Electricity Markets

PJM overestimates on capacity needs costs customers billions of dollars a year, report says

The PJM Interconnection has overestimated how much generating capacity it needs for more than a decade, while also offering to pay generators more than double their costs, according to a report commissioned by the Natural Resources Defense Council and the Sierra Club, both of which are national environmental groups.

This combination has resulted in customers paying as much as $4.4 billion a year in extraneous and unnecessary charges, according to the report by economist James Wilson.  

In order to ensure adequate electric generating capacity to meet customer demands in peak periods, PJM has an administrative mechanism – the Reliability Pricing Model (RPM) --to acquire commitments to provide capacity three years in advance.

Through RPM, PJM acquires a total amount of capacity -- the “Reliability Requirement” -- sufficient to meet peak loads plus a reserve margin, to account for plant outages and other uncertainties. 

“However, RPM has consistently acquired far more capacity commitments than intended or needed, due to auction design features and inaccurate peak load forecasts,” the report said.

The report said that while the target installed reserve margin is generally around 16% of the forecast peak load, the RPM auctions regularly clear significantly more -- equivalent to reserve margins of 20% or greater. And when these cleared reserve margins are re-calculated based on the final, typically lowered, peak load forecast for each delivery year, the reserve margins have been 24% or more for all but one of the years shown in the report (2014-2015). 

“So while the target reserve margin of about 16% of peak load represents the capacity PJM believes it needs to reliably operate the system, RPM typically results in commitments that are roughly 10% of peak load or more in excess of the target – over 15,000 MW of excess capacity in recent years.”    

The report pointed out that the actual reserve margins and excess capacity are even larger, because the actual, weather-normalized peak loads are generally even lower than the final forecast for each delivery year, and in addition, thousands of MW of additional resources that fail to clear in each RPM auction nevertheless continue to operate as “energy-only” resources on the PJM system. 

Such uncleared excess capacity is likely to increase in future years, the report said, noting that planned changes to the RPM minimum offer price rule (MOPR) will cause additional resources receiving state support to fail to clear in RPM.

“This over-procurement has direct and indirect negative consequences for PJM Region consumers and PJM’s wholesale electricity market.  It results in consumers paying for more capacity than needed, retaining older capacity that is no longer needed and should be retired, and acquiring new power plants that are not yet needed,” the report said. 

The excess capacity also depresses “spot” prices for electricity and for the various ancillary services PJM needs to operate the grid reliably, muting the price signals that are essential to attract the right kinds of resources -- such as flexible resources -- that are increasingly needed to provide these services.

Wilson found that PJM consistently overestimated the amount of capacity needed to meet demand with an adequate safety margin. In the worst year, PJM acquired an extra 18,700 MW of generating capacity above its safety margin. “On top of buying too much power, PJM offers to pay generators based on price estimates for obsolete and inefficient technologies. These overly rich prices attract unneeded new gas plants, and give them an undeserved windfall,” a news release summarizing the report notes.

Causes of over-procurement

The report said that the main causes of the consistent over-procurement are the following:

Inaccurate Load Forecasts: PJM’s three-year-forward peak load forecasts have consistently been far too high, resulting in overstated reliability requirements. This shifts the RPM demand curve to the right from where it should be.

Inaccurate Net CONE values: PJM’s administrative Net CONE values have consistently been far too high. Net CONE is the price parameter of the RPM demand curve, so excessive Net CONE shifts the demand curve higher.

RPM demand curve position and shape: The RPM demand curve is positioned and shaped such that, even if the load forecast, reliability requirement, and Net CONE values are accurate, and the auction clears at Net CONE, the demand curve nevertheless procures capacity in excess of the Reliability Requirement.

Over-procurement is not managed: While there is plenty of time for any over-procurement that occurs in the RPM auction three years in advance to be corrected, PJM makes such adjustments only to a very limited extent, the report said.

“These four causes result in over-procurement of capacity relative to the reliability requirement. It is also notable that the reliability requirement is based on a very conservative planning standard – ‘one day in ten years’ (an amount of capacity such that a capacity shortage is expected to occur not more than once in ten years). An economically optimal reserve margin that would balance the value of resource adequacy with its cost in the interest of consumers would be lower,” the report said.

Changing the market rules in PJM would initially save customers $4.4 billion and then will continue to save them up to $2.6 billion each year, Wilson estimated.

Report says over-procurement problem not likely to be corrected anytime soon

But Wilson also said that there is not “much cause for hope that the over-procurement problem will be corrected anytime soon.” 

Recent changes to the Net CONE values, shape of the RPM demand curve, and load forecasting methodology, fall far short of correcting the problem, while a new driver of over-procurement has arisen:  the new RPM MOPR, the report said.

“The changes to the MOPR will impose very high offer prices on many resources that receive revenues under state programs, including zero-carbon nuclear plants and renewables, and will likely cause many of them to fail to clear in RPM.  With these resources effectively pushed out of the RPM supply curve, RPM will clear other, duplicative capacity, and also set a higher clearing price that will falsely signal a need for additional resources. The new MOPR will exacerbate the over-procurement problem.”

The Federal Energy Regulatory Commission in December directed PJM to expand its current MOPR to address state-subsidized electric generation resources, with certain exemptions. This expansion of the MOPR will also apply to new public power and electric cooperative self-supply resources.

The American Public Power Association, American Municipal Power and the Public Power Association of New Jersey said in seeking rehearing of the decision that FERC’s PJM MOPR order will expose public power utilities and their customers to the risk of having to pay twice for new capacity resources, without providing them any effective way to mitigate that risk.