A recent order by the Federal Energy Regulatory Commission (FERC) tees up two starkly different potential outcomes: one that protects consumers and state authority over energy policy, and one that could unnecessarily add billions of dollars to customers' utility bills and frustrate the ability of 13 mid-Atlantic states and the District of Columbia to control the power supply mix serving customers within their borders.

We disagree with the premise of the commission's order, but agree that a workable outcome can be achieved if FERC and the states work together to implement the order in a reasonable manner.  

FERC's June order incorrectly found that state climate policies artificially distort the capacity market for the PJM region serving 65 million customers. To address this perceived distortion, FERC's order called for PJM to impose a Minimum Offer Price Rule (MOPR) that could block energy resources supported by those policies from selling capacity (which is a future promise to provide power when needed) in PJM's market.

But along with its decision to impose a MOPR on state-supported capacity resources, mainly renewable and nuclear, FERC also suggested that it may establish an alternate means to ensure that the capacity value of those resources is not ignored.

FERC must follow through on this plan because if it fails to do so, customers could be forced to spend billions on redundant capacity from other resources that aren't needed to support the reliability of the electric system. Stakeholders need to make their voices heard — loudly and before October 2 — the deadline for comments on FERC's implementation of its order.

FERC's order "preliminarily found" that PJM must enable an alternative path for state-supported resources to receive credit for their capacity contributions to the system, even if they are not permitted to sell capacity in PJM's organized capacity market. FERC terms this alternative path the "resource specific FRR Alternative option," which we abbreviate as "FRR-RS" for Fixed Resource Requirement - Resource Specific.

Many questions about FRR-RS remain, as FERC's order gives only a basic outline for how it might operate and only tentatively commits to following through with a solution. States, consumer advocates, utilities and other energy customers must strongly urge FERC to follow through on its FRR-RS plan in a way that allows states and customers to take full advantage of the capacity offered by state-supported resources.

Background on PJM's capacity market

PJM is the nation's largest grid operator and accounts for about one-fifth of the nation's total electricity consumption. FERC- and PJM-related charges generally account for a very significant portion of an end-use customer's bill.

In addition to operating a market for electric energy, PJM runs a capacity market, which compensates suppliers for being available to provide energy when called upon by the grid operator during times, like hot summer days or winter cold snaps, when the electric grid is under maximum stress.  

PJM holds capacity auctions every year, which seek to procure the lowest-cost set of capacity resources to meet a given level of demand forecasted for three years in the future based on sales offers submitted by potential suppliers.

PJM selects the cheapest sources of capacity needed to meet this demand, and the winning suppliers are compensated at a rate equal to the offer submitted by the most expensive supplier needed to meet demand, as shown in the simplified example below:  

Resources that clear the auction receive a capacity payment in exchange for being available during the commitment period. (If it is not available, there's a penalty.) Such capacity payments can be the difference between a resource continuing to operate or shutting down.

State energy policy authority must be preserved

Without FRR-RS, FERC's order threatens to force PJM customers to buy more capacity than necessary and frustrate state energy policy authority

For decades, states in the PJM region have sought to shape the power supply mix serving their customers through policies such as renewable portfolio standards (RPS), which mandate that a certain percentage of the state's load be serviced by renewable resources.

States advance a cleaner resource mix by promoting renewables, energy efficiency and clean demand response (supplying capacity by reducing usage during critical times) in their role as environmental regulators to protect their residents from harmful pollution that causes serious health problems and climate change.

In recent years, some states have expanded their RPS programs. A few states have begun to offer payments to nuclear generators for the emissions-free value of their electricity (sometimes called zero-emission credits) and/or designed policies to foster nascent markets for offshore wind and energy storage technologies.

These policies are an attempt to correct a basic wholesale market deficiency: energy and capacity prices paid to generators in PJM's markets fail to reflect the significant environmental benefits these resources create by displacing more polluting forms of generation. That's because those markets sell exclusively the commodity value of the power supply, without regard to any environmental or other beneficial attributes. 

Prior to FERC's order, when a PJM capacity supplier also earned revenue under a state energy policy that compensates it for avoided emissions, that enabled it to offer its capacity more cheaply into the PJM market — often displacing dirtier resources.

State climate policies enhance rather than detract from market efficiency, as explained by scholars at the Institute for Policy Integrity in this capacity markets report.

To the extent that state policies yield a lower capacity price, such a price is appropriate because less capacity is necessary from non-state supported resources to meet regional demand. Prior to FERC's order, PJM's capacity market design naturally ensured that state policies could be pursued without compromising the system's ability to maintain adequate resources to prevent blackouts.

FERC's order disagreed, finding that certain state programs (the exact scope of which is left unspecified) cause "unreasonable price distortions" that threaten the "integrity of the capacity market."

FERC told PJM to apply a Minimum Offer Price Rule, which would require affected suppliers to offer into the capacity market at prices at least as high as FERC's estimate of the cost of supply from those resources without factoring in revenue earned pursuant to state policies.

In the likely event that this minimum offer price is higher than the offers of other suppliers, the affected resources will not be selected by PJM. And if these resources continue to operate pursuant to state policies, customers could be forced to buy more capacity than needed to support system reliability.

Applying the MOPR without further adjustments would effectively provide a large subsidy to capacity suppliers not supported by state policies. The costs would be enormous, but because FERC's order leaves the MOPR scope unclear, the precise costs are difficult to estimate.

If the MOPR blocks PJM capacity market access for state-supported renewable and nuclear resources without offering an alternative path to account for their contribution to system reliability, Michael Goggin from Grid Strategies LLC estimates the cost to consumers could total nearly $25 billion.

FRR-RS could protect customers from being overcharged for capacity

Fortunately, FERC's order offered FRR-RS as a potential path to fix this problem.

Recognizing that applying the MOPR could force customers to "pay for capacity both through the state programs . . . and through the [PJM capacity] market," the commission suggested FRR-RS to provide an alternate route for crediting the capacity contributions of state-supported resources. Under FRR-RS, state-supported resources would not sell capacity in PJM's organized market, but rather would enter into separate arrangements to allocate their capacity to customers.

Critically, capacity purchase obligations in the organized PJM capacity market would be reduced according to the amount of capacity supply obtained through FRR-RS. Thus, in the simplified example, if capacity supplier E participated in the FRR-RS program, customers would only need to pay for capacity from capacity suppliers A-C through the PJM market, avoiding the need to purchase from capacity supplier D.

However, FRR-RS is not a foregone conclusion.

Even if FERC pursues it, states and customers won't be able to utilize FRR-RS unless it is designed well. Flaws in program implementation details like the process for a supplier to opt into FRR-RS or the manner in which FRR-RS resources are credited for their capacity could prevent the program from realizing its full potential, yielding costly outcomes for customers.

For example, in a presentation previewing its proposed approach to FRR-RS, PJM suggested that it might advocate for giving FRR-RS resources less than full credit for their capacity. Other stakeholders have suggested a cap on the amount of capacity that may elect to participate in FRR-RS. Such proposals would frustrate the ability of FRR-RS to protect customers.

Further, FERC faces a difficult timeline in implementing FRR-RS. Filling in all of the details as to how FRR-RS will work such that it can be fully utilized before PJM's next capacity auction in August 2019 will be difficult if not impossible, so FERC should delay implementing the MOPR to provide a smooth transition to FRR-RS.

In our view, the best approach would be for FERC to reverse its decision to expand the MOPR to state-supported resources.

At minimum, it should refrain from applying the MOPR to state programs like renewable portfolio standards that select winners through a competitive process. Such programs enhance competition in the PJM market and improve market efficiency.

A large number of stakeholders, including the Organization of PJM States (voting unanimously with one abstention), have asked FERC to reconsider its decision to set aside PJM's current rules and replace them with this uncertain construct. Other parties urging FERC to reconsider its decision include clean energy advocates, consumer advocates, commercial and industrial customers, public power, clean energy industry groups and various power companies.

Absent such a reversal, stakeholders, and especially states, must weigh in to ensure that FERC:

1. Follows through with implementing FRR-RS in a way that allows utilities and other capacity customers to buy capacity from all state-supported resources.

2. Designs the FRR-RS to provide maximum flexibility for matching capacity customers with state-supported renewable and nuclear resources; and

3. Allows for a smooth transition by postponing implementation of the MOPR until the May 2020 PJM capacity auction. This delay will give states and utilities time to understand the new rules and clarify state law as needed to take full advantage of the resource-specific FRR-RS. FERC must not change the MOPR until the regulatory framework for the FRR-RS is in place. Otherwise, capacity market prices will skyrocket and customers and the environment will suffer.

Comments to FERC on the scope of the MOPR and FRR-RS design are due October 2, with an opportunity to reply in November.

A wide variety of groups already plan to weigh in. NRDC, Sierra Club, Citizens Utility Board of Illinois, the District of Columbia Office of the People's Counsel, Exelon Corporation, the American Council on Renewable Energy, and a growing list of stakeholders have agreed to a more detailed set of shared principles for implementing FRR-RS in a manner that is workable for states and customers.

States should support these principles to protect their authority to adopt energy policies and to protect their customers from unnecessary capacity charges.