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Existing Resources Earning 93% of Capacity Payments in PJM, APPA Says

March 13, 2012

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Copyright 2010-12 Energy Choice Matters

More than 93 percent of the total revenue paid by customers under the PJM Reliability Pricing Model has gone to the owners of existing power plants, the American Public Power Association said in a recent issue brief.

Since it began in 2007, RPM has cost customers in PJM's territory approximately $50 billion (through the end of 2011), APPA said.

"Perhaps most significantly, very little of the $50 billion so far for RPM is financing new generation capacity; rather it is overwhelmingly going to existing generation capacity," APPA said, reporting than more than 93% has gone to existing assets.

"Only about 7,000 MW of new generation capacity was built in the [PJM] region from 2007-2011," APPA said. "Considering that the total installed generating capacity of PJM is nearly 180,000 MW, this 7,000 MW of new generation amounts to only about four percent of the total capacity added through five years of RPM auctions -- and again, it is impossible to determine how much would have been built without the RPM mechanism," APPA said.

"Power plants are expensive to build and maintain, so large sums are not unusual in the power supply business, but even by this standard, $50 billion is an imposing sum. The total cost so far would have paid for 129 medium-sized natural gas-burning power plants, or 9 large nuclear power plants, or over 10,300 wind turbines. This would equal between 9,000 and 51,000 MW of new capacity. New Jersey alone could have afforded 29 natural gas power plants, 2 nuclear power plants or over 2,300 wind turbines (or some combination of the three), or 2,000 to 11,000 MW of new generation," APPA said.

The Compete Coalition in response issued a resource document which Compete said, "goes to the heart of a key misunderstanding regarding PJM's capacity market: It isn't just about building new generation facilities."

While it isn't "just" about building new capacity, a review of PJM's original section 205 and 206 filing to institute RPM leaves no doubt that new capacity was the primary goal of the market.

Indeed, if the goal was simply assure reliability at the lowest cost by providing support to existing resources unable to recover costs in the energy market, the solution would have been a continuation of reliability must-run agreements, which are more economical to customers because only those at-risk units are directly paid their fixed costs, rather than all units receiving capacity payments based on the higher fixed costs of the last-cleared unit (under which all but the marginal unit receive a margin above their actual costs, which is designed to incent new investment).

However, it was recognized that these older units, which were no longer economic based on energy revenues alone, were inefficient (resulting in higher energy market prices), and it was expected that these units would be replaced with new investment if such investment could be certain of future revenues to recover fixed costs (e.g. capacity payments). Given the lack of new build in PJM, and thus reliance on assets which existed before RPM started, the inescapable conclusion is that RPM has resulted in what it was designed not to do (or what PJM claimed it was not intended to do), which is, extend the lives of fully depreciated, high variable cost assets, simply because such assets have low going forward costs and can clear RPM relative to new, more efficient assets which can lower energy market prices.

From PJM's original RPM filing (all emphasis added):

"RPM's locational capacity pricing is designed to incent new generators, new demand resources, or new merchant transmission projects to resolve potential local deliverability issues before they arise."

"The recent spike in announced retirements of older, marginally economic units also provides a warning that generator revenues in PJM may not be adequate to sustain the investments needed to maintain reliability in all parts of the PJM region."

"Such special arrangements [such as reliability must-run agreements] fail to provide the market signal or incentive needed for other generators to propose solutions to the system's reliability issues."

"Moreover, the units proposed for retirement typically are at or near the end of their original planned useful lives, and cannot be maintained indefinitely."

"[B]ecause the units announcing their retirement tend to be at the end of their useful lives, there are prudent limits to how long the system should depend on those units for local reliability"

"The relatively low revenues, resulting from [then-existing] low capacity prices, have caused cancellations of proposed new generation."

With respect to triggers proposed by load to modify or eliminate the capacity market once certain conditions are met (revenue adequacy achieved through the energy market, for example), PJM said, "PJM is concerned that providing triggers of the kind some have suggested would introduce a level of uncertainty into the market that would discourage the very investment that RPM is intended to stimulate."

Finally, PJM promised the following:

"However, if higher locational prices do not prompt new entry in a particular area, PJM will act to ensure that loads in the affected zone do not indefinitely pay higher capacity prices"

APPA also released an analysis of new electricity generation constructed in 2011 which, "finds that almost all of the new power plants studied were built under long-term contracts or utility ownership, and not for sales into the wholesale power markets."

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