Overview

The Independent Electricity System Operator (IESO) of Ontario’s wholesale electricity market is about to initiate a major reform of its market design.  This initiative will be the first significant overhaul of Ontario’s wholesale electricity market since it was first implemented 15 years ago.¹  The planned market reform will include significant changes to: (1) increase the efficiency of the “energy” component of the wholesale markets, (2) introduce a number of features to improve the system’s operating flexibility, and (3) implement an incremental capacity auction to support the investments needed to maintain the reliability of Ontario’s electricity supply.  This coordinated set of market reforms has been termed “Market Renewal” and represents the culmination of many years of analysis and observation by the IESO, the Ontario Market Surveillance Panel (MSP), and Ontario electricity sector stakeholders.

Our recently-completed analysis of market reform impacts, undertaken with extensive consultation of IESO stakeholders, shows that the initiative can mitigate or eliminate numerous existing inefficiencies associated with the current market design and provide substantial net benefits to the province.²  Based on these results, the IESO and its stakeholders decided to proceed with developing a revised market design in a manner that will maximize available benefits, mitigate implementation risks, and prepare the province’s wholesale power market for meeting future customers’ needs while supporting public policy priorities.

The key findings of our analysis include:

• The estimated benefits of Market Renewal significantly outweigh estimated implementation costs, with a present value of net benefits ranging from $2.2 billion to $5.2 billion over the next decade.  These province-wide benefits will be shared by customers and suppliers.
• The benefits from Market Renewal are likely to grow over time as Ontario’s electricity sector continues to decarbonize, as contracts expire, and as the sector becomes more distributed in nature.
• Market Renewal will better prepare Ontario for the future by creating a competitive framework for effectively incorporating new and emerging technologies.
• The IESO and stakeholders have substantial opportunities to enhance the benefit-to-cost ratio of the Market Renewal by learning from the experiences of other jurisdictions and applying lessons learned to Ontario’s unique context.

The Need for Market Renewal

The current wholesale market was originally designed to coordinate the operations of nuclear, hydro, and fossil-fueled resources, with coal-fired generation providing about 25 per cent of Ontario’s total energy needs and providing the bulk of the system flexibility.  The limitations of this market design were recognized by the Market Design Committee who originally developed the system, and the design was supposed to be a temporary solution that would have transitioned to a system with “nodal pricing” over an 18-month period after initial implementation.  Contrary to those former plans, this transitional design has now been in place for one and a half decades.

Over time, patches and temporary improvements have been layered onto the foundational design, but the existing system has nevertheless become increasingly inefficient.  These inefficiencies have been extensively documented and analyzed by the IESO, the MSP, and independent observers.³ In 2014, Ontario retired its last coal-fired generating plant as a part of a concerted effort by the province to decarbonize the electricity sector.⁴  Non-emitting generation resources (particularly nuclear, biomass, wind, and solar) and new natural gas generation have replaced most of the coal-fired generation.  The changing supply mix and increasing flexibility needs have amplified the challenges with the existing market design.  Looking forward, the challenges are likely to intensify, making the existing system increasingly inefficient and costly.  Further, with the adoption of new technologies that introduce additional operational complexities and the continued rise of participation at the distribution level will require significant improvements to the market design overall.

While the specific implementation details of the Market Renewal Program will still need to be developed, the general features of Market Renewal that the IESO and stakeholders have identified can be categorized into three workstreams:

• Energy: Move to a market with a single schedule for operations and financial settlement, including locational marginal pricing for suppliers, improved generation commitment and dispatch in real time, and a financially-binding day-ahead market.  
• Operability: Increase system flexibility and improve utilization of interties with neighboring systems to reduce the cost associated with surplus-generation conditions, variable renewable generation uncertainties, and the need to curtail resources.
• Capacity: Improve procurement of resources to meet the province’s resource adequacy needs through an incremental capacity auction that stimulates competition from all qualified supply resources in a technology-neutral manner.

These reforms will increase the extent to which Ontario relies on transparent market-based mechanisms to provide electricity to all consumers.  Experiences from other North American power markets that have already addressed challenges similar to those in Ontario show that the proposed market reform will help support a more efficient electricity sector.

Expected Benefits of Market Renewal

We estimated the benefits of each of the three Market Renewal workstreams based on stakeholder input, existing studies of the Ontario market, analyses of similar market redesign efforts in other North American power markets over the last decade, and an assessment of Ontario’s unique characteristics.  For each workstream, similar reforms in other markets have proven to yield efficiency benefits that significantly outweigh costs.  Energy market reforms in MISO, CAISO, ERCOT, and SPP between 2005 and 2014 implemented many of the same elements currently being considered in Ontario.⁵  Similarly, studies of operability and intertie enhancements in CAISO, ERCOT, MISO, NYISO, PJM, and ISO-NE have quantified significant benefits the IESO’s operability workstream could potentially capture.⁶ Furthermore, experience in other markets has shown that capacity auctions can attract substantial quantities of low-cost capacity resources.  In particular, the U.S. markets of PJM, ISO-NE, and NYISO have successfully relied on capacity markets to meet their reliability needs cost-effectively for more than a decade.⁷ Combining Ontario-focused analyses with the real-world experiences from other markets—after recognizing and controlling for differences across markets—provides a comprehensive picture of the potential benefits and risks associated with Market Renewal.

The primary benefits of Market Renewal are associated with:

• Fuel, Emissions, and Operations and Maintenance (O&M) Cost Savings.  The current market does not fully account for all costs and system constraints in price-setting, resource commitment, and generation dispatch.  As a result, the province is not taking full advantage of its lowest-cost resources.  Market Renewal will reduce operating costs by improving the system’s ability to identify and utilize the lowest-cost resources, including wind, solar, nuclear, hydro, storage, demand response, and interties.
• Reduced Curtailment/Spilling of Non-Emitting Resources.  The current market neither efficiently utilizes existing resources nor incentivizes innovative solutions to meet system flexibility needs.  Improved market design will avoid excessive costly curtailment of the province’s non-emitting wind, solar, and nuclear, and hydro resources.
• Increased Export Revenues and Reduced Import Costs.  A reformed energy market and optimized interties will increase the efficiency of trading with neighboring power markets.  Such improvements will allow for increased imports of lower-cost generation and enable Ontario suppliers to export more power whenever export revenues exceed Ontario’s generation costs.
• Investment Cost Savings.  Transitioning to a more market-based capacity procurement process, combined with enhanced energy and ancillary market incentives, will increase competition to meet system needs at lower investment cost.  A technology-neutral approach will level the playing field for existing and new resources, including innovative technologies that have been left out of the capacity procurement process traditionally.
• Reduced Gaming Opportunities, Administrative Complexity, and Unwarranted Transfer Payments.  The current system does not align generation dispatch with market prices, resulting in costly uplift payments.  These payments in part reflect the inefficiencies and administrative burden of operations for both the IESO and market participants; and they create incentives for some market participants to profit from the design flaws.  A more competitive market design can eliminate these inefficiencies and gaming opportunities.
• Enhanced Competition and Innovation.  Improved market design will yield market prices that accurately reflect market conditions which, in turn, will support competition among a broad set of traditional and non-traditional resources to minimize system costs and encourage innovation.
• Alignment with Provincial Policy Goals.  Market Renewal will create an improved platform for enabling market evolution in support of Ontario’s policy objectives and changing market fundamentals.

Figure 1 summarizes our estimates of the benefits and costs of Market Renewal.  As shown, the present value of estimated benefits between 2021 and 2030 is approximately $510 million from energy market reforms, $580 million from operability reforms, and $2.5 billion from capacity auction reforms.  Realized benefits will continue beyond 2030 and will grow over time as more existing contracts expire.  The benefits could be greater than we have estimated if the existing contracted resources are more responsive to market prices than assumed in our analysis.  As shown, these benefits compare to $200 million in estimated IESO implementation costs.  Modest additional implementation costs will also be incurred by market participants (not shown in the figure).

Overall, we estimate the 10-year present value of Market Reform benefits at approximately $3.4 billion (net of implementation costs), with a baseline benefit-to-cost ratio of 18-to-1.  Considering the uncertainties in the nature of reforms and the magnitude of benefits from each workstream, these net benefits over ten years could range from $2.2 billion to $5.2 billion, with a benefit-cost ratio ranging from 12-to-1 to 27-to-1.  In other words, the benefits from Market Renewal are expected to greatly outweigh the implementation costs, even considering the significant uncertainty range.

In addition to the quantified benefits included above, we expect Market Renewal to produce additional benefits that we have not yet quantified.  For example, the above estimates do not include benefits of better integration of diverse and emerging resources, they do not capture the benefits of reduced opportunities for gaming and administrative burden for both the IESO and market participants, and do not include the longer-term savings from enabling innovation through a more open, competitive marketplace.

The overall benefits will be shared by customers and suppliers.  Customers will pay less for electricity and the most competitive suppliers will benefit from increased opportunities to sell flexibility services, by generating energy where and when it is most valuable, and through improved opportunities to export energy and capacity.  Investors of new resources and technologies will benefit from opportunities created by the anticipated types of reforms for Ontario.  On the other hand, resources that do not contribute toward the flexibility needs of the system, those that have high net going-forward costs, or those that are currently receiving significant “above-market” compensation will likely see a reduction in total revenues as they will be exposed to greater competitive forces.

Figure 1 – Present Value of Market Renewal Benefits and Costs (2021–2030)

Notes: Results represent province-wide benefits from efficiency gains net of IESO implementation costs; they exclude any transfers payments among market participants.

Recommendations

Based on the significant net benefits to the province, the IESO and stakeholders have decided to proceed toward the design stage of the Market Renewal.  To maximize the benefits and mitigate the potential risks associated with Market Renewal, we recommend that the IESO and stakeholders carefully examine the available design choices and take advantage of experiences from other markets before selecting features that are most beneficial and consistent with Ontario’s unique fundamentals and policy environment.  We provide more specific recommendations for each workstream in the Findings and Recommendations section of our April 20^th report.

*Johannes Pfeifenberger, Kathleen Spees and Judy Chang are Principals, Mariko Geronimo Aydin is a Senior Associate, and Walter Graf is an Associate at The Brattle Group, an economic consulting firm with offices in Toronto, Boston, Washington DC, San Francisco, New York, London, Rome, Madrid, and Sydney. This article is based on work undertaken for Ontario’s Independent Electricity System Operator (IESO). We acknowledge the important contributions of IESO staff, members of the Market Renewal Working Group, and IESO stakeholders.  Brattle Research Analysts Peter Cahill, James Mashal, and John Imon Pedtke contributed to the analysis of benefits for this study. Vikki Harper, William Schwant, and Ken Donald of Utilicast contributed to estimating IESO implementation costs for the proposed Market Renewal initiatives. All results and any errors are the responsibility of the authors and do not represent the opinion of The Brattle Group or its clients.

1. See IESO postings related to Market Renewal, online: <http://www.ieso.ca/sector-participants/engagement-initiatives/engagements/market-renewal>.
2. Pfeifenberger et al, The Future of Ontario’s Electricity Market: A Benefits Case Assessment of the Market Renewal Project, The Brattle Group, prepared for IESO (20 April 2017), online: <http://www.ieso.ca/sector-participants/engagement-initiatives/engagements/market-renewal>.
3. For example, see Ontario Energy Board, Market Surveillance Panel: Congestion Payments in Ontario’s Wholesale Electricity Market: An Argument for Market Reform, (Toronto: December 2016), online: <http://www.ontarioenergyboard.ca/oeb/_Documents/MSP/MSP_CMSC_Report_201612.pdf>.
4. See Ontario Ministry of Energy, The End of Coal: An Ontario Primer on Modernizing Electricity Supply (Toronto: December 2015), online: <http://www.energy.gov.on.ca/en/archive/the-end-of-coal/>.
5. See section III of our April 20^th report, supra note 2, for a thorough discussion of the energy market reforms in these markets, how they compare with those being considered in Ontario, and how we used studies of benefits in these markets to estimate potential benefits in Ontario.
6. See section IV of our April 20^th report for details, supra note 2.
7. PJM’s capacity market was implemented in 2007, ISO-NE’s in 2010, NYISO’s in 2006, and MISO’s more recently in 2013. For a review of the experience with the first decade of capacity market operations, see Kathleen Spees, Samuel A. Newell & Johannes P. Pfeifenberger, “CapacityMarkets—Lessons Learned from the First Decade” (2013) 2:2 Economics of Energy & Environmental Policy, online: <http://www.iaee.org/en/publications/eeeparticle.aspx?id=4>.  For more discussion of the experience in other capacity markets and how these findings shaped our analysis of benefits in Ontario, see section V of our April 20th report, supra note 2.