The following is a contributed article by Rob Gramlich, of Grid Strategies, and Miles Farmer, of Miles Farmer PLLC.
At a time when states are struggling with COVID-19 health and economic impacts, the highly-criticized "MOPR" order by the Federal Energy Regulatory Commission (FERC) hasn't helped. Just the opposite — it's forced states like Maryland and New Jersey to scramble to keep the feds' new rule for the PJM wholesale electricity capacity market from driving up costs on electricity billpayers, making them pay for expensive capacity from gas and coal plants redundant to clean energy being prioritized locally.
As states consider their options in the wake of FERC's order, it's important they get clear information on the potential risks and benefits of an alternative to PJM's centralized capacity procurement called the Fixed Resource Requirement (FRR). While the region's market monitor, Monitoring Analytics, has provided analyses of the FRR to states, we explain in a new paper that this work holds the potential to confuse or even mislead readers not steeped in PJM's complex rules.
Predicting costs under an FRR is difficult, and there are pros and cons to FRR that states should carefully consider. But contrary to Monitoring Analytics' assertions, standard economic analysis suggests that adopting an FRR will not result in higher costs for customers.
While Monitoring Analytics' reports provide helpful data and a useful framework for assessing FRR, they miss the mark on key issues.
Capacity market alternative
FRR is a provision that allows utilities to submit their own capacity procurement plans instead of participating in the centralized PJM capacity market, and gives states broad latitude to design the process by which utilities develop such plans. Owners of sources are paid for capacity commitments as a way of ensuring there will be enough future electricity supply, and the FRR could help states ensure that capacity from clean energy sources continues to be valued despite FERC's efforts to the contrary.
Before electing to implement FRR, however, states must better understand the potential risks and benefits of such an approach, including its potential price impacts for customers.
We published Whether to FRRExit: Information States Need on the Costs and Benefits of Departing the PJM Capacity Construct in order to help states decipher Monitoring Analytics' reports, and to provide additional information on potential benefits of FRR, as well as challenges that would need to be overcome if FRR were to be implemented.
As we explain, Monitoring Analytics relies on a flawed assumption that utilities procuring capacity under FRR would not seek to do so at lowest cost. The price of capacity varies based on the location of capacity suppliers and constraints in the transmission grid. Capacity is more expensive in locations like Northern New Jersey where local capacity supply is insufficient to meet demand, as compared to areas such as Pennsylvania where capacity is more plentiful.
Monitoring Analytics assumes without explanation that utilities in Northern New Jersey would not seek to import such low-cost capacity to the maximum extent possible consistent with transmission constraints, and would instead rely on more expensive local capacity. But nothing in FRR prevents utilities from accessing cheaper external capacity and any reasonable FRR design would allow, or even require them to do so.
Our report explains that when correcting for this flawed assumption, and assuming capacity prices equal to those of the most recent PJM capacity procurement (as Monitoring Analytics does for half of the scenarios it analyzed), estimated costs would be lower under an FRR than for continued reliance on the PJM capacity construct. This is because under FRR, utilities would only need to procure sufficient resources to meet reliability obligations by providing a cushion above expected demand of about 15%.
By contrast, PJM's central procurement purchases far more capacity than necessary, with a reserve bloated upwards of 22%. Unsurprisingly, buying an excess of capacity costs more money. Trimming procurement to meet rather than exceed reliability obligations would lower customer capacity bills by about 5%.
The very high capacity cost estimates in other scenarios chosen by Monitoring Analytics flow from the simple fact that they assumed very high capacity prices equal to the offer caps currently used in PJM's market. Monitoring Analytics does not explain why it used this assumption in its reports analyzing the Maryland and New Jersey markets, leaving us to infer it did so out of a belief that use of an FRR would increase capacity supplier market power (which enables suppliers to manipulate the market by offering capacity at artificially high rates).
Yet rates in PJM's market are much lower than these offer caps despite Monitoring Analytics' own conclusion that market power is "endemic" in PJM's centralized capacity procurement, and its view that the rules of that procurement fail to adequately mitigate market power.
Market power concerns
We agree that market power is a significant concern that must be addressed by any FRR market design, but it is important to note that FRR does not create market power. The underlying physics of the system based on transmission constraints and where supply and demand are located are what lead to market power, which does not change whether or not states elect FRR.
Monitoring Analytics concludes that FRR increases market power, but that conclusion stems from its flawed assumption that arbitrarily restricts FRR plans to purchasing local capacity. Under any reasonably designed FRR, utilities wouldn't just purchase locally; they could continue to source capacity from external suppliers to an extent consistent with transmission import capability.
The question is not whether FRR creates market power, but rather whether FRR provides comparable tools for market power mitigation. As we explain, while market power mitigation is a challenge under FRR because the rules of the road have not yet been fully established, FERC has a duty to mitigate market power and can rely on established practices in doing so.
States have a lot to consider in how to cope with FERC's MOPR order, and our paper delves into a range of additional pros and cons of FRR. At the end of the day, its states' decision to make and they need trustworthy data and an evenhanded assessment of the facts in order to chart the right course.
Estimating capacity prices under FRR is difficult given unknown market dynamics and FRR implementation design practices that may shape prices. But industry-standard price estimation techniques suggest capacity prices under FRR are likely to be lower than those obtained through PJM's centralized capacity procurement, not higher as Monitoring Analytics has predicted.