Despite "Working" Capacity Market, FERC Orders PJM Load to Pay Energy/Reserve Price Three Times Higher than Current Cap During Shortages

FERC has approved a new shortage pricing mechanism at PJM which features an $850 per MWh reserve price cap, and a $2,700 per MWh combined energy and reserves price cap (ER09-1063).

FERC's order is subject to certain compliance filings, but major design components of PJM's shortage pricing proposal, including the combined $2,700/MWh cap, were approved.

Specifically, PJM will institute an operating reserve demand curve with a reserve penalty factor, or distinct price cap on synchronized and total ten-minute reserves, of $850/MWh after a four-year transition ($250/MWh in the first year, $400/MWh in the second year, $550/MWh in the third year, and $850/MWh in the fourth year and thereafter).

In conjunction with this new penalty factor and the joint optimization of the energy and operating reserves, PJM will institute a maximum energy price of approximately $2,700 per MWh, the price that would result from energy and two reserve products reaching their caps, to be transitioned in over the same four-year period.

FERC's approval of the shortage pricing mechanism came despite protests from several stakeholders, including those typically sympathetic to PJM's capacity market; namely, the independent market monitor, and the Pennsylvania PUC.

The Pennsylvania PUC said that the PJM design, "is likely to lead to inefficient and excessive prices, and must be modified both to protect wholesale and retail customers and comply with fundamental requirements of the Federal Power Act."

The Pennsylvania PUC said that while a high price may be justified when the system experiences a shortage and a loss of load is likely, PJM's proposed mechanism will trigger the maximum price when a reserve shortage is low, moderate or high. The Pennsylvania PUC added that under PJM's shortage pricing proposal, the last increment of reserve needed to satisfy the full requirement will be priced several hundred times its value.

The IMM stated that PJM's shortage pricing proposal is predicated on the false assumptions that prices are too low in PJM and the level of reserves available to PJM threatens system reliability. The IMM argued that PJM's response to these claimed concerns will raise the overall price of wholesale electric service in PJM while providing no corresponding benefit for PJM's customers. Specifically, the IMM argued that PJM's proposal will unnecessarily add fixed reserve penalty factors to the price of energy, thereby causing real-time energy prices to artificially exceed real-time energy offer caps and price caps.

FERC dismissed such concerns, relying on vague justifications that the shortage pricing mechanism will provided appropriate price signals and incent new investment.

FERC only addressed arguments that shortage pricing is not needed, given that the capacity market is designed for the specific purpose of assuring reliability, in one paragraph:

"We reject intervenors' arguments that PJM's capacity auctions procure capacity in excess of what is needed to meet system reliability requirements, and that, as such, energy prices in excess of the $1,000 per MWh offer cap are not needed to make PJM's system reliable. Shortages of operating reserves can and do occur for a limited number of hours even when PJM has procured capacity in excess of its reliability requirement. In addition, we agree with PJM that reserve shortage conditions may be experienced due to severe weather conditions, economic conditions more robust than expected, and/or due to the unexpected under-performance of a supply resource. Allowing prices to rise above the current $1,000 per MWh cap during such shortages, as PJM proposes, will encourage responsive actions by market participants that will lessen the extent of the shortage and signal investment in both demand response technology and generation, thus minimizing the economic harm of future shortages. Specifically, higher clearing prices will encourage customers to reduce their consumption, or encourage the owners of resources that may be shut down due to forced outages to bring their resources back online faster."

FERC's reasoning here is inconsistent with the arguments it espouses in requiring a capacity market in PJM. First, FERC does not explain why,
"[s]hortages of operating reserves can and do occur for a limited number of hours even when PJM has procured capacity in excess of its reliability requirement."

Apart from these uncited reasons, FERC said that, in addition, reserve shortage conditions may be experienced due to weather conditions, economic conditions more robust than expected, and/or due to the unexpected under-performance of a supply resource. First, for the last condition, this repudiates a major tenet of the capacity market; namely, that making forward commitments to generators to purchase capacity will assure reliability. While certainly generation committed in the capacity market may unexpectedly trip offline, this risk is already accounted for in: 1) the targeted reserve margin itself and 2) PJM's sloping demand curve that tends to purchase capacity in excess of the targeted reserve margin (burdening load with "unnecessary" capacity that FERC nevertheless requires load to pay for on the argument that such extra capacity provides an incremental benefit). Moreover, the capacity market penalties are supposedly designed to incent cleared capacity resources to avoid unexpected under-performance, lest such resources be subject to penalties.

FERC says that the shortage pricing proposal, "encourage[s] the owners of resources that may be shut down due to forced outages to bring their resources back online faster," but this would only apply to any capacity not cleared by RPM, since, as noted above, RPM penalties already incent generators that clear RPM to minimize outage time. Moreover, the very design of the capacity market is premised on the fact that that units that do not clear RPM are not needed, so designing shortage pricing based on the expected reliance on such plants contravenes the rationale that RPM assures reliability.

Furthermore, FERC does not justify why a $2,700 incentive is needed for these resources [or for customers to reduce demand], rather than the current $1,000 incentive (with recognition that certain changes may be required to the current mechanism to assure that pricing does reach $1,000 when shortage conditions exist).

Nonetheless, FERC approved PJM's proposed design.

FERC dismissed concerns that existing capacity market rules will not properly reflect the additional revenues earned by capacity resources from shortage pricing, relying on an earlier finding that existing energy and ancillary services offsets are adequate.

Among other things, PJM was directed to submit additional clarifying tariff language addressing the operation of its shortage pricing rules during emergency actions, as requested by the Pennsylvania PUC and generally the IMM.

Acknowledging that suppliers could become pivotal suppliers of contingency reserves and may, in this instance, possess market power FERC directed PJM to submit, in its compliance filing, provisions requiring that all on-line non-emergency generation resources providing energy are to be considered available to provide Tier 1 or Tier 2 synchronized reserves. FERC also directed PJM to submit provisions requiring all other non-emergency generation capacity resources to submit offers for either Tier 2 synchronized reserves or non-synchronized reserves, as applicable to the capacity resource's eligibility in these markets, following the issuance of warnings that indicate upcoming shortage conditions. "These requirements are consistent with the existing obligation for capacity resources to offer energy from all of their capacity to the PJM day-ahead energy market. We note that a must-offer requirement, when implemented, should not impede resources from exporting energy on a non-firm or recallable basis, i.e., that the must-offer requirement will not operate in manner that requires the resource to sit idle," FERC said.