United States: PJM Market Monitor Issues State Of The Market Report With New Capacity Market Design Recommendations

Energy

In accordance with Federal Energy Regulatory Commission ("FERC") requirements, PJM Interconnection, L.L.C.'s ("PJM's") Independent Market Monitoring Unit, Monitoring Analytics, LLC ("Market Monitor" or "MMU") issued its annual State of the Market Report for PJM on March 15, 2012 ("Market Report"). The Market Report provides a comprehensive analysis of PJM's market structure, market behavior and market performance in 2011. While the MMU concluded that the state of the PJM markets was "good," it nonetheless recommends numerous market design "improvements." Notably, the Market Monitor introduced recommendations in the Market Report that, if implemented, would affect PJM generation retirement as well as Reliability Must Run ("RMR") generator units. The MMU also recommended changes to PJM's demand-side response ("DSR") market design as a way to alleviate the inclusion of what it considers "inferior" demand-side resources in PJM's capacity market.

PJM Market Overview

Under PJM's Open Access Transmission Tariff ("OATT") and FERC rules, the MMU must issue an annual state-of-the-market report on the state of competition within, and the efficiency of, PJM's wholesale markets. The Market Monitor evaluates the operation of PJM's markets to identify ineffective market rules and tariff provisions, proposes improvements to market rules and tariff provisions when needed, identifies potential anticompetitive behavior by market participants and provides the comprehensive market performance analysis. This year's Market Report found that wholesale electric energy and capacity markets produced competitive results during 2011.

The MMU noted that, in 2011, gas prices in the PJM region decreased on average by 10% and coal prices increased on average by 19%. The Market Report confirmed that the load-weighted average locational marginal price was 5% lower in 2011 than last year and that capacity prices fell a substantial 18%. The Market Monitor found that while 2011 was a positive year for gas fired units (namely new combined cycle units) in terms of profitability, it was a negative year for older, smaller coal-fired units.

PJM had substantial new entry with five new large generators entering into service. In total, PJM added 5,008 MW of new nameplate capacity in 2011. Importantly, a total of 1,322 MW of generation capacity retired in 2011, and it is expected that a total of 18,886 MW will retire from 2011 through 2019.

PJM's Capacity Market

PJM's forward-capacity market known as the Reliability Pricing Model ("RPM") achieved a competitive rating in the Market Report. As in prior reports, the MMU deemed the RPM's market structure as non-competitive, but found that the capacity market performed competitively due to the implementation of market power mitigation rules. As the Market Report states, PJM's capacity market is "unlikely to ever approach the economist's view of a competitive market structure in the absence" of significant market change resulting in a greater diversity of capacity ownership. While certain capacity market structure recommendations are carried over from previous years, the Market Report includes new observations and proposed "improvements" regarding generator deactivation, RMR service and demand response.

Generator Deactivation and RMR Service

Pursuant to PJM's OATT, a generator owner must provide PJM with 90 days notice if it desires to "deactivate" (i.e., retire or mothball) a generating unit located in the PJM region. Along with the notification, the generator owner must include a "good faith" estimate of the amount of any project investment and the time period the generating unit would be out of service for repairs, if any, that would be required keep the unit in operation. After a receiving a deactivation notification, PJM conducts analyses to determine whether the unit is needed for reliability. If so, PJM requests that the unit provide RMR service under which the owner may collect its costs associated with providing such service.

With an eye towards reliability and market stability, the Market Monitor recommends that PJM modify its OATT to extend the deactivation notification from 90 days to "at least one year." In addition, the MMU recommends extending the amount of time that PJM and the MMU have to conduct their reliability and market power analyses to evaluate any potential adverse market consequences. Importantly, the Market Report recommends that PJM make RMR service mandatory on the basis that PJM market participants all share an interest in the reliability provided by the RMR service provider. The Market Monitor further recommends that the treatment of costs in RMR filings be clarified.

Demand Response

In RPM forward capacity auctions, demand-side resources may compete with traditional capacity providers to meet the region's installed capacity requirements. In 2011, PJM added two new demand resource ("DR") products, one that is unlimited and available throughout the year ("Annual DR"),and one with an expanded summer commitment period ("Extended Summer DR") compared to PJM's traditional Limited Demand Resource product ("Limited DR"). According to PJM, the 2011 RPM capacity auction, the first two include the two new DR products, saw a 50% increase in the amount of demand resources that cleared over the prior year.

Consistent with its arguments in the FERC proceeding leading up to the new DR products, the Market Monitor recommends that PJM eliminate Extended Summer DR and Limited DR. The MMU contends that such "limited" products are inferior to the unlimited Annual DR product because they "distort capacity market outcomes" and pose a risk to system reliability. The MMU also recommends that PJM implement improved measurement and verification methods. According to the Market Report, DR resource credibility relies on the ability of DR programs to accurately quantify and compensate actual load reductions which in turn depends on the program's ability to establish what a customer's metered load would have been absent any load reduction.

Conclusion

While state-of-the-market reports are filed on an informational basis at FERC only, they provide a useful roadmap of potential market design and policy efforts. The MMU noted that PJM's markets still contain areas of market design that need further improvement in order to ensure that they continue to adapt successfully to changing conditions. In the advent of substantial retirement of generation in the PJM region, and the expression by states of reliability concerns therewith, the recommendation of a longer notice of generator deactivation and additional time to analyze adverse reliability impacts appears well-founded. However, the MMU's recommendation of making RMR service mandatory could prove quite controversial. If generators are required to continue operation, they could run the risk of contentious cost recovery proceedings at FERC and spark concerns regarding the environmental impacts of the continued operation of inefficient generator equipment. The Market Monitor's call to eliminate the two "limited" PJM DR products is premature at this stage from a regulatory/policy perspective. FERC recently reaffirmed the original Limited DR product and accepted the new Extended Summer DR just last year and they were successfully included in last year's RPM forward auction.

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