Generation Adequacy Via Call Options Obligations: Safe Passage to the Promised Land

This paper outlines a strawman proposal for ensuring electricity supply adequacy by means of contracting obligations imposed on load serving entities (LSE). The mandatory contracts take the form of physically covered back stop call options with a high strike price so as not to interfere with normal risk management practices. These call options which can be covered by existing capacity, new investment in generation, or curtailable load contracts are of one year duration and a two year lead time so as to enable new entrant participation. The obligation, which is based on forecasted peak load plus adequate planning reserves, can be met with any forward or option contract that meets the physical cover requirement, has the same delivery period, and has a strike or forward price at or below the backstop strike price. The proposed mechanisms is intended to facilitate smooth transition to an energy only market where voluntary bilateral contracting and spot prices provide the needed incentives for adequate investment in generation capacity. We also describe a central procurement alternative that alleviates the credit problems associated with carrying long term option contracts. The features of the proposed approach are compared to those of the controversial LICAP mechanism proposed by the NEISO and endorsed by FERC