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Voice of Reason 2: Industrials, Consumer Advocates Say Load Shouldn't Be Forced to Cover Generators' "Poor Decision-Making" In Not Hedging Gas Risk, In Opposing Waiver of PJM $1,000/MWh Offer Cap
A coalition of industrial customers and consumer advocates said that granting PJM's requested waiver to allow offers in excess of $1,000/MWh to set the market-clearing LMP would compel customers to reward generators which failed to prudently hedge their variable costs of producing generation once they assumed a capacity supply obligation.
"Essentially, wholesale and retail customers will be forced to pay higher prices as a result of poor decision-making by natural gas-fired generators that decided not to hedge against high natural gas prices, notwithstanding their clear obligation to submit offers into the day-ahead market at or below $1,000/MWh. Customers already pay billions of dollars, in the form of capacity payments, to these Cleared Capacity Resources. Requiring customers now to pay unlimited energy prices whenever natural gas prices spike would be unjust and unreasonable to customers and market participants that supply the customers. Customers and market participants would be irreparably and substantially harmed by PJM's requested waiver," the load representatives said.
"Those generators that took a risk and did not hedge against natural gas price fluctuations now seek to pass the losses associated with that risk on to customers by retroactively changing the rules. Notably, there is no corollary provision that provides to customers any upside that Cleared Capacity Resources may have realized from this strategy. PJM should not be allowed to retroactively change the rules of the auctions simply to provide one-way protection to generators for hours in which their risk-hedging decisions cost them money rather than earned them money," the load representatives said.
"Cleared Capacity Resources (which includes generators that are receiving capacity payments) knew or should have known that, in exchange for receiving capacity payments, they would be required to bid into the Day-Ahead Energy Market at $1,000/MWh or less. Knowing their obligations, it is incumbent on the generators to hedge against the risk of natural gas price volatility. Customers should not be forced to cover any extra costs associated with generators' failure to hedge against the risk of price fluctuations Therefore, Cleared Capacity Resources should not be entitled to any payment above $1,000/MWh because no legitimate problem exists," the load representatives said.
"Generators knew their obligations and knew that they would need to offer into the Day-Ahead Energy Market at $1,000/MWh or less. The generators had adequate time between submitting their offers and the time that natural gas prices spiked to hedge themselves against the possibility of increased natural gas costs. Those generators that did not enter into fuel delivery agreements to hedge their risk and decided to purchase natural gas on the spot market made a business decision to do so. That generators' plans may not have been successful does not justify increasing costs to customers. Adequate opportunities were available to hedge against the natural gas prices, and it would be unjust and unreasonable to allow generators who took a risk to pass their losses on to customers. The offer-price cap rule was put into place strictly to protect customers from situations in which prices may spike. Allowing generators to circumnavigate the offer-price cap rule for the precise reason the rule was adopted is unjust and unreasonable," the load representatives said.
"Further, the capacity price is set using a Variable Resource Requirement ('VRR') Demand Curve, which is based on a combustion turbine generator with dual fuel capability. Therefore, the price of capacity assumes dual fuel capability. While dual capability is not a requirement to be a capacity resource, generators have the option to install dual fuel capability. Installing dual fuel capability is a business decision, and those generators that decide not to install such capability run the risk that natural gas prices will greatly exceed fuel oil that can be used by dual fuel units. As was the case with hedging, generators knew the risks that they faced when they decided not to install dual fuel capability, and customers should not be charged increased prices for the risks that generators consciously assumed. Doing so would simply reward those generators that decided not to install dual capacity," the load representatives said.
"PJM claims that using the natural gas prices for trades on January 21 and delivery on January 22 'equate to a marginal energy cost for a simple-cycle combustion turbine ('CT') generator, of a type that PJM would likely need in high-demand conditions, of approximately $1,200.' During this same period, and using the same representative heat rate of approximately 10 MMbtu/MWh that PJM used in its waiver request, the use of distillate fuel oil as an alternative fuel would have resulted in a marginal energy cost of about $310/MWh. Therefore, dual capability units were able to protect themselves from the spike in natural gas prices by switching to the much cheaper fuel oil source. That certain generators made an economic decision not to invest in dual fuel capabilities and therefore could not take advantage of lower fuel oil costs does not mean that there was a concrete problem that PJM needs to address. Rather, the generators assumed the risk and chose not to invest in strategies that would hedge against natural gas price spikes. The fact that certain generators' business decisions did not work out the way they envisioned does not create a concrete problem, and therefore, PJM has failed to meet its burden under the Commission's second requirement for a waiver," the load representatives said.
"Further, under PJM's proposed waiver of the offer-price cap rule, generators with marginal costs that exceed $1,000/MWh because of high natural gas prices will set the market-clearing price in the energy markets. Because the least efficient generators that chose not to hedge will set the market-clearing price, the incentives for other resources to optimize fuel delivery arrangements and operational efficiency are significantly reduced, if not eliminated," the load representatives said.
This could lead to gaming by generators to artificially raise the LMP, the load representatives said -- a potential scenario previously noted by EnergyChoiceMatters.com.
"For example, if a generation owner owns four generation units – one fueled by natural gas that purchases on the spot market and three that are not fueled by natural gas – the generation owner could have incentive to pay higher natural gas prices. If the natural gas fueled generator sets the market-clearing price for electricity, then the higher the cost of natural gas, the higher the market-clearing price received by all four of the generation units. The generation owner is better off because not only does it receive the marginal costs of the natural gas unit, but it also receives a windfall to the other three units whose costs are unchanged by the high natural gas prices," the load representatives said.
"[L]etting [such] Cleared Capacity Resources set the market-clearing price can reduce incentives to optimize fuel delivery arrangements and operational efficiency because higher market-clearing prices could be beneficial to generation owners when considering all of their units. There are obvious advantages in situations like the one described above to force the market-clearing price as high as possible. In order to increase the market-clearing price, generation owners could have a reduced incentive to hedge, causing them to rely on the spot market for their natural gas needs in the hope that prices will spike and increase their overall return. Without an offer-price cap, these incentives to increase the market-clearing price cannot be eliminated. The end result is a less efficient market with maligned incentives to increase market-clearing prices to the detriment of retail customers who are forced to pay higher energy costs," the load representatives said.
"In light of the incentives that generators may have to maximize the price they pay for natural gas, it is difficult to determine what a 'legitimate' cost of natural gas actually is for the generators. While it may be true that gas prices spiked to record levels, the price ranges were rather wide during the days of the price spikes. The wide price ranges could reflect different locations across the zones that were and were not pipeline-constrained and could also reflect trades earlier and later in the day as the situation evolved. These price variations afford generators the opportunity to pay a very high price for natural gas if doing so will set a higher market-clearing price to benefit the generators' overall generation portfolios. This maligned incentive could lead to customers paying higher energy prices that are simply unnecessary," the load representatives said.
"PJM's proposed waiver will also have future impacts because it will introduce significant risk to the energy market and will increase the cost of hedges. Under PJM's proposal, generators will be more likely to rely on the spot market, introducing significant risk, because they know they will be able to recover their marginal costs if natural gas prices spike," the load representatives said.
The load representatives further said that PJM's request amounts to impermissible retroactive ratemaking. "PJM's proposal violates this [retroactive ratemaking] doctrine because, through its proposal, PJM effectively asks the Commission to write an 'economic force majeure' into the PJM Operating Agreement and Tariff after Capacity Resources cleared in a Base Residual Auction ('BRA') or Incremental Auction ('IA'), took on the obligations of being Cleared Capacity Resources, and began receiving payment for those obligations. These post hoc actions are unjust and unreasonable because they require customers to pay capacity prices for the Cleared Capacity Resources while losing the benefit of the $1,000/MWh offer-price cap that applied to those resources," the load representatives said.
"PJM's proposal requires going back to the time the capacity resources cleared and retroactively changing the rules of the auction to the disadvantage of customers. No longer would there be an obligation on Cleared Capacity Resources to offer no higher than $1,000/MWh into the day-ahead market. Rather, the obligation would now be that Cleared Capacity Resources must offer no higher than $1,000/MWh into the day-ahead market unless they have an opportunity to, or are forced to, purchase natural gas at prices high enough that the Cleared Capacity Resource's marginal cost increases above $1,000/MWh. There is no question that a substantial rule change would be occurring, and there is no question that the substantial rule change would be occurring well after the obligations were undertaken. This is the essence of impermissible retroactive ratemaking," the load representatives said.
The load representatives included the PJM Industrial Customer Coalition, Consumer Advocate Division of West Virginia, Delaware Division of the Public Advocate, Illinois Citizens Utility Board, Indiana Office of Utility Consumer Counselor, Maryland Office of People's Counsel, New Jersey Division of Rate Counsel, Office of the People's Counsel of the District of Columbia, and Pennsylvania Office of Consumer Advocate
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January 31, 2014
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Reporting by Paul Ring • ring@energychoicematters.com
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