The 2022-2023 DY is the seventh DY to feature the Capacity Performance product, which was first procured in the Capacity Performance Transition Auction for the 2016-2017 DY. Across two Transition Auctions and five BRAs, the 2022-2023 BRA prices are easily the lowest on record for the Capacity Performance product. Over the past seven auctions, the RTO price of $50/MW-day falls below the previous low of $76.53/MW-day, from the 2020-2021 BRA. It is also the lowest RTO price in any BRA since the $27.73/MW-day price from the 2013-2014 BRA, and it is the fourth-lowest RTO price of all time across the sixteen BRAs that have been held thus far.
Although we have observed volatility in capacity prices in the past, especially for the RTO region, this is one of the first auctions over the past several years where prices are low across all LDAs. The weighted-average price of $74.27/MW-day in this auction is also well below the recent previous low of $115.56/MW-day from the 2020-2021 BRA. Additionally, the 2022-2023 BRA is only the third time across all sixteen BRAs where MAAC prices have fallen below $100/MW-day and is the first time EMAAC prices have fallen below $100/MW-day.
Potential factors impacting the 2022-2023 auction results
What is the cause of these price drops? Our initial assessment of potential factors, shared below, is based on the limited data that is available as of today, in addition to some of the known factors going into the auction, including lower demand, lower net Cost of New Entry (CONE), higher import limits such as Capacity Emergency Transfer Limits (CETLs), etc., that were expected to put downward pressure on pricing. There appears to have been a shift in participation strategy for many resources with PJM, with offer prices generally lower compared to the prior auction. The limited auction results information available thus far also suggests shifts in resource clearing outcomes that are counterintuitive when looking solely at the market fundamentals.
Auction timing and associated resource planning constraints
The relatively prompt timing of the auction, which was held one year ahead of the delivery period instead of the typical three years ahead, may have reduced the offer flexibility of various resources. The compressed timeframe between the auction and the DY could make it difficult for resources to adjust any plans in response to the auction results.
Cautious bidding in response to market design changes
The long delay between auctions and the large number of market design changes that occurred for this auction may have resulted in more cautious bidding. Resources may have preferred a “wait and see” approach to better understand the new market construct and conditions instead of risking being left uncleared and not receiving any capacity revenue.
Unit-specific exemption to MOPR
Resources subject to the Minimum Offer Price Rule (MOPR) may have been able to justify low offer prices through the unit-specific exemption process, thereby muting the anticipated price uplift resulting from the expanded MOPR.
Nuclear resources are a key driver of capacity prices in PJM. In recent auctions, the nuclear-heavy LDAs of ComEd and EMAAC have seen sustained price separation, which ICF believes reflects the nuclear resource economics in these LDAs. The prior auction also saw price separation for the ATSI LDA, in part due to nuclear resources failing to clear.
- PJM reported that the 2022-2023 BRA saw an additional 4,460 MW of cleared nuclear capacity compared to the prior auction. In other words, a larger amount of nuclear capacity cleared in this auction despite much lower prices, without any corresponding market change that can explain this shift in terms of fundamental resource economics.
- It is possible that nuclear resources are banking on increased federal or state support, which may improve their economics going forward. The Biden administration has been very vocal in their support of clean energy resources, and there have been discussions regarding a potential federal Production Tax Credit (PTC) for existing nuclear resources.
- It is also possible that the relatively prompt auction timing was particularly challenging for nuclear, given the need to schedule refueling cycles in advance and given the extensive process required to decommission a nuclear plant, which may have made retiring by the 2022-2023 DY impractical.
- In any case, nuclear resources may have preferred to receive some minimal capacity revenue in the interim instead of receiving no capacity revenue should they fail to clear in the auction.
New resource entry
The 2022-2023 BRA saw a large increase in the amount of new generating capacity that cleared, despite the low clearing prices. Capacity procured from new generating resources totaled 4,844 MW, compared to 893 MW in the prior auction, while capacity procured from uprates to existing generating resources totaled 1,210 MW, compared to 508 MW in the prior auction.
- PJM reported that the 2022-2023 BRA saw an additional 3,414 MW of cleared combined cycle gas turbines (CCGT) capacity compared to the prior auction. While we expected this increase in cleared CCGT capacity, it is interesting to note that this increase still occurred despite the low clearing prices. We believe that most of this increase came from the group of new CCGTs that are under development in western PJM.
- During the multi-year interval between auctions, many of these projects closed financing and started construction instead of waiting for the 2022-2023 BRA, despite not necessarily having received capacity commitments in prior auctions.
- At this point, these projects may have a limited ability to delay their development timeline, causing them to be potentially indifferent towards the capacity prices in this auction.
- This may explain why these new CCGTs likely cleared in the 2022-2023 BRA at $50/MW-day RTO prices than cleared at the $140/MW-day RTO prices in the prior auction. We expect that if there was not a multi-year gap between the two auctions, we would have seen more rational bidding from new builds. We also would not have seen a large amount of these new CCGTs clear at such low prices, and would have expected them to potentially delay their development.
- PJM also reported that the 2022-2023 BRA saw an additional 942 MW of cleared solar capacity and an additional 311 MW of cleared wind capacity, compared to the prior auction. These represent increases of about 22% and 165% for cleared wind and solar, respectively.
- While solar and wind both saw large increases in cleared capacity in this auction, it is not clear what portion of this increase came from resources that were able to offer at low prices through the unit-specific MOPR exemption process and what portion came from resources that were exempt from the MOPR due to the timing of their interconnection agreements.
- It is worth noting that even though 942 MW of new solar resource capacity cleared in the auction, the total offered capacity of new solar resources was 1,441 MW, indicating that only about 65% of the offered new solar resource capacity managed to clear.
Fixed Resource Requirement (FRR)
Dominion elected FRR in this auction, which significantly increased the amount of load that elected FRR and resulted in around 28.5 GW of load to be removed from the auction. However, utilities electing FRR must also remove corresponding supply from the auction to meet their capacity obligations.
- Over the past several years, the PJM system has cleared at an average reserve margin of around 20%. This implies that utilities participating in the BRA were typically procuring supply resulting in excess capacity reserves of around 20%. If a utility elects FRR and procures supply that results in capacity reserves equivalent to 20%, then FRR election will not have any material impact on the auction results.
- However, if the FRR utility procures capacity reserves that are lower than 20%, then more capacity would be available to participate in the auction and put downward pressure on the capacity prices. In contrast, if the FRR utility procures capacity reserves higher than 20%, then less capacity would be available in the auction and put upward pressure on the capacity prices.
- PJM publishes a list of resources that are included in the various FRR resource plans for each DY before each auction. But it is not clear if the resources can be partially committed to FRR plans, particularly in cases where resources have shared ownership.
- It is also possible that FRR entities may decide to sell some amount of excess capacity back into the capacity auction, though the degree to which this occurs is not clear. Thus, there is some uncertainty regarding the final amount of capacity that is excused from the capacity auction because of FRR commitments.
- The list of FRR resources published by PJM for the 2022-2023 DY had a cumulative ICAP rating of around 38 GW which would have implied a capacity reserve margin of around 33% for the FRR entities. But the auction data released by PJM indicates that only around 33.3 GW (ICAP) were excused from the auction because of FRR commitments, which implies a capacity reserve margin of around 17%.
- It is not clear whether this difference arises from partial FRR commitments for some resources or from FRR entities selling excess capacity back into the capacity auction. In either case, this difference in FRR capacity relative to pre-auction assumptions may have resulted in additional downward pressure on the RTO price.
LDA price separation
Structural differences in the resource mix between the major LDAs contributed to the price dynamics observed in this auction and in previous auctions. LDAs such as MAAC, EMAAC, BGE, ComEd, and DEOK rely in large part on older merchant coal, nuclear, and oil/gas steam resources to meet their capacity needs. As these LDAs are import constrained, much of their capacity procurement must come from local resources, which may insulate them from low RTO capacity prices.
However, this auction observed a significant decline in LDA pricing which was mostly driven by higher import limits for most of the LDAs and significant underbidding by nuclear resources that are a key driver of capacity prices in some of the nuclear-heavy LDAs like ComEd and EMAAC.
Despite the decrease in pricing, several of these LDAs continue to clear at a premium to RTO which is driven by several factors that put additional downward pressure on the RTO capacity prices compared to the LDAs, such as:
- Dominion FRR election and other non-FRR regulated capacity resources, which are primarily located in the RTO region, would have put downward pressure on RTO pricing without impacting the LDAs. Regulated resources generally bid lower than non-regulated or merchant resources, and thus higher concentration of such resources could potentially result in price suppression.
- Most of the new CCGT builds, in advanced development, have also been mostly expected to be in the rest of RTO region due to more favorable spark spreads. High concentration of these advanced development builds that were willing to accept lower pricing due to reasons discussed earlier, would also have negatively impacted the RTO pricing more than the LDAs.
- Out-of-merit order clearing caused by LDA separation.
With relatively minimal demand growth expected in the immediate term, and new resources, particularly renewables, expected to continue to enter the market, and with the potential for a revised MOPR that accommodates state subsidies, the only path to price recovery is for existing resources to exit the market or bid more rationally in the market reflecting their actual capacity price requirements.
Given that much of the coal and nuclear fleet has been struggling for several years now, it is difficult to see how such low prices are sustainable. For example, according to the PJM’s 2020 State of the Market Report, only 5% of the coal resources and none of the nuclear resources were able to recover their avoidable or fixed cost in 2020, when the weighted average capacity price of the system was around $116/MW-day.
It will be even more difficult for such resources in the 2022-2023 capacity period, with the weighted average capacity price declining to $74/MW-day. It is possible that the market will see a surge of retirement announcements in the coming months as resources react to the surprisingly low clearing prices.
Prolonged, low capacity prices will likely also cause new resource development to slow down, particularly for new thermal resources. Solar and wind resources may also be impacted; however, these resources will still be incentivized to enter the market through various state policy programs.
While new resource development may slow down, there nevertheless are several advanced-stage CCGT projects that we expect will participate as new resources in the 2023-2024 BRA for the same reasons that we discussed for the 2022-2023 auction. However, we do expect development activity to be impacted and materially less new thermal resources to clear or participate in future auctions if prices do not recover post the 2023-2024 capacity period.
Ultimately, the speed at which the price recovery will occur will depend largely on how quickly supply responds—through retirements, low development activity resulting in significantly less new builds, or generally more rational bidding by existing generators as they continue to lose money on a consistent basis. Overall, we anticipate some form of price recovery by the 2024-2025 or 2025-2026 auction as we see supply likely to respond to the low prices.