Electricity Markets

FERC OKs PJM changes to capacity auction parameters; Glick dissents

The Federal Energy Regulatory Commission on April 15 accepted proposed revisions made by the PJM Interconnection to the parameters of the grid operator’s capacity auctions.

But the decision drew a dissent from Commissioner Richard Glick, who said FERC should take a holistic review of the capacity market given the “mountains of evidence” indicating that PJM’s capacity market is over procuring resources.

The changes accepted in the FERC order were the outcome of an analysis and stakeholder review that PJM is required to undertake every four years, known as the “Quadrennial Review.” As requested by PJM, the revisions became effective on January 17, 2019 (Docket Nos. ER19-105-001, ER19-105-002).

In its Oct. 26, 2018 filing, PJM filed its quadrennial revision of its Variable Resource Requirement (VRR) Curve used in PJM’s Reliability Pricing Model (RPM)

The VRR curve is an administratively-determined demand curve that is used, in combination with the supply curve formed from capacity supplier sell offers, to clear the RPM Auctions. 

The PJM Open Access Transmission Tariff defines the VRR curve as a set of lines connecting several price-quantity points that are stated as multiples or fractions of the Net Cost of New Entry, or Net CONE, reflected as $/MW-day (on the price axis) and the target reliability requirement (on the megawatt quantity axis). 

PJM indicated that the current VRR curve is composed of three linear segments, each extending down and/or to the right from the point where the immediately preceding segment ends. The Commission has repeatedly accepted downward-sloping, administratively determined demand curves for capacity markets, citing the advantages of such curves, according to PJM.

PJM’s Open Access Transmission Tariff requires PJM and its stakeholders to review every four years both the shape of the VRR curve used to clear the RPM auctions and the inputs to that curve. These inputs include the CONE established by a representative, theoretical new power plant (Reference Resource) and the expected net energy and ancillary services revenues that a plant participating in the capacity market would earn in PJM’s other markets.

Higher prices -- above Net CONE -- are associated with capacity shortage conditions (generally below the target reliability requirement) and lower prices are associated with excess capacity conditions, the grid operator said. 

PJM concluded that the current VRR curve produces the highest price when capacity is 0.2 percentage points below the approved installed reserve margin or lower.  PJM stated that the current effective tariff sets that price as 1.5 times the Net CONE.

Based on the analyses produced by PJM’s independent expert, the Brattle Group, PJM proposed several changes for implementation in connection with the 2019 base residual auction for the 2022/2023 Delivery Year, which were approved by the Commission.

FERC approves PJM changes

The Commission approved several changes proposed by PJM.

First, FERC signed off on a shift of the VRR curve to the left by one percent.

The grid operator is PJM is reversing a prior rightward shift from the previous Quadrennial Review, which was justified as needed to account for regulatory and market uncertainties.

The grid operator said that the rightward shift in 2014 was meant to address:

  • Large scale generation retirements resulting from both the Environmental Protection Agency’s (EPA) Mercury and Air Toxics Standards rule and fuel pricing changes due to the emergence of low-priced shale gas;
  • Heightened competition from the increasing efficiency of gas combined-cycle technology;
  • The D.C. Circuit court’s vacating of FERC Order No. 745; and
  • Uncertainty in the manner in which states would implement the EPA’s greenhouse gas rule.

“We accept PJM’s proposal to undo the previous one percent shift to the right, finding that the specific concerns justifying the 2014 shift largely have been resolved,” the Commission said.

Updating, reducing estimate of Gross CONE

FERC also approved a PJM proposal related to updating and reducing the estimate of the Gross CONE. Gross CONE is a precursor to Net CONE, a variable in the structure of the VRR.

This is determined by an analysis of the construction, operation, and capital costs of the combustion turbine (CT) peaking plant Reference Resource. PJM proposed to retain a CT as the reference resource and update the definition to recognize newer, more efficient, turbine technology, revise the escalation rate used to annually adjust Gross CONE and revise the cost of capital from 8.0 to 8.2 percent. The revised reference resource definition would also reduce capacity prices.

10% adder in dispatch modeling

FERC also approved PJM’s proposal to include a 10% cost adder in the dispatch modeling used to estimate net energy and ancillary service revenue offsets.

The energy and ancillary service offset is the estimated revenue earned by a CT from historical energy and ancillary service prices and is subtracted from Gross CONE to determine Net CONE. PJM argued this proposal was consistent with tariff provisions allowing for such an adder to be included in energy market offers.

A protest from AMP and the PJM Industrial Customer Coalition objected to the cost adder inclusion in the modeling because not all generators include the adder in their energy offers, and PJM will therefore understate the energy and ancillary service offset and overstate Net CONE.

AMP, the PJM Industrial Customer Coalition, the PJM Market Monitor and others also proposed that PJM use a forward-looking energy and ancillary service offset instead of one based on historical prices, but FERC rejected those requests.

Glick dissent

In his dissent, Commissioner Glick said that for many years now, the PJM capacity market has suffered from a chronic oversupply of generation resources.

He said that the primary factor driving that oversupply is PJM’s excessively high Net CONE, “which has incentivized new resources to enter the market when they are not needed and caused PJM to procure far more resources than it should.”

Glick noted that since the 2015/2016 Base Residual Auction, over 31,000 MW of new generation resources have cleared the PJM capacity market, despite the auctions clearing at prices that were on average 60 percent below Net CONE.

“Those figures indicate that developers are willing to enter the market at a fraction of PJM’s estimate of Net CONE. An excessive Net CONE distorts the shape of the demand curve that PJM uses in its capacity market, causing PJM to procure too many resources at too high a price, with obvious detrimental consequences for consumers,” wrote Glick.

At the same time, he pointed out that the harm from an excessive Net CONE goes beyond its impact on consumers’ bills. By retaining too many resources, PJM “dulls the price signals” in the markets for energy and ancillary services, “impairing their ability to incentivize the services we actually need to reliably operate the grid,” wrote Glick.

“A market is only as efficient as the price signals it sends. So long as the flaws in PJM’s capacity market distort the prices throughout the other PJM markets, consumers will pay excessive prices and get a suboptimal resource mix. Net CONE also sets the market seller offer cap, giving it a significant role in protecting against the exercise of market power in the capacity market. As a result, an artificially high Net CONE increases the potential for market power abuse,” the Commissioner said.

“Faced with mountains of evidence indicating that PJM’s capacity market is overprocuring resources—harming customers and hindering price formation in its other markets—one might expect that PJM and the Commission would take a holistic review of the capacity market, starting with the VRR curve,” Glick wrote.

But FERC’s order “does not give this matter the careful consideration it demands. Instead, the Commission uncritically accepts PJM’s filing in the face of contrary Commission precedent, persuasive protestor arguments, and many unresolved questions of material fact.”

Glick said the record in this proceeding “simply does not provide a basis for the Commission to make a reasoned finding that the proposed VRR curve is just and reasonable and not unduly discriminatory or preferential. Rather than summarily accepting PJM’s filing in the face of these shortcomings, I would instead set the issues for hearing in order to develop the record needed to adequately address them.”

Glick also used his dissent to recommend that a combined-cycle unit be used as the reference resource instead of a combustion turbine and encourage PJM and its stakeholders to initiate a process to develop a forward-looking methodology for determining energy and ancillary services revenue estimates.