How FERC's 'unprecedented' PJM order could unravel capacity markets
The landmark order echoes longstanding arguments from the coal and gas sector, but observers say it could end up a boon for renewables and nuclear.
The Federal Energy Regulatory Commission last week ordered changes to PJM’s capacity market rules that regulatory veterans say will reshape the grid operator’s relationship with its state participants and could lead to the unraveling of the capacity market construct altogether.
"This is unprecedented federal intervention in state policy," said Rob Gramlich, an energy consultant and former advisor to former FERC Chair Pat Wood III. "We've never seen this kind of federal intrusion in the energy industries."
Friday, FERC rejected two proposals from grid operator PJM to compensate for state energy subsidies in its capacity market, which PJM says are depressing prices for other generators. Neither option — a two-part capacity market or an expanded price floor — would sufficiently mitigate the impact of policies like nuclear subsidies and renewable energy mandates, regulators wrote in a 3-2 decision.
"Something bigger is at play here than you usually see in a FERC order."
Former Republican FERC Commissioner
Rejection of the two closely watched proposals would have sent PJM back to the drawing board, but the FERC majority went further, outlining a detailed plan to change the grid operator's capacity market construct to remove some level of subsidized resources altogether.
"In terms of the commission doing something really new from a policy standpoint, it caught my attention immediately," said Tony Clark, a former Republican commissioner nominated nominated by President Obama. "Something bigger is at play here than you usually see in a FERC order."
That plan is a novel recasting of the Fixed Resource Requirement (FRR), a rule in PJM that allows utilities to opt out of the capacity market if they can serve power demand with their own generation resources. Under FERC's proposed Alternative FRR, specific resources like a wind farm or a nuclear plant could also opt out, removing them and their subsidies from the market.
"That's a really big rule change that could fundamentally alter capacity markets in PJM," said Robbie Orvis, director of energy policy design at the think tank Energy Innovation.
The two Democrats on FERC lambasted the decision, with one writing that it puts the commission on the "wrong side of history in the fight against climate change." But depending on its structure, Orvis and Gramlich said such a rule could ultimately be a boon to renewable and nuclear energy and contribute to the gradual decay of the remaining capacity market.
"It could be the beginning of the end for capacity markets," Gramlich wrote in an email.
‘A tipping point’
FERC's Friday order is the culmination of years of hand-wringing in the PJM market over the impact of state energy policies. Owners of coal and natural gas plants complain that state support for renewables or nuclear plants allows competitors to bid lower prices into the capacity market than they otherwise would, cutting into the revenues for fossil generators and forcing some to retire.
For years, the question mostly considered modest renewable portfolio standards and federal clean energy support like the production tax credit for wind energy — still a relatively small part of the PJM electricity mix.
But in recent years, states have begun to step up those mandates and subsidize some large nuclear generators at risk of retirement, dramatically expanding the amount of capacity in the market subject to direct state subsidy. Illinois passed a nuclear subsidy in 2016, New Jersey passed one this year, and a similar proposal in Pennsylvania could come up for debate before the next PJM capacity auction.
That expansion of state subsidies likely pushed regulators to issue their bold order, Clark said.
"There was always this open question about whether a tipping point could be reached with the commissioners just too uncomfortable with the results of the [PJM capacity] auction in terms of it not producing just and reasonable rates," Clark said. "They feel like the tipping point finally has been met and I think that's what this order is what they're saying, at least within PJM."
The decision comes less than two months after FERC approved a two-part capacity market proposal from ISO-New England similar to the PJM option it rejected Friday. The difference between the two proposals, Commissioner Robert Powelson wrote in a concurrence, is that the ISO-NE proposal largely sought to compensate for market impacts of new subsidized resources — namely offshore wind and imported hydro — while the PJM proposal focused more on existing resources — the newly subsidized nuclear plants.
"The nuclear subsidies I think are really what brought us to the point where we are," Clark said. "Barring the payouts to these big, dispatchable nuclear units, who knows if we would have reached this point where the commission really questions the entire capacity market construct."
The FERC majority urged PJM stakeholders to act quickly, calling for initial comments on the proposal within 60 days and reply comments 30 days after that — a timetable both Democratic commissioners say is too short for such a broad reform.
The commission's reasoning on its timetable remains unclear. Last month, President Trump directed the Department of Energy to recommend policies to save uneconomic coal and nuclear plants in PJM from retirement, a move that sector observers say could "blow up" PJM's market altogether. The directive came after DOE officials argued FERC has ignored the consequences of coal and nuclear retirements, including rejecting an earlier bailout proposal from the agency in January.
One explanation for FERC’s expedited timeframe could be that it aims to outpace the DOE action, Orvis said, but the order itself makes no mention of the bailout, which FERC is addressing in a separate docket on grid resilience.
"It could also be to try to guarantee that all of the likely things that are going to happen with this order are in place for the next base residual auction," Orvis said, which happens in May 2019. "I'm not sure why, but I agree this is an unrealistically accelerated timeframe."
"I think the commission is concerned about the next base residual auction," Clark agreed, noting that PJM could still ask for an extension. "If you're going to have any prayer of changing that you almost by definition need to do something quickly."
Wither capacity markets?
On its face, FERC's order appears to be a boon for independent coal and gas generators, who have argued for years that energy mandates and subsidies unfairly depress market prices for other participants. Even the language of Powelson’s concurrence — which sought to further explain the Alternative FRR concept — echoed the longstanding arguments of gas generators that individual states should bear the cost of energy subsidies.
Under FERC's outlined Alternative FRR, states could still subsidize power resources, but they would be removed from the market along with a commensurate amount of load that they serve. Any resources not removed could still participate in the capacity market, but would be subject to a strict Minimum Offer Price Rule that would ensure they cannot bid in below a certain price.
The majority argues that this will ensure that states, and not all market participants, bear the cost of state power subsidies, while the Democratic commissioners said it would overrule power mix decisions that are supposed to be left to the states.
One potential unintended consequence, the dissenters wrote, is that states will double down on their energy policies when presented with the Alternative FRR option, removing so many resources that the remaining capacity market cannot function.
"[T]he expanded FRR construct appears to provide states with a clear option to re-regulate certain generating facilities, and to the extent a state made the decision to transition from the capacity market to state resource selection, the expanded FRR construct could be one possible approach," Commissioner Cheryl LaFleur wrote. "However, no state in PJM has indicated its desire to re-regulate, a choice that could potentially be forced upon them by this proposal."
How the Alternative FRR impacts the capacity market will largely depend on how it is structured, observers agreed, particularly which subsidies allow a resource to qualify for it. If applied broadly, Orvis said it could be a boon to new clean energy technologies by "creating a lot of new optionality for utilities and state regulators."
"Right now if the utility wants to go out and bilaterally contract for their load, they have to do that for all of their capacity and they don’t participate in the capacity market at all," he said. "Now they would be able to go out and just procure for part of their capacity bilaterally and still put the rest in the capacity market."
"Capacity markets, which procure the wrong product and prevent full clean energy participation, are no friend of clean energy."
Energy consultant and former FERC advisor
This, he said, could allow for more flexibility for states looking to increase renewable energy or preserve existing nuclear plants.
"If you're a renewables developer I would imagine this makes life a little easier for you because now instead of having to sign a contract for differences with a utility where you have to forecast your energy and capacity market revenue, you can just sign a [power purchase agreement] for the utility to just buy power from you," Orvis said.
But the devil remains in the details, all observers said. Clark cautioned that the new FRR rule could also make states pull back on clean energy support.
"On one hand I could say for the nuclear and renewable generators, maybe this is net positive because if adopted it gives them a path forward at the states and they can go the states and sell it and if states want to support the resources they can," Clark said. "On the other hand, I could probably make the case that individual states, if they feel like they have to pay the full freight for these resources, may be less inclined to enact some of those public policies that support them.
"It's almost too early me to tell if this becomes a net positive for those resources or a net negative," Clark said.
Initial reaction from Wall Street indicates analysts indicates they expect nuclear generators and states where they are located to push for a robust and easy-to-access Alternative FRR.
"We anticipate states like Illinois and New Jersey will vigorously defend their ability to remove their nuclear assets from the capacity market and pay them directly, opening the door to other assets not presently clearing the auction but also potentially needing subsidies in both states (e.g. Dresden in IL from the last auction)," Bank of America analyst Julien Dumoulin-Smith wrote to clients in a note.
If other states take a similar tack and begin pulling substantial capacity out of the market, it could leave too few resources in some areas to support a functioning capacity market, Gramlich and Orvis said. That could make LaFleur’s concern of a forced re-regulation of the capacity market a reality — but the analysts say that may not be a bad thing.
"If the FRR opt-out can be made workable, that might be a good thing for clean energy and consumers," Gramlich wrote. "Capacity markets, which procure the wrong product and prevent full clean energy participation, are no friend of clean energy."
Follow Gavin Bade on Twitter