Federal Energy Regulatory Commissioners, grid operators, states and stakeholders continue to collide over what to do about the minimum offer price rule (MOPR) in wholesale capacity markets. In the PJM Interconnection, where the grid operator ran its first auction with the highly contentious expanded MOPR in effect to mitigate any resource receiving state-driven revenue, debate is intensifying over how to ensure strong competitive markets that foster innovation and reliability at least cost, while also facilitating state decarbonization and climate goals.

Debate about the MOPR has focused mainly on whether state policies that pay clean energy resources for an environmental attribute (including through renewable energy credits (RECs) and zero emission credits (ZECs)) have detrimental effects on the capacity market and if, when, and how FERC may mitigate the effect of those policies.

At one extreme, some stakeholders argue that state environmental and energy policies lead to buyer-side market power with uncompetitive effects, and so those effects must be mitigated by requiring benefiting resources to offer at a minimum price. At the other end, PJM and others argue that as long as state actions are not preempted (that is, they don't exceed state authority or conflict with the Federal Power Act), their effects on the markets are irrelevant and they should not trigger an offer floor.

But both sides miss the mark. State externality payments are not exercises of buyer-side market power; therefore, buyer-side market power cannot be a valid justification for mitigation of state policies. However, whether a state policy is preempted is a different question than whether that policy inefficiently distorts FERC-jurisdictional wholesale rates and can be mitigated — preemption is not the right test for deciding whether economic mitigation is appropriate.

Conflating these issues complicates the conversations among stakeholders. It creates confusion around if and when FERC can mitigate inefficient outcomes in wholesale markets.

So, it is time for ISOs/RTOs, the commission and stakeholders to have a frank discussion about the issues facing the market and options for dealing with those issues. Inaccurately claiming states are using generation-based externality payments to exercise buyer-side market power obscures the problem, and demanding a preemption-based test obscures the available solutions.

From a legal perspective, there is no question that state policies, like RECs and ZECs, are valid and not preempted by federal law. But legally valid policies can be uneconomic — even purely rent seeking — and so harmful to the efficiency of market outcomes. Take, for instance, a dirty energy credit that pays resources for polluting. If and when policies are adopted that harm the efficiency of market outcomes, FERC must have authority to take action to protect competitive markets and ensure just and reasonable rates.

Using a legal standard for preemption as the trigger for mitigating an economic problem is confusing and inappropriate. It also has the potential to create more problems. What happens when FERC, relying on the language in the Supreme Court's decision in Hughes v. Talen that invalidated a Maryland subsidy for natural gas plants, finds a policy is conditioned on capacity market clearance for the purposes of mitigation, but a federal court using the same standard finds the policy is not preempted? What happens to auction results and to resources that were incorrectly mitigated and prevented from clearing in the auction?

From an economic perspective, state externality payments tend to correct the inefficiencies in FERC-jurisdictional markets that are caused by greenhouse gas emissions and other pollutants, and hence improve the economic efficiency of the outcomes in FERC-jurisdictional markets. Therefore, for current state policies, economic efficiency concerns are not sufficient to justify mitigation.

Furthermore, regardless of how, or even if, generation-based payments like RECs and ZECs affect the capacity market, these policies are not exercises of buyer-side market power as many continue to assume. States' policies concern the purchase of environmental attributes, not capacity; their policies are simply not exercises of buyer-side market power in capacity markets. Therefore, market power concerns cannot justify mitigation either.

Instead, if FERC must mitigate the effect of state policies to protect competitive markets, it should do so using narrowly tailored rules and only where it has demonstrated with substantial evidence that the payment, when factored into an offer, harms the efficiency market. The Expanded MOPR never met either requirement and should be eliminated.

Going forward, FERC should be judicious when applying mitigation measures to state policies and should consider tools beyond the MOPR. Multiple tests are available to assess whether payments are increasing or threatening competition and economic efficiency. FERC should use them. Importantly, those tests are grounded in rigorous economic analysis, rather than rhetoric about state subsidies, buyer-side market power and preemption.

Conflating economic problems has led the commission to implement inappropriately broad rules without grounding its decisions in rigorous economic analysis. The Expanded MOPR was based on a faulty premise and unsupported by economic theory. Ending the snipe hunt for state exercises of market power in capacity markets is a critical first step toward empowering stakeholders to craft durable economic solutions that allow markets to work.