The PJM Interconnection has in recent months put forward two proposals that could have significant impacts on delivered power prices in the region.  One would alter how LMPs (Locational Marginal Price, the technical name for the cost of energy) are calculated while the other would change how capacity charges, fixed fees paid to generators, are created.  Both of these are forecast to increase final delivered prices for customers in the Mid-Atlantic and Chicago areas.

The Status Quo

At present, LMPs are calculated based off the price that it will cost to deliver one additional megawatt of power to a given location.  This is based on generators offering their costs to produce electricity into a central marketplace on a daily basis.  From these offers, grid operators will adjust the price of energy to incentivize producers to start or stop generation, as higher prices make more generators economical, creating more power generation.  However, since they cannot be incentivized to enter and exit the market on an hourly basis, so-called “inflexible generators,” namely coal, nuclear, and most renewable generators, cannot be the unit used to set the LMP.  This has not been an issue historically, because it infrequently occurred.

LMPs only pay for the marginal costs to produce electricity and there will be a number of generators that will only be economical to run several times a year, but they are needed year-after-year.  Since the cost of energy alone does not justify maintaining these units, a capacity market was introduced.  In a capacity market, grid operators first announce how much generation capacity they wish to procure.  After this, generators submit their daily cost to always be ready to produce 1 megawatt of energy year-round and how many megawatts they can guarantee.  These submissions are then ranked from the least expensive to the most expensive, after which the megawatt portion of the offers are added cumulatively.  When the cumulative megawatt value matches the amount of megawatts to be procured, the corresponding dollar amount will be paid to each generator below that point on the list.

The Proposals

As natural gas has become less and less expensive, the economics of power generation has changed.  In 2016, for example, natural gas combustion turbines were more efficient than many coal facilities, and in many places natural gas was cheaper than coal.  This led to a greater number of hours where coal and nuclear generators were producing power below their costs, though they were still needed for overall capacity reasons. 

PJM’s LMP Formation proposal seeks to change this by allowing inflexible generators to set the price of power.  According to their analysis this move would increase LMPs, though because fewer generators would need to recover costs in the capacity market, annual capacity prices would decrease.  All-in-all, PJM estimates that the change in policy would lead to a 3% increase in the total cost of energy.

Another aspect of the changing economics of power generation is the changing priorities of the sector.  While most power markets work to procure enough electricity at an affordable price, many states have given subsidies to some generators based on other goals such as carbon-free generation or to support major regional employers.  While in regulated markets this does little other than increase costs for end users to accomplish stated goals, in deregulated markets these subsidies have the effect of making generators in other states less competitive.  As these subsidies are becoming more common, PJM officials felt action was warranted.

This action took the form of PJM’s Capacity Repricing proposal, which would effectively remove facilities that receive subsidies from capacity auctions in the name of creating a more level market.  However, this will also have the effect of increasing capacity prices as resources are taken out of the auction.  PJM has yet to make an estimate on how much this will increase prices.

Next Steps

Neither of these proposals are ready to be implemented in their current form, and both will need to be heard by FERC before being implemented.  The LMP formation proposal will likely have the toughest time making it past regulators, as it creates substantial avenues for market manipulation by large generation owners.  If this proposal does succeed, it is likely that additional provisions will need to be added to control this potential problem.

The capacity proposal, however, is more likely to succeed, although it faces challenges as well. Against it passing are the facts that the proposal will have a similar effect to the DOE’s Notice of Proposed Rulemaking that FERC overturned in January, and FERC also granted PJM a massive re-write of its capacity rules less than four years ago.  In its favor, however, is the reality that FERC tends to give ISOs free reign, so long as they act responsibly.  And importantly, it does address a problem that is very specific to PJM in a way that does not explicitly favor generators based on the fuel that they utilize, which FERC has indicated as a top priority.