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PJM Files Changes to RPM to Further Inflate Capacity Prices

December 2, 2011

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Copyright 2010-11 Energy Choice Matters

PJM has filed several proposed tariff changes with FERC, the principal design of which are to increase capacity prices in the Reliability Pricing Model.

The instant tariff revisions do not contain any material changes to the New Entry Price Adjustment, as PJM said more stakeholder development is needed. PJM did propose that a filing regarding a longer-term New Entry Price Adjustment, or alternative mechanism, shall be submitted by August 1, 2012.

Among the changes PJM is proposing is that the numerator of the price equation for point 1 on the Variable Resource Requirement (VRR) curve reflects the greater of the Cost of New Entry or 1.5 times (the Cost of New Entry minus the Net Energy and Ancillary Service Revenue Offset).

In others words, the highest point on the VRR Curve would be set equal to the greater of gross CONE or 1.5 times Net CONE.

This proposed action is taken to maintain higher capacity prices when operation of the Energy and Ancillary Service (EAS) revenue offset would otherwise provide capacity price relief to load, by reducing the Cost of New Entry (CONE)

Specifically, since the EAS offset is based on historic pricing over three years, PJM claimed that absent changes, "unusually high EAS conditions might result in a very large offset to CONE and produce an unacceptably low value for the portion of the curve at 1.5 X Net CONE that is intended to reflect shortage conditions."

In short, the change is meant to prevent a capacity "curve collapse" which would result in lower capacity pricing (at this point it should again be emphasized that "competitive" capacity pricing does not result from the interaction of buyers and sellers, but tariffed formulas on file with the federal government).

Brattle, which advised PJM on the tariff changes, claimed that without the proposed change, the VRR curve, "does not provide the investment signals that can be depended upon to maintain reliability targets." An admittedly more radical approach would allow "investment signals" to be provided by the actual demand of consumers (in this case, load), rather than an administratively determined demand curve.

Furthermore, PJM has proposed to modify the EAS methodology so that it is able to reflect commitment of the Reference Resource in the Day-ahead Energy Market to the extent economic on a Peak-Hour dispatch basis, in addition to reflecting commitment on a real-time basis. Under this approach, PJM said that there is no pre-determined split between the day-ahead and real-time markets. "Whether and the extent to which the Reference Resource is committed in the Day-ahead and/or Real-time Energy Markets will be determined by whether the plant is economic over the given hourly blocks, based on its assumed heat rate, historic fuel prices, historic day-ahead LMPs, and historic real-time LMPs."

Finally, in another bid to raise capacity pricing in the Base Residual Auction (which is the price paid for the vast majority of capacity procured by PJM), PJM proposes to retain the 2.5 percent Short-term Resource Procurement Target, or "hold-back" that defers resource procurement for a portion of the overall load in RPM from the Base Residual Auction to the Incremental Auctions, but proposed to eliminate the current application of the hold-back to the separate minimum procurement requirements for two distinct resource categories, i.e., Annual Resources and Extended Summer Resources.

Notably, clearing prices in the incremental auctions have been persistently below Base Residual Auction prices, in part reflecting low incremental demand for capacity due to declines in load forecast and increased transmission capabilities.

Brattle claimed that the hold-back for the separate Annual Resource category, which consists of mostly generation, resulted in artificially suppressed Base Residual Auction prices, with the proposed change meant to increase the Base Residual Auction clearing price paid to all cleared resources which comprises the vast majority of capacity costs assigned to load.

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