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Consumers in PJM Being Asked to Pay for Improved Reliability via New Capacity Performance Structure

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This post was authored by Direct Energy employees Marjorie Philips, David Scarpignato, both of the Government & Regulatory Affairs team, and Tyler Little, a trader for east power operations.

Equipped with knowledge from the system performance during the Polar Vortex in January 2014, compounded by concerns regarding coal plant generation retirement in 2015-16 as a result of the EPA’s Mercury & Air Toxic Standard (MATS) rules coming into play, PJM proposes to radically overhaul its existing resource adequacy construct, now the Reliability Pricing Model (RPM), and replace it with a “Capacity Performance” structure. The ultimate goal is to provide PJM with sufficient megawatts (MW) throughout the winter, and more “flexible” MWs that do not require long start-up notice time.

This effort, complemented by other changes in the energy market, such as increasing reserves requirements during predicted and actual periods of grid-related stress, will lead to higher capacity and energy prices in the short term. PJM believes that by not allowing longer lead time generators to qualify for capacity performance will reduce up-lift, or costs related to out-of-merit generation that reached the hundreds of millions of energy consumers during the Polar Vortex.

Mixed messages?

PJM suggests that the higher energy costs will reduce capacity costs long-term, as a component of the capacity payment nets out energy revenues. They also claim that their Capacity Performance program will attract more efficient generation, with more MWs available, ultimately reducing energy costs.

The jury is out as to actual net cost benefits (there are likely to be reliability benefits), but it’s clear that over the next few years, customers will see significantly higher capacity costs. 

In a nutshell

PJM is trying to force out of the capacity market non-base load generation unless it has firm fuel supply. In other words, it wants nuclear generation in and long lead-time generation out. It wants its gas generators to have access to firm gas supply regardless of weather conditions. It wants its generation to perform as well in winter as in summer, as some generators claimed they weren’t able to run in cold weather.

PJM plans to accomplish this force out of the capacity market eliminating any excuse for failure to perform, unless due to transmission or distribution outages, and imposing a fairly harsh penalty for failure to perform during critical peak days. In return, generators will be allowed to bid up to the Net CONE amount, or the cost of new entry less revenues received over the past three years based on a hypothetical gas peaking unit, and may even bid above it if they can demonstrate that their costs, including performance risks, exceed Net CONE. PJM also plans to eliminate the use of renewable resources, unless coupled with firmer supply such as storage, and demand response in the capacity market and instead allow customers to net their peak obligations against the amount of MWs they would be willing to curtail on any day of the year. 

With the exception of nuclear plant owners and some gas generators, PJM stakeholders have voiced considerable concerns about the plan for three reasons:

  1. PJM plans to transition to its new Capacity Performance structure by introducing an additional procurement of up to 10,000 MWs in 2015-16 and then continue to procure a percentage of additional MWs that would meet the “Capacity Performance” MWs for 2016-17 and 2017-18 for incremental auctions for those delivery years. Yet customers have already paid for capacity during these delivery years because the base residual auction has already cleared. In essence, a nuclear plant owner that cleared the 2016-17 auction will be able to re-offer in the same exact MWs, but at the higher Net CONE cost. Additionally, as part of the transition, PJM would eliminate capacity provided by demand response providers relieving them of their obligations, unless specific obligations can be matched directly to a load eliminating the aggregation benefit many demand response providers rely on, and procure the “vanished” demand response MWs. Many stakeholders question the need to transition to the new structure, particularly because the transition is likely to impose costs of up to $4B.
  2. Stakeholders are concerned that the new construct throws too much money at generators that won’t have to make any additional investment to receive that money (nuclear plants), or to generators that may or may not firm up their fuel supplies. The problem PJM appears not to appreciate is that a gas generator may have a firm fuel contract, but if it doesn’t nominate in a timely manner, it may not be able to access the fuel anyway.
  3. Furthermore, stakeholders are concerned that the penalties are so high that justifiable risk premiums will increase costs exponentially. The end state of Capacity Performance may increase costs to consumers up to $14B over what they paid in 2014-15. 

Will PJM’s proposal fix these problems at an efficient cost to consumers?

Fundamental changes need to be made to PJM’s capacity market. It was structured on the assumption that peak generation was only needed in the summer, not the winter. PJM needs to incent newer, more flexible MWs. 

Unfortunately, it’s extremely difficult to predict what PJM will do. Stakeholders met with the PJM Board on November 4, 2014 to plead for more time to discuss the new structure and implore them not to run the incremental auctions under the new construct but to continue to use the existing RPM model. Demand response providers noted that there’s significant legal uncertainty around the role of demand response and PJM shouldn’t take actions prematurely until the courts provide more clarity on jurisdictional issues.

Terry Boston, CEO of PJM, announced that the Board has listened to stakeholder input and will be directing staff on what to file with FERC. Stakeholders will not have input on the filing. Additionally, Boston stated that for now, PJM will leave demand response rules in place until receipt of further direction from the courts or FERC.

What is Direct Energy doing about this?

We at Direct Energy are working with a number of parties to try and ensure that customers pay for what they receive and do not double pay. We strongly urged PJM to not introduce the new construct into incremental auctions, and requested they take additional time to ensure that their proposal will produce the desired results. We have pointed out that a number of changes are being made both at PJM and FERC with respect to gas-electric coordination that may go a long way to improve generator availability without having to throw “Capacity Performance” money at gas generators.

We are working with state utility commissions to ensure that if these costs do go through, they are billed to customers in the most efficient manner. We urge you to reach out to your utility commissions to express your concern.

Additionally, you can expect to see a FERC filing by PJM and we will participate in the proceeding. We will post a blog update at that time outlining the filing to keep you updated.

Posted: November 24, 2014

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