PJM’s Pricing Reformation: Will It Replace the DOE NOPR?
November 21, 2017
On November 15, 2017, PJM Interconnection, L.L.C. (“PJM”) announced plans to make major reforms to its energy market pricing rules, which could increase electricity market costs by as much as $1.4 billion/year. In essence, PJM wants to reduce “out-of-market” payments to generation resources, and also to change its shortage pricing rules to more accurately reflect the value of energy and reserves during reserve shortages. These pricing reforms will not directly compensate for the “resilient” nature of any resources, as discussed in the Federal Energy Regulatory Commission’s (“FERC”) Department of Energy (“DOE”) Notice of Proposed Rulemaking (“NOPR”). Nonetheless, PJM’s proposal could make some coal-fired and nuclear-powered generation facilities more profitable, and thus it could prevent some generation facility retirements, which is a major goal of the DOE NOPR.
Reforming Energy Market Pricing: For almost 20 years, PJM’s energy market has been based upon the principle that only “flexible” generation resources (e.g., those that can offer varied electricity output at different prices) can set locational marginal prices (“LMP”) for electricity. LMPs are established when flexible units, for example, offer electricity in “stair step” increments for various levels of pricing. PJM defines “inflexible units” as “those with declining average costs that are unable to economically produce power within a certain range, or that require an economic minimum output.” Inflexible units can include coal, nuclear and large natural gas units, which have difficulty varying their output based on either their technology or the way that they purchase natural gas.
The existing simplification of LMP pricing made sense when “inflexible” generation resources were often the lowest cost resources and “flexible” generation (e.g., natural gas “peaking” units) were much more expensive than base load resources, such as nuclear power plants. In recent years, however, this paradigm has shifted. New gas generation facilities at today’s relatively low natural gas prices can economically provide power at lower prices than nuclear facilities. In addition, renewable generation facilities (e.g., solar and wind generation) often experience zero marginal costs, and thus may offer electricity at significantly reduced LMPs.
LMP prices have been impacted by changes in fuel prices and more efficient technologies, as well as a slow-down in the growth of demand for electricity. PJM believes that such changes “have revealed an opportunity to enhance energy market pricing” so that electricity prices accurately reflect the “true incremental cost of serving load and minimize the need to recover those costs through out-of-market uplift payments.” Other Regional Transmission Organizations, such as the Midcontinent ISO, have addressed the need to allow inflexible generation units to set prices through programs such as MISO’s Extended LMP algorithm.
PJM’s tariff permits some inflexible generation units to recover their costs through uplift payments, so being eligible to set prices will not necessarily benefit these units. PJM believes, however, that allowing inflexible units to set prices at the margin will reduce “the price suppression effects resulting from their current ineligibility to set price and further reinforces the incentives for all units to offer into the energy market at their actual costs.” PJM proposes to reform LMP algorithms to allow both flexible and inflexible units to set LMP prices, and thus provide appropriate incentives to support a more efficient commitment and dispatch solution. See, Proposed Enhancements to Energy Price Formation. PJM’s proposal may also reduce instances of negative LMP pricing, which occurs when there are too many generation resources delivering electricity into the grid.
Changes to Shortage Pricing Rules: The term “shortage pricing“ refers to market rules that govern how energy and reserve prices are calculated when there is not enough supply of electricity on the system to meet demand and reserve requirements. An effective shortage pricing model provides clear, transparent pricing signals to the market to indicate the current operating state of the system and also incentivizes market participants to act in a way that promotes system reliability. Prices that escalate commensurate with tightening conditions on the system help mitigate emergency operating conditions by incenting “at will” supply (such as interchange, non-capacity generation resources, and other supply that is not committed) to sell energy to PJM. PJM plans to create a 30-minute operating-reserve product to supplement its current 10-minute reserves. In addition, PJM plans to revise its operating reserve demand curve to more accurately value granular amounts of reserves.
Potential Economic Impacts: PJM estimates that the net impact of proposed pricing reformation changes will increase total energy and capacity market costs by between $440 million and $1.4 billion annually (i.e., between 2 and 5 percent), compared to total simulated energy and capacity market costs of approximately $28 billion/year. PJM predicts that this net impact will be composed of an increase in energy market costs of approximately $2.7 billion, offset by a decrease in capacity market costs of between $1.2 billion and $2.2 billion. Although it is difficult to predict whether these increased market costs will delay or prevent the retirement of any coal or nuclear generation units, pricing reformation will likely benefit such resources.
PJM plans to present its pricing reformation proposal during the December 7, 2017 meeting of the PJM Markets and Reliability Committee. PJM apparently believes that these pricing reformation changes are necessary in the relatively near term, whether or not there is broad stakeholder support. As a result, PJM may decide to work with the PJM Board of Managers to make a unilateral Section 205 filing at FERC, if there is insufficient stakeholder support for these pricing reformation changes.
This Eckert Seamans Energy Blog is intended to keep readers current on matters affecting businesses and is not intended to be legal advice. If you have any questions, please contact Daniel Clearfield at (717) 237-7173 – dclearfield@eckertseamans.com.