PJM's capacity market proposal: Bad for customers, states, and the fight against climate change
While FERC expressed concern about the impact of clean energy policies among different states in the region, it did not ask for a plan that would prop up generators at the expense of customers.
The following is a viewpoint from Ann McCabe, an energy and environmental consultant and former commissioner at the Illinois Commerce Commission, and John Moore, the director of the Sustainable FERC Project at the Natural Resources Defense Council.
In the absence of federal climate leadership, state and local governments have shown up with strong commitments to decarbonize the energy sector. PJM's proposed redesign of its regional electricity "capacity" market would hamstring state clean energy initiatives throughout the largest electricity market in the United States, cumulatively about one-fifth of the U.S. power supply.
Of the 13 Mid-Atlantic states, plus the District of Columbia, in the PJM electricity market, 12 have a renewable portfolio standard or serious renewable energy goal. In the wake of increasingly alarming concerns about the pace of climate change, states throughout PJM are developing more aggressive clean energy goals. There's a lot at stake.
The Federal Energy Regulatory Commission (FERC) recognizes the importance of allowing states to meet these goals without overburdening customers. When FERC ordered PJM to reshape its capacity market (in which electricity is contracted for three years into the future to secure long-term grid reliability), FERC also ordered PJM to explore ways to accommodate state clean energy programs and protect customers from unnecessary costs.
Unfortunately, PJM's proposal released this month goes in the opposite direction: punishing clean energy and charging customers. We have until November 6 to raise concerns to FERC and prevent PJM's proposal from becoming a market rule.
PJM's plan is akin to a billion-dollar giveaway at consumers' expense to a few lucky fossil fuel generators. While we previously raised alarms about PJM's plans, this proposal is worse than expected. It may be better for many future clean energy resources to exit the PJM capacity market than take the extended resource carveout option, in which they must literally make payouts to dirtier plants.
The proposal targets low-carbon energy sources because PJM views financial support in the form of state renewable energy or zero-emissions credits as "distorting" the market.
PJM proposes three ways that low-carbon generators receiving state support would be able to participate in its capacity market:
- Operate as usual under state programs, but be subject to a minimum offer price rule (MOPR) in the capacity market;
- Commit to foregoing any payment from state programs, but not be subject to the MOPR; or
- Opt out of the capacity market through the "resource carveout option," or potentially the even more punishing "extended" carveout.
PJM's proposed options for clean energy resources represent body blows to state climate policy and customer wallets in the following ways.
A misguided default option
Under PJM's plan, generators receiving a state subsidy of more than 1 percent of their expected revenue would automatically have their bid prices increased through the MOPR, which is essentially a resource-specific price floor for bids in the capacity auction. The way the MOPR works is complicated, but the effect is that it sets a higher minimum price in an attempt to estimate what the price might have been without any state support — in other words, canceling out state clean energy policy.
PJM and other MOPR proponents argue that state clean energy support allows generators to bid at a lower-than-actual cost, distorting the market. This view ignores the fact that state policies like renewable energy credits (RECs) compensate resources for their environmental attributes.
The chart below depicts PJM's rationale. Each blue bar represents a supplier bidding in the capacity auction (forming a supply curve), and the downward-sloping line represents capacity demand. Generators submitting prices lower than the "clearing price," marked by the star where supply meets demand, are selected to sell capacity. The green bars represent revenue a low-carbon resource might receive from a state program. The MOPR forces resources to include this revenue in their bid price.
As demonstrated in the next chart, the consequence of the MOPR is that the subsidized units often no longer clear in the auction. As a result, capacity prices increase and excess capacity is procured because the subsidized resources still provide electricity according to state mandates.
The FERC order explains why this option is bad for customers: state policy mandates clean energy as part of the electricity mix, so the plants already exist and are able to provide capacity. But if the MOPR prevents this clean energy from clearing in the capacity market, customers must then pay for more — and unnecessary — capacity to meet PJM's capacity requirement.
PJM suggests that if state-supported energy sources want to avoid the MOPR, they can commit to not taking any subsidy revenue. Telling generators to forego state clean energy programs isn't exactly "accommodating" such policies.
Billion-dollar handouts under the guise of accommodation
Instead of facing the MOPR, subsidized resources could opt out of the capacity market competition and instead select PJM's resource carveout option. Again, the resource carveout is supposed to be PJM's answer to the excess-capacity problem FERC recognized with an extended MOPR. Unfortunately, the conditions of the carveout are so unfavorable to clean energy options, it is unclear why a supplier would choose it over not participating altogether. Even if renewable generators do choose this course, it will be at a high cost to customers.
PJM's Independent Market Monitor found that capacity costs would nearly double in a single year, from $9.3 billion to $17.7 billion, under PJM's carveout plan. This near-doubling of costs would occur in a potentially realistic scenario assuming just under 15 percent of the total market resources would be affected by PJM's plan.
An irony can be found in the distribution of costs. PJM claims that state clean energy policies are unfair because policies in one state can affect customers in another PJM state without such policies, yet PJM's proposal would result in wide-ranging impacts by geography, with some zones seeing price increases as high as 214 percent while others experience only a 20 percent change.
Under the proposal, when a resource chooses the carveout, the capacity it will provide according to state mandates (and likely bilateral purchase agreements) is counted toward PJM's overall capacity goal. In other words, the renewable energy is credited to the system so that less capacity must be bought from other sources. However, the carved-out resources aren't compensated by PJM, per the first step of PJM's two-stage proposal shown in the graph below.
In the first round of the capacity auction, the carved-out resources are still considered when capacity obligations are selected. In this case, the carved-out resources are from Suppliers A and B. Note that Suppliers F and G are not assigned any capacity obligations.
The second stage of the auction is what PJM calls an extended resource carveout. While typical market designs would determine capacity obligations and clearing price (in broader economic terms, equilibrium supply and demand) together, PJM determines the capacity obligations in the first stage of the auction, and then runs a second stage without the carved-out resources to determine price (ignoring already-built renewable energy).
The most outrageous part of PJM's proposal is that the carved-out low-carbon energy resources are required to pay a consolation prize of sorts to the dirtier fossil plants that cleared in the second auction but aren't actually necessary for system reliability because of the presence of the subsidized units in the first auction.
PJM says these payments represent the "deadweight loss cost" to the power plants whose capacity is not necessary for the system, called inframarginal units. These units don't have to provide capacity services, but the subsidized resources would be forced to pay them their hypothetical profits from the capacity market anyway. PJM justifies this unwarranted cash giveaway as necessary to preserve the competitiveness of the market.
All of this is demonstrated in the graph below, where the subsidized generators A and B are carved out of the market, and price is set in an imaginary scenario where existing low-carbon generation is ignored. Generators F and G appear to clear, but aren't actually assigned capacity — just payments from A and B.
To emphasize: carved-out clean energy sources that provide capacity unpaid by the market will have to pay made-up profit margins to dirtier energy sources that do not provide capacity services. A supplier could submit a bid for capacity from a power plant to be built three years in advance, be categorized as an inframarginal unit, choose to never even build the plant and still receive the payment three years into the future.
The final graph illustrates that in addition to the arbitrary payments, carved-out resources must pay inframarginal units, the resource carveout design has market-wide impacts of higher costs.
PJM seems to assume that all subsidized resources will pick one of the three options. But what if the resource opts out of PJM's capacity market altogether, an option that could likely be in a renewable generator's best financial interest? This possibility is significant because low-carbon energy can also face penalties for not performing when needed under existing rules for capacity performance — meaning that renewable energy would need to be paid enough other revenue for its capacity to make the risk of incurring these market penalties worthwhile.
This opt out scenario would also take the market back to the same unacceptable situation as having an expanded MOPR with no "options" at all: more capacity being purchased than customers need, resulting in higher costs and more high-polluting power plants.
More honest design alternatives
While FERC expressed concern about the impact of patchwork clean energy policies among different states in the region, it did not ask for a plan that would prop up generators at the expense of customers. PJM's proposal would penalize clean generation owners, the majority of states in the region with clean energy policies, and anyone with an energy bill in these areas.
Luckily, FERC has other options, including a proposal from clean energy and consumer advocates that designs a mechanism for accommodating an opt-out of the capacity auction that doesn't result in unnecessary handouts to uncompetitive generators or in excess capacity procurement. A set of shared principles from an even broader group of stakeholders gives FERC another way of looking at these issues.
Reply comments, where stakeholders can respond to the PJM plan, other comments and proposals submitted to FERC in early October, are due to FERC on November 6. Until then — and until FERC makes its decision, let's increase awareness about what PJM's resource carveout option would mean for America's biggest energy market. State governments should submit comments in strong support of their right to clean energy and climate policy, and anyone paying bills in PJM or with concern about climate change should urge them to do so, too.