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FERC Orders New Course for Nation's Largest Capacity Market

Jul 11, 2018 8 MIN. READ

The order rejects PJM capacity market reforms but finds issues with current market structure and proposes alternative methods to protect market competitiveness.

With expected growth in resources with state and federal subsidies, there have been increasing concerns about the impacts of such subsidies on the PJM capacity market.

Subsidies provide resources with out-of-market revenues that can distort market prices and competitiveness. This can undermine the effectiveness of capacity markets to ensure system reliability. Common out-of-market revenues include:

  • Renewable energy credits;
  • Zero emissions credits for nuclear units;
  • Regulated power plants with rate base support; and
  • Other state subsidies for non-regulated generators, demand response or energy efficiency efforts.

In PJM’s current capacity market construct, there are buy-side mitigation rules for such out-of-market payments but such rules are only applicable to new gas generators. For other resources, there are no buy-side mitigation rules. As a result, in early 2018, PJM filed with FERC two alternative and mutually exclusive capacity market reforms to address the impact of state subsidies on the PJM capacity market. One proposal was with an extended Minimum Offer Price Rule (MOPR), referred to as MOPR-Ex, and one with a two-part capacity market. In the two-part proposal, one part established the amount and identity of cleared capacity and the other determined the price, with the price only being set by resources not receiving out-of-market payments.

On June 29, FERC rejected both of PJM’s proposed measures, a reflection on several factors. The two-part capacity market proposal was mostly rejected due to disconnect between quantity and price determination as well as concerns around potential windfalls for subsidized resources under this proposal. The alternative MOPR-Ex proposal was mainly rejected mainly due to inclusion of various resource exemptions that were not justified as per FERC. Despite these rejections, FERC did find PJM’s existing tariff unjust and unreasonable. As a result, FERC proposed an alternative measure to address the issues with the current tariff.

In FERC’s proposal, virtually all capacity resources receiving out-of-market revenues and participating in the PJM Capacity market would be subjected to a Minimum Offer Price Rule (MOPR). The MOPR is applicable regardless of capacity type. As an alternative, such resources can be removed from the capacity market through a resource specific Fixed Resource Requirement (FRR) option. PJM’s current FRR designation allows utilities to procure capacity through bilateral contracts instead of the capacity markets. FRR resources do not participate in the PJM capacity market, and their load is exempted from buying from the capacity market. The new FRR would also allow individual assets to opt, together with a commensurate amount of load, to become FRR resources

FERC’s proposal impacts virtually all units receiving out-of-market revenues

The FERC proposal will expand the MOPR from a selected subset of new gas-fired power plants to virtually all resources participating in the capacity market: “we propose that the replacement rate include an expanded MOPR that covers out of market support to all new and existing resources regardless of resource.” (page 68) The expansion is meant to prevent capacity price suppression by bids from resources receiving out of the market revenues.

FERC would like to implement the new arrangement by January 6, 2019, so that it will be in place for the next PJM auction. FERC has identified many issues for comment, including the details of the MOPR. (page 74) Until there is a resolution of these implementation issues, some uncertainty will exist.

Potential Market Impact

Under the FERC proposal, resources that are currently receiving out of market payments will be required to increase their capacity offer prices to competitive levels. At the same time, some resources and the corresponding load will choose the FRR alternative and exit the market.

Our preliminary expectation is that the FERC proposal will provide some uplift to PJM capacity prices and mitigate the risks of future subsidies on capacity prices. ICF expects that price uplift will come from mitigation of existing resources that currently are receiving out of market payments which may include the following:

  1. state-regulated PJM generators in the states of Virginia, West Virginia, Indiana, Michigan, and Kentucky
  2. public power capacity in all states
  3. demand response and energy efficiency resources
  4. renewable generators receiving REC payments or long term contracts
  5. IPPs with contracts
  6. nuclear generators with state subsidies

The price uplift will depend on (a) the amount of existing capacity that is currently receiving out-of-market payments, (b) the way this capacity is currently bidding in the capacity markets and, (c) whether these resources choose the FRR alternative or bid at competitive levels set by MOPR. ICF expects that to the extent currently subsidized existing resources choose the FRR alternative then the potential impact on the capacity prices could be decreased.

Geometrically, higher offer prices raise prices. FRR opt-out impacts are indeterminate. This is because both the demand curve and supply curves shift to the left, and depending on the curves exact shape, the impact can be an increase or a decrease. Furthermore, the bidding information is highly confidential so full resolution is not possible. However, a combination of higher offer prices due to the MOPR and some amount of FRR is likely to increase prices for a given stack, and minimize risks of major decreases due to future out of the market intervention.

Consider the following examples (see exhibits):

  • The subsidized resource is subjected to MOPR price which prevents the resource from clearing the market and increases the market price.

  • The subsidized resource is subjected to MOPR price which is low enough for the resource to clear the market. In such a case, there is no impact of the market price.

  • The subsidized resource elects FRR instead of being subjected to MOPR and as per the FERC proposal, a commensurate amount of load is removed from the demand curve. In such a case, there will be not significant impact on prices as there is not material change in the supply/demand balance.

  • An uneconomic resource which was not clearing the capacity market earlier begins to receive subsidies and elects to be an FRR resource. As per the FERC proposal, a commensurate amount of load is removed from the demand curve. In such a case, there will be downward impact on capacity prices as demand decreases but there is no impact on the cleared supply as the resource was not clearing earlier.

Going forward, ICF expects that capacity prices will be more reflective of excess or shortage conditions in the market, and not on average “suppressed” due to suppressed bidding. This is because government intervention will be less likely to suppress prices, intentionally or otherwise. ICF is currently in the process of simulating the possible impact of this proposal on the capacity prices under different scenarios. ICF plans to complete this analysis and follow-up with some high level findings later in July or early August.

FRR option expanded

Heretofore, FRR was only available for Load Serving Entities. Under current FRR, the entity is responsible for certifying it meets its capacity obligations, and neither its demand nor supply participated in the capacity auction i.e., no bids, no revenues, and no demand. Under the FRR alternative proposed by FERC, specific generators can opt for FRR status along with a commensurate amount for load, the determination criteria for which has yet not been specified. This facilitates resource support from states and other sources, including for generators disagreeing with the MOPR level.

Risk for some units

The FERC proposal potentially creates a risk for subsidized resources that do not receive sufficient out of market revenues to fully cover their cost. Such resources cannot become FRR resources as they still depend on capacity markets for additional revenues. However, the expanded MOPR could cause these plants to fail to clear the market. In such a situation, they would not receive capacity market revenues. This differs from the PJM capacity repricing proposal that would have allowed such resources to receive capacity revenues while preventing them from suppressing market prices.

New opportunity for some units

The lack of clarity heretofore on mitigation of out of the market support was a major obstacle in new programs to support specific resources. For example, one concern had been that under the DOE resilience proposal, support for fuel-secure plants would lower prices. Now, that concern would be lessened because the plant would either be an FRR resource or bidding with a MOPR. FERC specifically requested additional input on the intersection of the new rules and resilience issues (p. 74).

Overall, the FERC proposal for PJM capacity market reforms has interesting elements and sets the stage for discussions going forward. However, the details around the proposal needs to be delineated before any assessment can be made on its effectiveness. It remains to be seen how PJM and its stakeholders will respond to the FERC proposal and whether they will be able finalize the reforms in time for the next auction.

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