PJM Offers Two Proposals: A Rock and a Hard Place

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April 11, 2018 by Jennifer Chen, Attorney, Sustainable FERC Project

PJM, the transmission grid operator for parts of the Mid-Atlantic and Midwest, filed two competing proposals this week at the Federal Energy Regulatory Commission (FERC), the agency tasked with ensuring that wholesale electricity market rules result in reasonable rates. Both proposals would drive up the utility bills of 65 million electricity customers in the region for no additional benefit. PJM filed its own proposal as the preferred approach, even though PJM’s stakeholders overwhelmingly rejected it, as well as an alternate proposal that would force utilities to over-procure generation.

PJM’s stated concern underlying the proposals is hypothetical: it worries that state public policies preferring certain types of resources—such as wind, solar, nuclear, or even coal power—might suppress prices in PJM’s capacity market by “subsidizing” these resources. (The capacity market obtains commitments from resources to supply electricity in the future.)

While this may sound reasonable at first, there are serious issues with this framing of the problem.

First, the way PJM formulates the “problem” assumes that state subsidies are a key driver of “suppressed” or “low” prices. But zero evidence supports that state public policies are materially affecting prices; in fact, data and modeling suggests other factors are much more significant. Further, low prices are not necessarily a sign that market rules need to be fixed. Thus, it’s not surprising that 64 percent of PJM stakeholders prefer no change to the capacity market rules over either proposal.

Low prices, especially when the market is oversupplied with generation compared to customer demand, are a signal for the least efficient power plants to retire. Once excess supply is shed, prices will rebound. For example, FirstEnergy’s nuclear plant closures, which will take more than 4,000 megawatts (MW) of capacity offline (about 2 percent of PJM’s overall operational capacity), could boost prices in PJM’s upcoming capacity auction to double that of last year’s capacity price. On the flip side, natural gas generation coming online has contributed to “low prices”—about 5,500 MW of new gas entering PJM’s capacity market brought prices down by 12 to 25 percent. Notably, “low” prices are not deterring new market investments, as PJM is projected to gain 11,615 MW of net capacity in 2018, largely from new gas plants.

In contrast, no evidence indicates that state subsidies have actually depressed prices. Theoretically, PJM’s modeling suggests that subsidizing two nuclear plants (Quad Cities and Three Mile Island) would depress capacity market prices by only 2 percent. This is small compared to the impact of resources entering or exiting the market, suggesting that the excess capacity in PJM has a bigger effect on prices.

Second, PJM’s formulation of the “problem” ignores the fact that all resources benefit from subsidies. Many traditional forms of generation have received government aid for almost a century; these subsidies have enabled fossil and nuclear generators to scale up and build infrastructure. Only now focusing on state assistance disparately shines the spotlight on policies helping new technologies scale up and gain a foothold in the markets and would impede these new resources from competing with traditional power plants. Further, many of the resources participating in PJM’s markets receive subsidies that are not in the scope of PJM’s review, such as support for fuel extraction, transport, and waste disposal.

Third, PJM’s formulation ignores the real problem—that PJM’s capacity market is not really a market. In a real market, customers can buy what they want and in quantities they want, and if they can’t find what they’re looking for, they can purchase it elsewhere. Not so in PJM’s capacity market—customers’ utilities must purchase a specific amount of capacity and customers don’t get to choose what kind they buy because PJM’s market only sells basic capacity. There’s no option to purchase emissions-free or locally generated capacity. Further, it’s extremely difficult for a utility to opt out of buying from the market to instead purchase what its customers want elsewhere. A workaround of this must-buy requirement has been to pay for emissions-free attributes through other means (such as renewable energy credit markets) while paying for the renewable resources’ basic capacity through the capacity market. But now, PJM is proposing to be the judge of what is a fair market price, making its capacity market even less market-like than before.

In fact, this problem—that the capacity market isn’t really a market—is at the crux of the imagined tension between an idealized free market (that is somehow devoid of all subsidies) and state public policies attempting to influence what they can procure from the market: If PJM’s capacity market provided flexibility for utilities to buy what their customers want from the market, or enabled utilities to obtain capacity elsewhere when they cannot get the type of power they want, this tension disappears.

But instead of addressing the real problem, PJM’s proposals would continue to require that utilities buy from its market, and if a resource is deemed materially subsidized, the resource’s offer price would be inflated to reflect the “true” cost of that resource without a subsidy. Under PJM’s own proposal, the “subsidized” resource would stay in the market, and thus, PJM claims, PJM’s proposal accommodates state policies while maintaining competitive capacity market prices.

However, PJM’s proposal does neither of these things. States that implement these policies would see their citizens hit with higher capacity prices in addition to paying for their state policies (e.g., through state taxes). Thus, the states’ citizens would have to pay nearly double for the capacity they must buy, and the subsidized generator receives both a state subsidy and the higher capacity price. If the subsidized generator is an old, inefficient power plant, PJM’s mechanism would help prop up the power plant, and it would also generally help retain excess capacity longer by inflating capacity prices. (These features make PJM’s two-step proposal very different from a recent proposal from the grid operator for New England.)

PJM’s proposal is a fundamental change to the capacity market. While most competitive markets determine the quantity procured and the price paid by finding the intersection of the supply and demand curves (see the figure below), PJM’s proposal splits this process so that PJM would first establish which resources will receive a capacity commitment (and thus quantity) and then establish the price for them.

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PJM stakeholders (consisting of consumer advocates, generators, transmission owners, demand response providers, utilities, and financial traders) disliked PJM’s proposal so much that they requested that it be brought it up for a vote at PJM’s highest stakeholder committee to emphatically express disapproval (nearly 80 percent opposed it). Moreover, various groups urged PJM’s board of managers not to file PJM’s proposal at FERC, which will rule on the proposals, likely later this summer.

Despite widespread opposition, PJM still filed its own proposal, but in an unusual move, also filed a competing proposal (known as “MOPR-Ex”) that most stakeholders thought they could hold their nose and accept if necessary (although PJM didn’t give stakeholders sufficient time to fully shape that proposal). PJM already has a Minimum Offer Price Rule or “MOPR” (see here for a MOPR explainer), and MOPR-Ex would expand it to more resources.

MOPR, like PJM’s proposal, would inflate a “subsidized” resource’s offer to reflect the “true” cost of that resource without a subsidy. The main difference is that MOPR could result in a “subsidized” resource failing to receive a capacity commitment, in which case the “subsidized” resource would not receive capacity revenue and utilities that already have capacity lined up from that resource would have to procure that amount of capacity again from PJM’s market, leading to over-procurement. Therefore, MOPR, like PJM’s proposal would penalize a state (and its citizens) for implementing a public policy by making them pay for twice as much capacity as they’d normally require. Further, MOPR distorts the market by forcing this over-procurement (although, MOPR could be designed to avoid this outcome if a utility with a MOPRed resource were allowed to procure less capacity from PJM’s market).

While MOPR-Ex is a version of MOPR with an exemption to protect resources participating in state Renewable Portfolio Standards (RPS) programs, it does not cover all such programs and PJM indicated that it is willing to scrap the RPS exemption.

Interested parties will be submitting comments urging FERC to reject PJM’s proposals. We hope that FERC will see that PJM is offering two non-solutions to a non-problem at the expense of the consumers FERC is tasked to protect.

The views expressed in this blog are those of the author, and do not necessarily represent the views of the Sustainable FERC Project or Natural Resources Defense Council.

Written by Jennifer Chen