FERC Increases Retail Electric Costs with ISO-NE Peak Energy Rent Order

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February 18, 2011  

In another decision which will increase retail customers' electric bills, FERC has adopted changes to the calculation of the Peak Energy Rent strike price in ISO New England, which will essentially increase the capacity costs borne by load versus the current mechanism (ER11-2427).

Under the Peak Energy Rent mechanism, the Forward Capacity Market capacity price paid to capacity suppliers is reduced to reflect revenues received in the energy market, using an administratively determined Peak Energy Rent strike price, based on a proxy unit, to establish the amount of such revenue and accompanying offset in capacity payments.  The mechanism is meant to reduce incentives for generators to increase energy market prices.

Generators, along with ISO New England, complained that the current Peak Energy Rent pricing mechanism has reduced generators' capacity revenue by more than $100 million from June 2010 through the December 2010, and sought changes to essentially mitigate these deceased revenues.  ISO-NE filed tariff changes seeking to change the fuel cost used for the Peak Energy Rent proxy unit from the lower-of to the higher-of the following: (1) ultra low-sulfur No. 2 oil measured at New York Harbor plus a seven percent markup for transportation; or (2) day-ahead gas measured at the Algonquin City Gate, as determined on a daily basis (see 1/12).

Generators claimed that such changes were needed due to a recent divergence in gas and oil prices; however, the Retail Energy Supply Association noted that such commodity prices have diverged every year since 2006.  Yet from January 2008 through May 2010, despite this divergence in commodity prices now claimed to be a problem, "there [were] seemingly no complaints about the operation of the mechanism," RESA noted.

Furthermore, while there was a spike in the Peak Energy Rent credit calculated in the summer, corresponding to a spike in the spot market, RESA noted that the Peak Energy Rent rate has since been declining, and called the change to higher-of fuel pricing a "knee-jerk" reaction to a single anomalous event.

Though RESA said that a thorough evaluation could eventually determine that higher-of pricing is in fact justified, no such examination of all aspects of the Peak Energy Rent (PER) mechanism was undertaken to determine the root cause of the recent spike.

"A number of substantial issues of material fact exist. For example, why did the PER Strike Price reach the level that it did this summer (which has apparently created the urgency of generators in effectuating a change to this one part of the PER mechanism)?  Was it the divergence of oil and gas as ISO-NE suggests?  Was it the result of the abnormally hot summer in New England, coupled with an outage of the largest quick start unit in the region (Northfield Mountain)?  Were the increased costs of generators resulting from the increased deduction for the PER Strike Price also coupled with higher than usual generator profits resulting from these same summer and outage conditions? Were generators really harmed as they suggest or did the PER mechanism work as intended?" RESA asked.

RESA further said that the proposed changes, "creat[e] a situation where the PER mechanism will rarely result in a credit to load, thus thwarting the very purpose of the mechanism as a, 'disincentive for suppliers to raise prices in the energy market and a hedge for load against energy price spikes.'"

FERC did not address any of these issues in its order.  FERC, with scant elaboration, simply stated that higher-of fuel pricing is appropriate, "because [it] would enable the PER Strike Price to more closely approximate the operating costs of the marginal unit during shortage conditions."

In accepting this change to the fuel pricing, FERC also waived the 60-day prior notice requirement for tariff changes, and accepted the change in the fuel cost calculation effective December 22, 2010.

FERC did throw load, and retail suppliers, a bone in finding that the Peak Energy Rent credits paid to load shall continue to be based on a 12 month rolling average, rather than a six month rolling average, though FERC all but asked generators to file a different proposal to change this requirement.

The Peak Energy Rent credits are currently paid over 12 months to smooth out volatility in the mechanism.  This payment schedule means load is not fully credited for the Peak Energy Rent offset it is entitled to for a particular month until a year after the high energy market prices which triggered the payment.  Therefore, shortening the averaging period for Peak Energy Rents to six months, as sought by generators, would have essentially denied load the Peak Energy Rent credits they are currently due for past periods, particularly during the summer of 2010 when the credits due to load were particularly high.

Even FERC called the shortening of the rolling average period "particularly troubling," since it would, "transfer from load to generators all of the benefits of the PER mechanism for high cost summer months."

"We note, however, that this finding is made without prejudice to the Filing Parties submitting a different proposal intended to address the same concerns as the revisions proposed here," FERC said of its denial of shortening the rolling average period to six months.

Aside from the timing issue noted above, FERC also declined to shorten the rolling average period to six months at this time since retail load serving entities had entered into fixed price contracts relying on the 12-month rolling average nature of the PER credit.

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