the current and future design of Ontario’s completive wholesale market can survive the CER as they are currently drafted. Operationally speaking, gas-fired generation currently operates well beyond the proposed 450-hour operating limit in the draft CER. In 2022, for example, Halton Hills – one of the most efficient gas-fired generators in the province – provided energy to the grid in more than 5,700 hours in 2022, or more than 12 times the CER limit. The 2022 annual capacity factor for the Halton Hills facility is around 40%. Other gas-fired generators operated a similar number of hours, and Ontario’s Annual Planning Outlook is expecting a significant increase in gas-fired generation over the next 20 years.

While dispatch of some of Ontario’s natural gas-fired units can be reduced through investment in additional supply from non-emitting resources, more time is likely needed to secure those resources than the 2035 target allows. Large resources – such as new nuclear and hydro units that will likely be required to allow for decarbonization other sectors of the economy – typically take 10-15 years of planning and construction. Ontario currently has no plans for new large-scale nuclear and hydro units beyond a few high-level public announcements from the Minister of Energy in support of further analysis. From a market design prospective, the CER will disrupt Ontario’s wholesale market to such an extent that significant changes will be required to make the market viable, including to:

Market Renewal Program (MRP): One of the primary outcomes of the Independent Electricity System Operator’s (IESO) MRP is to more efficiently commit natural gas-fired generation. The two primary components of MRP that achieve this are through the Day-Ahead Market (DAM) and the Enhanced Real-Time Unit Commitment (ERUC). Neither of these components are likely necessary to the future market based on the CER. If gas-fired generation is only allowed to operate 18 days out of the entire year, the imperative of implementing a DAM is low, as most other resources operating in Ontario – nuclear, hydro, wind and solar – do not require a DAM to efficiently commit units. ERUC contains a number of programs – such as offer guarantee payments – that will not be required given the small amount of time that gas-fired generation is expected to run post-2035. If the CER is implemented in its current form, it will likely require a re-assessment of various components of MRP.

Offer Behaviour: Gas-fired generators will have to drastically alter their energy offer strategy beyond 2035 to include the opportunity cost of only operating for 450 hours annually. Given the small number of hours they are allowed to operate, gas-fired generators would be expected to move energy offers in most hours to the price ceiling ($2,000/MWh) to account for the opportunity cost of not being dispatched outside of the few hours in which they are allowed to operate.

Market Power Mitigation (MPM): MRP will include a much more comprehensive MPM framework. Among other changes, the IESO will be able to mitigate energy and operating reserve offers on an ex ante basis, including offer adjustments by the IESO based on constraints in the grid (both day-ahead and real-time). If gas-fired generators are limited to just 450 hours a year, the number of hours when there are MPM-related constraints in place are likely to increase materially. If a gas-fired generator is dispatched when a constraint is in place, its offers will be mitigated back to pre-determined reference levels based on the marginal cost of the unit. The combination of a 450-hour operating limit and MPM rules that mitigate energy offers back to marginal costs will undermine the ability of gas-fired generators to control their dispatch and the potential revenues they can earn from the wholesale market. There is currently no consideration of thermal generators’ opportunity costs being included in their energy offers (which would partially mitigate this perverse outcome).

Future Gas-Fired Commitment Programs: A number of commitment programs and operational constraints included in MRP – notably the day-ahead and real-time generator offer guarantee programs and must-run constraints – are likely at odds with the current design of the CER. Gas-fired generators have both a Minimum Loading Point and a Minimum Generation Block Run Time that require the unit to operate at a certain level and for a certain amount of time. The current and future design of the wholesale market incorporates these operational constraints in the dispatch of gas-fired units and financial guarantee programs made available to them. The design of these programs must be updated to account for their interaction with the CER and whether they are fully compensating gas-fired units for the cost of being dispatched to operational constraints, which are not included in the CER. Gas-fired units may also be dispatched on the basis of their ramping capabilities. The 450-hour operating threshold may limit the IESO’s dispatch software from relying on ramping capabilities of these units going forward.