FERC Nixes PJM’s Fixes for Capacity Market Besieged by Subsidized Resources

In a 3-2 decision, the Federal Energy Regulatory Commission (FERC) rejected approaches filed by PJM Interconnection to reform its capacity market, whose integrity and effectiveness has been increasingly and "untenably threatened" by state subsidies for preferred generation resources, the federal regulatory body acknowledged.

The June 29 order sharply divided the commission, prompting Democrat Commissioners Cheryl LaFleur and Richard Glick to issue separate dissents. The Commission's majority (which includes Commissioner Robert Powelson, who announced on June 28 he would leave FERC by mid-August) determined that PJM's existing Minimum Offer Price Rule (MOPR) renders the grid operator's tariff "unjust and unreasonable." However, FERC left the issue unresolved for now, saying it was unable to make a final determination regarding a "reasonable replacement rate" for PJM's tariff based on the existing record.

The commission instead preliminarily found that modifying two aspects of the PJM tariff "may produce" a just and reasonable rate. To supplement the record, it consolidated filings from dockets related to Friday's decision and initiated a paper hearing to allow for submission of "additional arguments and evidence." It plans to make a final decision by January 2019.

Industry experts Raymond Gifford and Matthew Larson, who are partners in the Denver office of the Wilkinson Barker Knauer LLP law firm, called the order "seismic."

"At first blush, the order amounts to a finding that state 'around market' actions and other patches have overrun the market itself. It puts in place a tall directive for PJM to analyze, repair and likely redesign the capacity market construct-basically by the end of the summer." However, the commission's decision "should not be viewed as surprising," they added. "The path of continued 'around market' and 'in-market' interventions was bound to lead one or more of the fully restructured markets to this moment someday. For PJM, the time is now."

A Flood of State Subsidies

The order stems from concerns that the amount and type of generation resources receiving out-of-market support has increased substantially, evolving beyond small-scale renewables to thousands of megawatts from larger nuclear units. More states in PJM's 13-state region are meanwhile considering providing more support based on an "ever-widening scope of justifications." The decision notes that these subsidies have a "suppressive effect" on the price of capacity procured by PJM through its capacity market, which is known as the Reliability Pricing Model (RPM).

The RPM is designed to enable PJM to ensure long-term grid reliability by procuring enough power supply resources to meet demand expected three years in the future, and incentivizing resources to deliver on demand during system emergencies. It also sets long-term price signals to attract investments. But according to FERC, out-of-market payments, whether made or directed by a state, allow supported resources to reduce the price of their offers into capacity auctions, causing artificially lower auction clearing prices-and kicking off an insidious spiral.

"As the auction price is suppressed in this market, more generation resources lose needed revenues, increasing pressure on states to provide out-of-market support to yet more generation resources that states prefer, for policy reasons, to enter the market or remain in operation," FERC noted. "With each such subsidy, the market becomes less grounded in fundamental principles of supply and demand."

PJM's Tariff Is 'Unjust and Unreasonable'

In response to increasing out-of-market support, several independent power producers (IPPs) joined Calpine Corp. in a March 2016-filed complaint (Docket No. EL16-49-000) alleging that PJM's tariff-and more specifically, the tariff's existing MOPR-is unjust and unreasonable because it does not address the impact of subsidized existing resources on the capacity market. Among other out-of-market payments, Calpine cited the Illinois zero-emission credit (ZEC) program, which is under review by the U.S. 7th Circuit Court of Appeals.

On Friday, FERC agreed with the generator. FERC determined that the existing tariff is unjust and unreasonable and unduly discriminatory. "It fails to protect the integrity of competition in the wholesale capacity market against unreasonable price distortions and cost shifts caused by out-of-market support to keep existing uneconomic resources in operation, or to support the uneconomic entry of new resources, regardless of the generation type or quantity of the resources supported by such out-of-market support," it said.

However, FERC only granted Calpine's complaint in part: While Calpine proposed interim and immediate tariff revisions to extend the MOPR to a limited set of existing resources, FERC did not accept Calpine's remedies.

FERC: PJM's Approaches Aren't the Answer

The FERC order also addresses a second proceeding (Docket Nos. ER18-1314- 000, et al.)in which PJM filed two alternate proposals to revise its tariff under section 205 of the Federal Power Act (FPA). The proposals were designed to address the price suppressing effects of state out-of-market support for certain resources.

The first alternate approach-which PJM preferred, though the grid operator noted in filings that neither alternative gained the two-thirds affirmative sector vote required for endorsement, despite a lengthy stakeholder process-comprised a two-stage annual auction to replace the MOPR. The first stage would determine capacity commitments and no resource offers would be mitigated. In the second stage, offers from subsidized resources would be replaced with PJM-determined competitive offers, and the auction would be run again to set the final clearing price (also known as "capacity repricing") for resources that were selected in the first stage.

The second alternate approach-which PJM urged FERC to consider only if FERC determined capacity repricing was unjust and unreasonable-would revise PJM's 2006-established MOPR. The existing MOPR, which currently sets a price floor only for certain types of new natural gas-fired resources, does not address the price suppressive impact of resources receiving out-of-market support, as FERC noted in its order. PJM's approach was to expand the MOPR so that it would apply to any type of generation resource that receives subsidies, with exemptions. The so-called "MOPR-Ex" approach would extend the geographic reach of the MOPR to apply to external capacity resources as well as internal capacity resources, without a resource size threshold.

However, FERC rejected both of PJM's alternative proposals because they were not shown to be "just and reasonable, and not unduly discriminatory or preferential."

As expected, PJM's capacity repricing proposal or mechanisms that accommodate state-supported resources was backed by the Nuclear Energy Institute, PSEG, and Exelon. Exelon argued that subsidies that address carbon pollution costs make markets more efficient-not less.

PJM's own market monitor railed against capacity repricing, saying it isn't a market solution and would undermine competitive markets by allowing subsidized units to displace competitive units. The New Jersey Board of Public Utilities argued that the capacity repricing proposal was significantly broader than the Competitive Auctions with Sponsored Policy Resources (CASPR) approach that FERC approved for ISO-NE.

The Electric Power Supply Association (EPSA), a trade group representing IPPs and marketers that it says "understand what it means to compete," argued that state subsidies would dictate entry and exit, essentially undermining the role of the Base Residual Auction (BRA) clearing price to provide signals. NRG Energy argued that a two-stage auction would push economic merchant resources out of the market in favor of subsidized resources, and, like the Natural Gas Supply Association (NGSA), the company argued that the non-fuel-neutral proposal could actually incentivize states to subsidize resources.

In its order, FERC said the capacity repricing proposal would allow subsidized resources to submit offers into PJM's capacity market as price-takers, acquiring capacity obligations without mitigation, and this would in turn suppress capacity market clearing prices. "We agree with intervenors that, by setting a clearing price that is disconnected from the price used to determine which resources receive capacity commitments, the market clearing price under Capacity Repricing will send incorrect signals, leading to greater uncertainty with respect to entry and exit decisions," it said.

The alternative, MOPR-Ex-which a number of intervenors such as EPSA and PJM's market monitor, were generally supportive of-would prevent "some (but not all) resources that receive Material Subsidies from obtaining capacity commitments at the expense of competitive resources," FERC's order says. However, FERC determined that PJM has not provided "a valid reason for the disparity" among resources that receive out-of-market support through renewable portfolio standard (RPS) programs, which are exempt from the MOPR-Ex proposal and other state-sponsored resources, which are not.

More Work Needed to Determine a Replacement Rate

Yet, FERC acknowledged it did not have a clear answer for a workable solution, noting that it was "unable to determine, based on the record of either proceeding, the just and reasonable rate to replace the rate in PJM's Tariff."

The federal body instead moved to consolidate the two proceedings-PJM's proposals and Calpine's complaint-into a new proceeding (Docket No. EL18-178-000) and set a "paper hearing" to address a proposed alternative approach in which PJM would modify two current aspects of the tariff.

Specifically, that approach could expand PJM's MOPR-with few or no exceptions-to apply to new and existing resources that receive state subsidies. It will also accommodate state policy decisions and allow subsidized resources to remain online. To "avoid the potential for double payment and over procurement," FERC also preliminarily found that the approach should include an option in the tariff to allow some subsidized resources to choose to be removed from PJM's capacity market, along with a commensurate amount of load, for "some period of time," the order says.

The option is similar to the Fixed Resource Requirement (FRR) that currently exists in PJM's tariff, which allows load-serving entities to exit the capacity market on a utility-wide basis. But unlike the FRR, FERC's proposed "FRR Alternative" would function on a resource-specific basis.

"The resource-specific FRR Alternative would accommodate such resources by allowing them to remain on the system, despite their inability to compete in the capacity market based on their costs, by permitting them to exit the capacity market with a commensurate amount of load and operating reserves," FERC said, noting that it was seeking comment on the "best method of accounting for both the load and reserves."

Resources and load that take advantage of the FRR Alternative wouldn't participate in the PJM capacity market. "However, those resources and their associated load would continue to participate in the energy and ancillary services market, as is the case under the current FRR construct. Unlike the current FRR construct, the resource-specific version would not require a load-serving entity to remove its entire footprint from the capacity market; rather it would remove a specific resource (and accompanying load)."

FERC acknowledged that a number of details will need to be addressed to implement this resource-specific FRR Alternative, and it published a list of questions in its decision (starting on line 165).

Interested parties must submit their initial round of testimony, evidence, and arguments within 60 days of the order (by August 28, 2018). FERC said it expects to make a decision on "establishing a just and reasonable replacement rate" no later than January 4, 2019.

A Pervading Issue

The impact of out-of-market support for specific resources on competitive markets-beyond PJM, including ISO New England (ISO-NE) and the New York Independent System Operator (NYISO)-has been a long-standing concern for FERC. The federal body in May 2017 convened a technical conference to explore the issue. As a result of discussion at that conference, FERC staff outlined five potential paths forward:

• Implementing a limited or no-MOPR approach.
• Accommodating subsidy-receiving resources.
• Leaving things as they are.
• Balancing state policy goals and the needs of the centralized capacity market.
• Extending the MOPR to apply to both new and existing resources.

Over the past few months, however, the issue has grown more complex. In March 2018, FERC accepted ISO-NE's proposal to modify its wholesale capacity market to better accommodate state actions to procure resources outside the New England wholesale market. That mechanism is known as Competitive Auctions with Sponsored Policy Resources (CASPR).

At the end of May, meanwhile, a coalition of generators, including CPV Power Holdings, Calpine, and Eastern Generation, filed a formal complaintagainst PJM seeking, under FPA section 206, a FERC directive for PJM to adopt a "clean" MOPR-without exclusions or exemptions-which would apply to both new and existing resources. The coalition argued that state subsidies represent a "serious and imminent threat to the RPM market."

That complaint cites an April 9 PJM filing with FERCin which Dr. Anthony Giacomoni, senior market strategist of PJM's Emerging Markets division, noted that many of the "subsidy payment rates, when converted to MW-day values, in factexceedcapacity clearing prices in PJM's most recent annual auction" (emphasis in PJM's filing).

Giacomoni found that Illinois ZEC prices equate to about $265/MW-day; New Jersey onshore wind power renewable energy credit (REC) prices equate to $250/MW-day; and solar REC prices in the District of Columbia equate to $4,751/MW-day. Those subsidies "greatly exceed prices" in PJM's 2020-2021 base residual auction, which ranged from $76.53/MW-day to $187.87/MW-day, the complaint alleges. PJM's more recent auction for the period spanning 2021-2022 yielded prices of about $140/MW-day.

PJM itself has repeatedly acknowledged that reduced capacity price offers from subsidized resources can significantly reduce capacity clearing prices, and that these programs threaten competition and resource adequacy objectives.

The expansion of resources eligible for state subsidies is also a concern for the grid operator. Between 1,400 MW and 3,360 MW of nuclear generation is eligible for ZEC payments under Illinois law, and New Jersey's newly enacted legislation could provide similar payments for Salem and Hope Creek facilities-a total of 3,360 MW. Eligible offshore wind includes 250 MW in Maryland and 1,100 MW in New Jersey. Finally, 5,000 MW of generation from various renewable resources is eligible under RPS programs in various PJM states, including New Jersey, Delaware, and the District of Columbia. Existing RPS commitments could grow to 8,000 MW by 2025, PJM said.

In her dissent, LaFleur agreed with the commission's rejection of the capacity repricing proposal but noted that she would have preferred to offer guidance to PJM and stakeholders to refine the MOPR-Ex proposal, rather than reject it, to ensure it would not interfere with the operation of existing state RPS programs. "Alternatively, I would have suggested that PJM consider an expanded CASPR-like construct that could include opportunities for new and existing subsidized resources to buy out the capacity obligations of other resources in the market. I think either approach could yield a just and reasonable result."

But LaFleur had bigger concerns. "[B]y declaring the PJM capacity market unjust and unreasonable, the Commission has imposed an ex parte restriction on its ability to meaningfully engage with stakeholders outside of formal Commission proceedings, while also creating a timing crisis related to the May 2019 Base Residual Auction," she wrote. "I am particularly troubled that, as a result of today's order, the Commission will be hamstrung in its ability to openly and honestly engage with the states about whether this proposal will meet their needs, and how they might operate under this construct."

Glick, meanwhile, argued that FERC's order is "interfering with the states' exclusive jurisdiction." On Twitter, he summarized his contentions: "The commission should not use its authority to limit state efforts to address the threat of climate change," he wrote. "Doing so puts the commission on the wrong side of history in the fight against climate change."

In a statement, PJM said that it was pleased FERC is taking action. "The Order appears to be a positive step to change competitive electric market design while recognizing the important role states play in influencing the resource mix through retail energy policies," it said. The grid entity plans to "begin work immediately to develop the kind of bifurcated capacity construct envisioned by the Commission and actively engage stakeholders, including the states, within the timetable laid out by the Commission."

-Sonal Patel is a POWER associate editor (@sonalcpatel, @POWERmagazine)

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