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Load Would Avoid $3 Billion in Capacity Charges Annually Under N.J., Md. Capacity RFPs

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January 31, 2011

The introduction of 1,800 MW of new capacity in the Pepco zone, which would bid into the Reliability Pricing Model at $0 due to a ratepayer-based long-term contract, would save PJM end users $1 billion annually in capacity payments, according to an analysis by the Independent Market Monitor.  

Of that total, $92 million in avoided capacity payments would accrue to end users at Pepco.

The IMM, which opposes the Maryland PSC's draft RFP for 1,800 MW (first reported by Matters, 12/30), cited the decline in supplier revenue as a negative impact from the RFP.

When combined with the potential 2,000 MW of new capacity in New Jersey offering at $0, PJM end users would avoid $3 billion in capacity payments annually, the IMM said.

"This substantial reduction in revenue would affect the investment decisions of current owners of capacity and potential investors in capacity both in and outside of Maryland.  The likely result is less investment in capacity. Depressing the price in Maryland would also mean that the required direct subsidy by Maryland ratepayers would increase with perhaps significant unintended consequences for the business and residential customers who would have to pay the subsidy," the IMM said.

However, retirements, and a lack of new capacity, are already occurring under the RPM "market" even without such interventions as the Maryland RFP.  In other words, customers are paying billions of dollars in capacity payments, but are still facing looming retirements with no new base load having been constructed.

As argued by the Maryland Energy Administration:

"Maryland should no longer continue to wait in hopes that market signals will be sufficient to spur new generation.  As noted by the Governor, the perverse system of capacity charges imposed by the regional transmission organization, PJM Interconnection (PJM), effectively adds hundreds of dollars to residential bills with little benefit.  From 2007 to 2014, it is estimated that Maryland ratepayers will pay nearly $5 billion in capacity charges to incentivize the private sector to build new generation.  If history is any guide, no new base load generation will be built with these incentives."

Maryland PSC Staff asked for an extension to file its comments on the RFP, citing the snow emergencies experienced in the area last week.

As expected, incumbent generators howled at the prospect of Maryland re-asserting its authority over resource adequacy, and attempting to blunt the transfer of wealth created by federal regulators who are insulated from retail customers.

Had Matters not spent the majority of the past three days reading through nearly 1,000 pages of AEP Ohio electric security plan documents, the responses of the incumbent generators would have been critiqued more in depth.

However, the arguments can be essentially reduced to: (1) no need for the RFP has been shown, and (2) the PJM "market" is working, and the RFP would harm the "market."

The first is irrelevant since the PSC explicitly said it would issue the RFP without making a determination on need, which will be addressed upon evaluating results.  The second argument is absurd because only in the utility industry would a construct which compels end users to buy a specific quantity of a product, with such amount determined by bureaucrats as essentially a guess (e.g. the administratively determined demand curve), be considered a "competitive market."

As shown by the IMM, the Maryland RFP will undoubtedly "harm" current RPM suppliers, by reducing their revenues.  This should not be confused with harming the "market," however, as asserted by several of the competitive generator trade associations.  While there is a certain level of competition in the offering price of RPM, most offers are mitigated due to inherent structural problems in the market, and, as previously noted, end users cannot determine the amount of capacity they wish to purchase.

The most sickening display is the touting of customer migration by some incumbent generator trade associations as somehow showing that the PSC should not take actions to reduce the wealth transfer in the form of capacity payments occurring in its state.  The increased migration is a sign that customer choice is successful and can reduce customers' retail prices.  And, at the highest level, "competitive markets" are a sound policy.

But RPM is not a competitive market, and, in some ways, is antithetical to retail choice.  RPM is essentially a forced, and expensive, hedge required of all end users in PJM.  When it comes to a retail customer's energy (e.g. throughput) requirements, the customer, through competitive retailers, can elect a term length, and accompanying risk premium that suits their needs.  However, when it comes to capacity, all are essentially required to enter a three-year forward payment for capacity, regardless of whether they have a different risk appetite.

It's also something of a strawman that mitigating capacity payments paid under PJM's administrative capacity construct is somehow incompatible with retail choice.  The Maryland PSC has already ordered the procurement of demand response capacity without impacting SOS pricing (see Case 9149).  New Jersey's capacity contract legislation also appears that it will not impact BGS rates.

While we understand the proclivity of a regulator to intervene in one market (e.g. wholesale capacity) may not bode well for a continued hands-off approach when it comes to other markets (e.g. retail generation supply), and that the PSC's actions may raise a very general concern with retail markets, two points should be stressed.  First, that the PSC's action regarding RPM is taken because that market has failed its stated intent: assure reliability and attract new baseload.  So long as retail suppliers can undercut the SOS rate and maintain migration levels, arguments that retail choice has failed are not analogous.

Second, retail choice faces a larger threat from the continuation of exorbitant capacity prices that go to incumbent generators and not new entrants, than it faces from a competitively neutral capacity procurement.  The introduction of capacity payments on retail pricing is one of the biggest drivers in the increase in retail prices often blamed on the introduction of choice to the industry.  Retail suppliers enjoy none of the benefits from the introduction of capacity charges to the market, but they bear the brunt of political backlash against the higher rates, especially as regulators and politicians realize they have little control over the FERC-administered capacity markets.  While an RFP for 1,800 MW of capacity may not be an ideal market design for retail suppliers, if it is competitively neutral, it is a better "fix" for high prices than moving towards a managed portfolio for all SOS requirements: energy, capacity, and RECs.  

In any event, the ERCOT market has shown that a capacity market is not a pre-requisite for successful retail choice, or resource adequacy in a competitive environment, for that matter.

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