Court Rejects Industrial Consumers Challenge to New York ISO's Design for Pricing Capacity Reserves

            Over the spirited and multifaceted objections of industrial power consumers "• represented by the Electricity Consumers Resource Council ("ELCON") "• a US appeals court upheld FERC orders allowing the New York ISO ("NY ISO") to replace a flat-rate price for installed capacity with a price set equal to a downward-sloping demand curve.  The sum of ELCON's arguments boiled down to a complaint that the new prices were simply too high and would unduly burden New York consumers.  But the court agreed with FERC that the downward-sloping demand curve price would induce needed investment in generating capacity by providing more stable and predictable pricing of capacity than resulted from the flat-rate price.  

Similar to other regulators and operators of organized power markets, NY ISO requires that all providers of retail power service maintain a reserve of installed capacity or "ICAP" in excess of peak demand "• 118 percent of peak demand in the case of NY ISO.  Formerly, a retail service provider within NY ISO who was ICAP deficient was required to make up the deficiency in monthly ICAP auctions in which the price of  ICAP was a deficiency charge equal to $255 per kilowatt/year or three times the annualized cost of installing new peaking capacity.  This produced a vertical demand curve:  All demand for ICAP up to 118 percent of peak demand was flat at the deficiency charge, beyond which the price fell to zero.  NY ISO found that this scheme resulted in extreme price volatility that deterred investment in new capacity.  Accordingly, NY ISO proposed, and FERC agreed, to replace the flat-rate prices with a structure that priced ICAP on a downward-sloping demand curve under which price declines as quantity demanded increases.  Specifically, for ICAP equal to 118 percent of peak demand the price would be the annualized cost of new peaking capacity; the price for demand beyond 118 percent gradually would to zero at 132 percent of peak demand, and for demand less than 118 percent the price gradually would increase to the 200 percent of the cost of new peaking capacity.  

FERC found that the sloping continuum of prices was likely to eliminate the extreme volatility of pricing under the old scheme and, as a consequence, would likely induce new investment in ICAP at not too high of a cost to consumers.  The court agreed and rejected ELCON's contention that FERC could approve a system of what ELCON characterized as "incentive rates" only if FERC determined that the increased price of ICAP was no more than absolutely necessary to achieve the objective or encouraging new investment.  FERC need only demonstrate that the new pricing is supported by the available evidence.  The court also took comfort in FERC's insistence that NY ISO monitor and report on the new pricing system's performance during the first two years of its operation.  (D.C. Circuit No. 03-1449) [NEW MATTER]