States' Rights, Gamed Markets

Citing what it called “mounting evidence of risk” that PJM’s RPM capacity market could indeed “be gamed,” the Federal Energy Regulatory Commission (FERC) last week OK’d most of the tariff amendments PJM had proposed to correct flaws in its Minimum Offer Price Rule (MOPR), which allows the grid operator to mitigate or predatory, below-cost bids by suppliers who would sell generating capacity into the region.

But while FERC may have averted any danger that low-ball bidding could manipulate or distort prices in PJM’s upcoming May 2011 Base Residual Auction, to procure new generating capacity for delivery three years out, FERC perhaps has left questions unanswered on how best to reconcile federally regulated power markets with the legitimate interest of state regulators or legislators in seeking to favor certain energy resources or technologies, or in dictating how the state and its utilities should develop new generation, meet resource adequacy needs, or address long-term economic or policy goals.

In short, the commission’s ruling seems to say that states remain legally and constitutionally free to interfere with RTO capacity markets, yet if they dare to dabble, FERC will go after them with a heavy hand.

‘Dumping’ for Dollars

The case had attracted wide notice around the country, as it had concerned a law enacted recently in New Jersey that appeared to be aimed directly at manipulating or at least undercutting prices set by competitive auction in PJM’s bid-based capacity market, known as the Reliability Pricing Model (RPM). That law, plus a threatened regulatory action in Maryland, had sought to remedy concerns in those two states that the RPM market was imposing high costs on local ratepayers.

The New Jersey law, for example, had sought to mandate development of new, in-state generating plants that would then bid into the RPM Base Residual Auction (BRA) at seemingly uneconomic, below-cost levels. As a result, this “out-of-market” capacity would bring down the market clearing price artificially, and earn savings for in-state ratepayers.

In fact, the New Jersey law had represented a real threat to PJM’s RPM construct. As originally designed, the RPM market and its Minimum Offer Price Rule were designed to block low-ball bids. Yet the old MOPR provision had contained a loop-hole that exempted state-sponsored generation development aimed at resolving a projected capacity shortfall.

PJM had carved out that exception in recognition that, despite the infl uence of federally regulated regional power markets, state regulators retain a legitimate interest in shaping the in-state power industry —and especially generation. Yet PJM probably never dreamed that New Jersey legislators would someday use this exemption to engage in legally permissible state-sponsored market price manipulation.

Tabbed as “capacity dumping,” the strategy was described in detail an article that appeared recently in Public Utilities Fortnightly, which cited evidence from PJM’s Independent Market Monitor that low-ball bidding under the New Jersey law could cost power producers $500 million or more each year in lost capacity revenues. (“Capacity Contest: Raising the Stakes in RTO Markets,” by Michael T. Burr, February 2011, p. 24.)

In particular, the Fortnightly article had cited comments from Maryland Gov. Martin O’Malley that faulted PJM’s RPM market as “a perverse system of capacity charges [that] has added hundreds of dollars to residential bills with little benefit.”

In fact, back in March the Maryland Public Service Commission had filed a motion with FERC asking Commissioner Philip Moeller to recuse himself from the case, after reading reports in the trade press in late January that had quoted Moeller that the New Jersey law (then a bill awaiting the Governor’s signature) would “crater the capacity market,” and that FERC’s attempt to resolve the issue would, as Moeller again was quoted, make for “very good theater.”

In fact, it was not until April 11, the day before FERC’s ruling came out, that Moeller announced he would participate on the case. Only a week earlier Moeller had received an advisory opinion from FERC’s alternate designated agency ethics official, that his comments should not be seen as prejudicial.

The Ruling

In its ruling, FERC agreed to fix the MOPR to improve market monitoring oversight for bids submitted in the PJM capacity auctions. In doing so, FERC OK’d a number tariff changes how PJM now may conduct capacity auctions, determine proper estimates of capacity costs, and scrutinize and mitigate bids in correcting for market manipulation and below-cost bidding. Here is a partial list of some of the approved rule changes.

CONE Values. The new rules now will set Cost of New Entry (CONE) for new combined-cycle (CC) and simple-cycle (CT) proxy gas turbine units in the same way for monitoring low-ball bidding, as is done to set the actual clearing price, using the VRR (Variable Resource Requirement), as the RPM sloping demand curve is known. That is, the CONE value used to set the minimum bid fl oor now will be updated periodically with regular, automatic and location-specifi c cost-indexing adjustments for construction costs. In a similar way, the net CONE value for bid-floor purposes also will reflect the same EAS offset (to account for revenues earned in energy and ancillary services markets) as is now applied to the CONE value in the VRR curve that sets the clearing price. These changes generally will tend to raise the estimated nominal cost of new capacity, which should have the effect of increasing the minimum supplier bid floor allowed in the capacity auction.

Conduct Test. The MOPR threshold for flagging below-cost bids for cost review will be raised from 80% to 90% of net CONE, for the CC and CT asset classes, thus increasing the likelihood that the low-ball bids will be reviewed and mitigated.

Impact Test. This test now will be eliminated, so that so that PJM will be able by rule to review and mitigate bids below-cost bids without any required showing whether the bids would exert any particular minimum impact on clearing prices.

Net Short Test. This test is also eliminated. Previously, under the “net short” rule, the price floor was invoked only if the bidder offering generation into the market was in fact “net short” in the market — i.e., buying more capacity than it was selling. The purpose was to prevent a net buyer from taking a small loss in selling a small amount of below-cost capacity, in order to reap big savings from a lower capacity price for a greater volume of purchases. But problems came when the New Jersey law was aimed to reward certain power producers for submitting below-cost bids — generators who were not buyers, and so were not “net short” in the market, and so would escape the bid floor entirely. PJM stakeholders probably never anticipated such a situation. In any case, the elimination of the “net short” rule aligns PJM’s RPM with the installed capacity (ICAP) market in the New York ISO, for which the FERC eliminated a simlar restrictive requirement in a 2008 ruling.

Zero-Price Bids. Finally, the FERC ruling adds wind & solar units to the list of generating resources (nuclear, coal-fired, and IGCC — Integrated Gasification Combined-Cycle) that already are allowed to submit zero-cost bids into the RPM auction.

A Questionable Impact

FERC’s ruling, while no doubt welcome to PJM and most market players, nevertheless seems to leave some questions unanswered regarding the exact boundary between the FERC-regulated wholesale power markets, and legitimate state interests.

As it happens, PJM’s old MOPR bid floor rule had exempted state initiatives from price mitigation review if the state program had been designed to fix an anticipated capacity shortfall. In fact, that was a key loophole that had allowed New Jersey to enact a law to inject low-cost power into the market to manipulate the price.

Seeking to close that loophole, PJM in its new tariff had proposed to exempt state-mandates, even if designed to further “a specific legitimate state objective,” but only if the bid offer also would not would produce “artificially depressed capacity prices,” and would not “directly and adversely impact [FERC’s] ability to set just and reasonable rates for capacity sales.”

On review, this new tariff language proposed by PJM was rejected, but FERC curiously offered nothing to take its place.

As FERC explained, PJM’s proposed new tariff language was overbroad, as it only memorialized powers that state policymakers already enjoyed — including the statutory right to develop generation resources and manage resource adequacy for in-state utilities and ratepayers. Thus, in FERC’s view, any attempt by PJM to dictate what sort of state initiatives on generation resources that an RTO would abide would obviously run counter to federalism and constitutional separations of powers.

Nevertheless, on this question FERC made no other attempt to craft new tariff language to deal with the issue, and essentially took a pass. It found PJM’s current tariff was unworkable, but yet struck down PJM’s attempt to fix the problem, and offered no alternative tariff language of its own.

Thus, FERC was left walking a very fine line. On one hand, FERC appears to concede that states remain exempt from PJM review under the bid-fl oor rule. Yet, on the other hand, FERC threatens to act if states should take advantage of their lawful exemption.

Here, to erase any doubt, is FERC’s precise language:

“While the commission acknowledges the rights of states to pursue legitimate policy interests, and while, as we have said, any state is free to seek an exemption from the MOPR … [yet] because below-cost entry suppresses capacity prices … we are statutorily mandated to protect the RPM against the effects of such entry.”

And if you can figure out what this paragraph means, you might well consider yourself a seasoned power market player.

ABOUT THE AUTHOR: Bruce W. Radford is publisher of Public Utilities Fortnightly.