FERC Adopts Final New Compensation Mechanism for Regulation Service

FERC yesterday adopted as final new rules for the compensation of regulation service in the jurisdictional RTOs, retaining a capacity payment and adding a performance-based payment (RM11-7).

Frequency regulation resources shall first receive a capacity payment, determined through a uniform clearing price, that includes the marginal resource's opportunity costs.

Although certain public interest organizations questioned whether the capacity payment would be necessary given other reforms FERC is making in its order, FERC said that, "[t]he capacity payment is necessary, because it exists in order to ensure that resources are indifferent between offering their capacity as a frequency regulation resource or as an energy resource."

"While the market-clearing price for frequency regulation service may eventually fall as lower-cost resources enter the market, the capacity payment provides resources that clear as frequency regulation capacity recompense for holding such capacity in reserve from the energy and other markets so that it is available to the system operator as frequency regulation capacity," FERC said.

In addition to the capacity payment, the Commission will require payment for the performance of frequency regulation, using a market-based price, rather than an administratively determined price. This market price must reflect the market participant bids submitted by the resources for the provision of frequency regulation service.

FERC said that current frequency regulation compensation mechanisms, by ignoring performance, are unduly discriminatory, "because resources are compensated at the same level even when providing different amounts of frequency regulation service."

Unlike in the proposed rule, FERC will not require a specific methodology for how that market-based price shall be determined. FERC will not mandate specific bidding parameters or other technical details that will determine the pricing methodology. FERC will require two-part bidding for this market price, however.

FERC said that the new pricing will enable greater competition in the organized markets and allow existing generation to provide more capacity in the energy markets and to run closer to their optimal output levels.

FERC claimed that the displacement of existing resources in the regulation market may result in those resources being able to more efficiently operate in the energy markets, submitting lower offers to supply energy, and thereby lowering costs to consumers in that market.

Several commenters had warned that due to the decreasing revenue made available to conventional generation through the regulation market under FERC's new compensation mechanism, such generation would be compelled to increase their energy market offers, which in turn would raise clearing prices.

"We ... disagree with the contention that, while short-run costs might decrease, long-run costs will increase due to displaced frequency regulation resources demanding higher prices in the energy market to make up for their lost frequency regulation revenue. There is no reason to believe that energy costs would increase when the supply of available energy capacity increases. If markets currently clear with a sufficient level of capacity, adding new capacity at a higher cost would not change that and would not lead to higher market-clearing prices in the energy market. Any market participant that chooses to raise its offer price runs the risk of its capacity not clearing in the energy market. And because energy resources would be able to operate at more efficient heat rates, they would be able to offer their capacity into the energy markets at a lower price," FERC claimed.