Capacity, Capacity Everywhere, Not a Drop to Drink

Why a capacity-starved grid still can't get batteries financed

On the ground at the NY-BEST Capture the Energy Conference in Albany this May, I was taken by a paradox simmering deep within the heart of energy markets that I felt but couldn’t quite articulate.

On one hand, the capacity crunch and rising electricity rates dominate every nook and cranny of the energy discourse as datacenter developers frantically scour the grid in search of reliable power and a seat at the table in the AI arms race. We’re seeing load growth unlike anything the industry has experienced in generations and the capital deployed to get compute online shows no signs of slowing down. And as a result, we’re short generation capacity. So short, in fact, that some VPP folks I spent time with at the conference have had customers disenroll from their demand response programs because they weren’t being paid enough relative to how often they were being dispatched.

As my boss James remarked at lunch one day a few weeks ago, in an environment such as this, selling power (or capacity) should be as easy as “selling water to people dying of thirst”.

Yet the discourse at the conference itself, both in terms of scheduled programming as well as side conversations in the exhibition hall, was quite different: storage developers can’t get projects to pencil. Specialized programs to fill in market gaps were the talk of the town. One of the best panels of the week was run by Bram Peterson, covering NYSERDA’s Index Storage Credit (ICS), a new program designed to solve the missing money problem pervasive in New York utility-scale storage development. Basically, the idea is that a developer submits a bid that represents the revenue threshold they need per MW-day to make the project financially viable: build costs plus their required return baked into a single strike price. NYSERDA then calculates a reference price each month, which is an estimate of what a battery should be able to earn in wholesale markets. If the reference price falls below the strike price, NYSERDA pays the developer the difference. If actual revenue comes in above the strike price, NYSERDA keeps the upside. In effect, NYSERDA acts as a hedge provider by bearing the volatility risk in exchange for capturing any outperformance. It is a program designed to assuage investor anxiety around the inherent merchant risk of monthly and seasonal markets for energy and capacity.

My friend Elias Hatem, developing BESS projects with MEI, called out that New York isn’t acting alone here; Massachusetts, Maryland, and Illinois are all pursuing similar mechanisms within their respective ISOs, suggesting this is becoming the default playbook for states trying to close the storage financing gap.

As far as headwinds go, the conference touched on familiar bogeymen like permitting uncertainty, broken interconnection processes, volatile network upgrade costs, supply chain volatility, and the evisceration of the ITC. I also met with some developers who made salient points about ancillary services saturation and a less forgiving interest rate environment.

These are all challenging realities of energy development that make the supply curve for grid-connected power super inelastic. But even the most inelastic supply curve should get more capacity online without using out-of-market subsidies to plug holes if prices get high enough. The mystery, as I see it, is with a seemingly infinite demand for power, why aren’t prices rising even higher? Billions of dollars flow to datacenter development without batting an eye. Shouldn’t this appetite for risk spill over to the constraining element of this load growth as well?

Then Lynne Kiesling published a piece that crystallized what I’d been circling: a comprehensive review of PJM’s new whitepaper, where BESS developers appear to be struggling with the same issues I saw up close within NYISO. Basically, her argument is that the capacity markets we rely on to send investment signals were themselves created to patch over a deeper distortion: wholesale energy markets cap scarcity prices, and retail rate design keeps most consumers on flat rates where they never see those prices anyway. Demand is institutionally prevented from responding to scarcity, not because the technology doesn’t exist, but because the market was designed around passive load and the particular characteristics of thermal resources. Energy markets alone can’t generate enough revenue to justify building resources needed during peak events, so we created capacity markets to fill the gap. But capacity markets clear on short time horizons and set prices through administrative demand curves that substitute for actual preference revelation. The result is a revenue signal that’s too noisy, too short-term, and too politically vulnerable to underwrite a 15-year battery project. And so we get the ISC, where a state agency has to manufacture the long-term revenue certainty that neither the energy market (price-capped) nor the capacity market (administratively determined, short-tenor) can provide. Unfortunately, it is another attempt to remedy the consequences of a distortionary policy with another distortionary policy” as Kiesling wrote in 2009.

What’s funny to me is that many of the most knowledgeable pro-renewables advocates working in wholesale markets complain that energy markets were built around natural gas in the late 90s as this now dominant molecule burst onto the scene right when ISOs were forming. Wind, solar, and BESS have had an uphill climb against this bias towards thermal resources ever since. But now, capacity markets can’t even get gas built, the resource type they were literally designed around!

Although noble, the way out will not be found through continuing the hamster wheel of administered programs but rather via bilateral contracting at prices that reflect actual scarcity. The datacenter developers driving load growth need capacity yesterday and have the credit quality to contract for it directly at prices that actually reflect their willingness to pay. The solar industry didn’t scale on ISO market signals alone; it scaled because corporates with a desire for price certainty and clean power signed 15-year VPPAs that gave developers bankable offtake. The battery equivalent is an emerging class of bilateral tolling agreements with the customers whose load growth created the crunch in the first place, at prices negotiated between parties who know what reliable power is actually worth to them.

ERCOT, as usual, is already showing the way: Modo reports that 1.6 GW of battery capacity is now under tolling agreements, up from nearly zero two years ago, as developers who got burned by merchant revenue volatility turned to bilateral contracts to get financed. The question is whether this energy-only plus tolling model migrates to structured markets like NYISO and PJM, where the administered capacity market is still the default pathway and the need is arguably even more acute. However, there are signs this is already happening: in the whitepaper Lynne highlights, PJM’s CEO floats the idea of an energy-only market, and there has been real momentum behind signing tolls from utilities in Arizona for a while.

The paradox I couldn’t articulate in Albany turns out to have a straightforward explanation: we built a market that caps the price of scarcity and then wonder why no one will finance the resources we need to resolve it.

When market design suppresses volatility, it tends to leak out in unexpected and inconvenient places. Cap energy prices, and scarcity leaks into the capacity market. Administer the capacity market, and scarcity leaks into state subsidy programs like the ISC. And when none of it produces prices high enough to justify participation, existing resources start walking away from the grid entirely – even when they are needed most – which is exactly what those VPP operators at the conference described.

The people dying of thirst aren’t buying water because we’ve made it illegal to charge what it’s worth.