On December 19, 2019, the Federal Energy Regulatory Commission (“FERC”) issued the much-awaited order on the operations of the PJM Interconnection LLC (“PJM”) capacity auctions. FERC’s order will require PJM to extend its Minimum Offer Pricing Rule (“MOPR”) to all generation, both new and existing. Whereas the prior MOPR mainly addressed offers from new gas-fired generation with state support, FERC will now require the MOPR to cover all non-utility existing thermal generation (such as nuclear, coal, gas, and oil) with state support as well as all new generation with state support—including new renewable generation and new utility generation.
PJM is the world’s largest centrally-dispatched electric power market, covering parts of thirteen states plus the District of Columbia. Most of PJM’s revenue comes from wholesale sales of electric energy, which retailers resell to homes and businesses. PJM also requires retailers to pay for the generation capacity that is necessary to serve the demand reliably. Capacity prices are determined in annual capacity auctions in which PJM sets a demand curve and generation owners submit offers to supply capacity.
Historically, there was a single capacity auction for the entire PJM market. Because PJM had excess generation capacity, capacity prices were low. In 2007, the capacity auctions were revamped, using the Reliability Price Model, to allow for locational prices. The Reliability Price Model allowed higher prices where capacity was needed for reliability reasons. Following its implementation, capacity prices rose significantly—particularly in the eastern part of PJM. In response, New Jersey and Maryland authorized programs to subsidize the financing of new generation facilities in order to drive down capacity prices in their regions. Each state required these new subsidized facilities to clear the capacity auctions, and their electric retail customers would cover any losses the new plants would incur. Because the subsidies were less than the decline in capacity payments, the programs benefited retail customers at the expense of generation companies not participating in these state-subsidized programs.
Several of these independent power producers filed lawsuits challenging the New Jersey and Maryland programs. In Hughes v. Talen Energy Mktg., LLC, the Supreme Court ruled the state programs unconstitutional, because they required the recipients of the subsidies to clear the PJM capacity auctions and drive down the auction prices. Specifically, the Court ruled that state programs that required price effects in federally-controlled auctions are impermissible.
Other states undertook different approaches to address capacity issues. Both New York and Illinois adopted Zero Emission Credit programs that subsidized nuclear power plants to keep them viable. Part of the rationale for these programs was that the states had an interest in maintaining enough capacity without emissions to meet federal and state carbon-reduction goals for electric generation. The Second and Seventh Circuit Courts found the new programs permissible, because they did not require the subsidized generation to clear long-term capacity auctions. The Supreme Court upheld these rulings in April 2019. In July 2019, Ohio adopted a similar subsidy program to maintain both nuclear and coal-fired generation in Ohio.
Although the courts differentiated between the programs offered by New Jersey and Maryland and those offered by New York and Illinois on legal grounds, all of the programs have the same economic effect. By keeping generation capacity in the market that would otherwise exit, the programs depress prices in capacity and energy auctions.
FERC’s new PJM order will counteract the state subsidies’ price-decreasing effect on capacity. The new MOPR establishes different offer floors on generation units supplying capacity, based on whether a unit is new or existing and the generation technology of existing capacity. The floor for new units is 90 percent of the Net Cost of New Entry, which is a measure of annualized greenfield unit installation costs less the expected net revenues from energy and ancillary service sales. The floor for existing units is set at the Net Avoidable Cost Rate (Net ACR), which is a measure of the annual losses that a unit would incur if its net revenues came only from energy and ancillary service sales. FERC’s new order requires PJM to calculate the Net ACR by technology class. The Net ACR likely will be set at a level above the auction price caps, so that nuclear and coal-fired generation will be unable to clear capacity auctions.
All generation units will be subject to these price floors unless a unit meets one of five exemptions. The exemptions indicate that existing rate-base and existing renewable generation will not be subject to the floor, nor will demand response, energy efficiency, or storage devices. Also, as currently, generation not receiving state support (competitive generation) will not be subject to the floor.
The likely effect of the new FERC PJM order will be higher capacity prices in the PJM, because some generation units will have higher offers than they would otherwise. Thus, states may seek ways to reduce the burden of the order. States may respond through litigation. States also may consider requiring retailers to utilize the Fixed Resource Requirement (FRR) alternative to the capacity auctions. Under the FRR alternative, energy retailers obtain capacity resources outside of the auction and thus do not pay the auction prices for capacity. Additionally, subsidized units become valid resources without a price floor, and the demand served by them reduces the demand in the auction. This depresses auction prices just as if the subsidized resources had cleared the auction. States requiring the FRR alternative also could operate their own auctions to match supply and demand (and also realize other goals such as renewable energy, carbon reduction, and employment).
Although the new MOPR addresses state programs that depressed prices in capacity auctions and negatively impacted non-subsidized generation, the new MOPR also creates uncertainty. States may challenge the new rule or require their electric retailers to forego the PJM auction process and obtain capacity directly. Thus, the only certainty going forward is that the capacity auction process in PJM will be changing.