Electricity Markets

FERC accepts significant changes to PJM reserve market design

The Federal Energy Regulatory Commission on May 21 found that the reserve market design in the PJM Interconnection is unjust and unreasonable and conditionally accepted significant market changes that could cost consumers between $500 million and $2 billion annually. 

At the same time, FERC required conforming modifications to the PJM capacity construct rules that could reduce the net impact to consumers by improving the accounting for increases in energy and ancillary services earnings when determining capacity prices. 

The role of reserves

Reserves play an important role in maintaining the reliability of the bulk power system, FERC noted. The North American Electric Reliability Corporation (NERC) mandates that each regional transmission organization and independent system operator (RTO/ISO), as balancing authorities, maintain sufficient reserves to respond to the loss of the largest single contingency on its system within 15 minutes. 

RTOs/ISOs also seek to maintain sufficient reserves to address other real-time operational uncertainties, such as deviations of load, generator availability and performance, and interchange from forecast values.  RTOs/ISOs use different reserve product specifications and set different minimum reserve requirement (MRR) quantities, but the objective is the same -- to adequately prepare for operational uncertainties.

PJM submitted filings in March 2019

On March 29, 2019, PJM submitted filings pursuant to sections 205 and 206 of the Federal Power Act (FPA), asserting that the reserve market provisions of its Open Access Transmission Tariff and the Amended and Restated Operating Agreement are unjust and unreasonable. It proposed revisions to the tariff and Operating Agreement as a just and reasonable replacement rate.

PJM noted that reserves play an important role in maintaining the reliability of its bulk power system, including managing system uncertainties.  PJM stated that the solution to managing these uncertainties is to line up resources that are not scheduled to serve load during the target period but that are capable of providing energy on short notice if needed.

The grid operator said that its reserve requirements, and the procedures and products used to meet those requirements, have evolved over time.  PJM explained that with any complex system, flaws can develop and become more apparent the longer they are left unaddressed.

PJM stated that several such flaws have developed within the PJM reserve market which are unique to the grid operator and which lead to unjust and unreasonable rates that are unduly discriminatory and preferential.

PJM identified the following concerns: 

  • A Synchronized Reserve product definition that has led to under-compensation and poor performance because it is subdivided into Tier 1 and Tier 2 reserve products with disparate rules for commitment, compensation, and non-performance penalties;
  • Operating Reserve Demand Curves that fail to address uncertainties around load, wind and solar forecasts, and unanticipated supply resource outages and thus require PJM operators to frequently bias their scheduling of supply resources and take other out-of-market actions to preserve reliability;
  • Reserve market clearing prices that do not reflect the operational value of flexibility;
  • A Reserve Penalty Factor of $850/MWh that is below the legitimate opportunity cost some resources could face in shortage or near-shortage conditions; and
  • Misalignment of reserve products between the day-ahead and real-time markets that leads to inadequate procurement of forward reserves and inefficient commitment and pricing outcomes.

PJM proposals

To address these concerns, PJM made several proposals.

First, it proposed to consolidate the Tier 1 and Tier 2 reserve products into one product -- Synchronized Reserve -- with uniform commitment, compensation, and non-performance penalty structures.

It also proposed to raise the reserve penalty factors to $2,000/MWh and revise the ORDCs’ shape to be based on a probabilistic analysis of the risk of a reserve shortage due to operational uncertainties.

The grid operator also proposed to align reserve procurement in the day-ahead and real-time markets by establishing two 10-minute reserve requirements (Synchronized Reserve Requirement and Primary Reserve Requirement) and one 30-minute Reserve requirement (30-minute Reserve Requirement) in each market.

In addition, PJM proposes to define two new terms that are related but distinct:  30-minute Reserve and Secondary Reserve.  Secondary Reserve is the reserve capability of resources that can be converted fully into energy within 30 minutes.

Secondary Reserve implicitly excludes reserve capability of resources that can be converted fully into energy within 10 minutes, which would be categorized instead as Synchronized Reserve or Non-Synchronized Reserve.  By contrast, 30-minute Reserve is all reserve capability that can be converted fully into energy within 30 minutes, and is thus comprised of Synchronized Reserve, Non-Synchronized Reserve, and Secondary Reserve.

PJM submitted two concurrent filings: tariff revisions pursuant to FPA section 205 and Operating Agreement revisions pursuant to FPA section 206, with identical provisions in each.  

Among the parties that filed protests in response to the PJM filings was the PJM Load/Customer Coalition, which included American Municipal Power, Inc., the American Public Power Association, and a number of other entities including state consumer advocates and utility commissions.

Among other things, the PJM Load Coalition argued that PJM has not demonstrated that energy and reserve prices are unjust, unreasonable, or otherwise fail to fairly compensate generators. 

The coalition noted that PJM only cites one example as evidence that synchronized reserves are undercompensated -- cold weather conditions from January 30-31, 2019 -- which does not prove that the current market design is flawed, but rather that low prices occur when there is excessive supply relative to demand. 

The PJM Load Coalition argued that PJM was carrying reserves significantly in excess of its MRR during the cited period, and that PJM’s analysis confirms that many supply resources with capacity obligations were simply not needed to meet demand.

The coalition argued that PJM has not shown that it is incapable of attracting sufficient reserves to meet its MRR, nor has it presented any analysis to substantiate its speculative assertion that, absent reserve pricing changes, anticipated higher levels of intermittent resources will lead to future reliability problems.

The PJM Load Coalition also argued that PJM has not demonstrated that uplift cost levels are unjust or unreasonable.

The PJM independent market monitor also filed an extensive protest against PJM’s filing.

FERC order

In its May 21 order, which was approved at FERC’s monthly open meeting, the Commission found that PJM met its burden to show that its current reserve market design is unjust and unreasonable.

“PJM presents record evidence that its reserve market is systematically failing to acquire within-market the reserves necessary to operate its system reliably, to yield market prices that reasonably reflect the marginal cost of procuring necessary reserves, and to send appropriate price signals for efficient resource investment,” FERC said.

“PJM also demonstrates that the reserve products it procures in the day-ahead and real-time markets produce poor incentives for resource performance and inhibit efficient procurement of the types of reserves needed to address various operational uncertainties,” the Commission said.

FERC also said it agrees with the grid operator that its existing reserve market fails to produce market prices that reflect the marginal cost of providing reliable service, including reserves necessary to address legitimate non-contingency operational uncertainties.  “The evidence shows that PJM’s operators will, and do, acquire needed additional reserves at costs in excess of what the current reserve market design allows to be reflected in price.”

The Commission also agreed with PJM that the resulting lack of price transparency is inconsistent with proper market design.

Moreover, PJM is correct in concluding that the existing market design is consistently failing to produce prices reflecting the marginal cost of procuring necessary reserves, FERC said.

And, the evidence on the record shows that PJM’s current reserve product definitions and procurement across the day-ahead and real-time markets is inefficient and provides perverse incentives for resource performance, the federal agency said.

Replacement rates                            

Having found that PJM met its burden to show that its current reserve market construct is unjust and unreasonable, FERC addressed the appropriate replacement rate.

FERC largely adopted PJM’s proposal as the just and reasonable replacement rate, subject to certain modifications.

FERC adopted as part of the just and reasonable replacement rate PJM’s proposal to consolidate the existing Tier 1 and Tier 2 reserve products into a uniform synchronized reserve product with a single clearing price.

It also signed off PJM’s proposal to establish a reserve penalty factor of $2,000/MWh for all reserve products.

Meanwhile, FERC adopted as part of the just and reasonable replacement rate PJM’s proposal to modify its ORDCs to establish a downward-sloping portion to the right of the applicable MRR, and to construct that portion as a function of the Reserve Penalty Factor and the probability of experiencing a reserve shortage in real-time at varying reserve procurement quantities.  “We agree with PJM that it is just and reasonable for ORDCs to value reserves in excess of MRRs, and to determine the value of those reserves using the empirical probability formulas proposed.”

In addition, FERC adopted as part of the just and reasonable replacement rate PJM’s proposal to align its day-ahead and real-time reserve markets.

The Commission, however found that these reserve market changes render PJM’s existing methodology for calculating the energy and ancillary services offset the capacity construct unjust and unreasonable, and instead establish a forward-looking offset as part of the replacement rate. The PJM Load Coalition had asked FERC to implement such a mechanism in the event it approved PJM’s proposed replacement rate. Because the replacement rate will produce a major change in the energy and ancillary services markets, which expected to increase revenues from these markets, the current use of a historical offset would not account such increases when capacity prices are determined.

 FERC largely adopted PJM’s proposal to impose on some resource types a must-offer requirement for reserves, and to determine resources’ eligibility for providing reserves in a manner similar to PJM’s current practice with regard to Tier 1 reserves. 

It also adopted PJM’s requirement for market sellers to submit offer data to PJM that is an accurate representation of the resource’s capabilities given the confines of the PJM software.

“However, we find that certain protestors’ arguments have merit and that additional clarity on how PJM’s eligibility determinations will be made is necessary.”

The Institute for Policy Integrity at New York University School of Law (IPI) raised concerns over the lack of a transparent process or outline of criteria in how PJM determines eligibility for resources providing reserves. 

“We agree  with IPI that PJM’s tariff should contain clear provisions on:  (1) resource classes  that PJM has designated as incapable of providing reserves, for each reserve product;  (2) the exemption process PJM will use to determine reserve eligibility if a resource is automatically deselected from providing reserves; and (3) the process by which PJM  will communicate this information and determination to the market seller.”

Accordingly, FERC directed PJM to include in its compliance filing within 45 days of the date of the order revisions to its tariff and operating agreement to adopt the capacity construct changes and clarify the process through which PJM will determine resource eligibility to provide reserves.

Commissioner Glick dissents

FERC Commissioner Richard Glick dissented from the order, saying the decision is “just the latest in a series of PJM proceedings that have gone against consumers as the Commission has prioritized high prices over efficient markets.”

None of the record evidence regarding low prices, uplift, market actions, or the growth of renewable resources shows that the existing energy and reserve market is unjust and unreasonable.  “The only thing revealed by a careful review of the record, is that PJM has failed to satisfy its burden of proof to show that the existing rate is unjust and unreasonable,” he wrote.

PJM principally contends that its tariff is unjust and unreasonable because it does not price reserves in a manner that reflects the operational value of the flexibility that they provide, he said. “But that argument overlooks -- or ignores -- that an efficient market prices a service at, or at least near, the marginal cost of producing it,” Glick said.

Moreover, Glick argued that FERC failed to show that the replacement rate is just and reasonable.

“In setting a replacement rate, today’s order largely rubber stamps PJM’s proposal to impose a complex and opaque administrative pricing scheme, which is expected to increase prices by between $500 million and $2 billion per year,” Glick said. 

That replacement rate “will result in pervasive scarcity pricing, even when reserves are plentiful. That result is inconsistent with basic economic theory and, taken seriously, would appear to raise serious questions about how locational marginal prices are formulated in all other RTOs,” Glick argued. 

“Suffice it to say, forcing customers to pay outrageous costs for reserves substantially in excess of the reserve requirements established by NERC and without any evidence of additional benefits commensurate with that additional cost is about unjust and unreasonable as you can get.”

Glick said that scarcity pricing is an essential element of any market-based approach to managing an electricity system. “It provides an economic incentive for resources to provide services that are in short supply, thereby providing more of those essential services.  But the logic of shortage pricing presupposes that there is a shortage,” he wrote in the dissent.  Imposing scarcity pricing in the absence of a shortage is a way to generate windfalls for generators, not a just and reasonable response to market conditions, Glick argued.

Ride-sharing company analogy

“Imagine if ride-sharing companies, such as Uber or Lyft, all suddenly began doubling or tripling the cost of rides when there were far more cars on the road than customers using those apps,” Glick wrote.  “Now imagine that those companies had a monopoly on transportation and you had to use those services to get where you want to go.  That would look a lot more like price gouging than a reasonable response to market fundamentals. And yet, that is distressingly similar to the pricing regime that the Commission is imposing today.”

Glick said that is “a sad state of affairs for an agency whose primary purpose is supposed to be customer protection.”