Why FERC’s PJM Capacity Market Order Could Herald Carbon Pricing

Political cartoon
Image courtesy of Lee P. Sauer
July 12, 2018

Understanding the very basics of FERC recent order on state policy and PJM capacity market redesign, it’s not hard to fathom an unintended consequence – renewed state interest in carbon pricing.

States will pay more. FERC’s order as proposed will require mitigation for all state-subsidized resource bids in the capacity market (e.g. from renewable energy supported by renewable portfolio standard policy, through zero emission credit subsidies for existing nuclear units), either through imposition of a minimum offer price rule (MOPR) or by removing the resource and a corresponding amount of load from the capacity market via a modified fixed resource requirement alternative (FRRA).

This means instead of paying incremental costs to support preferred resources – as is done now via RPS and ZECs – states may soon have to shoulder much higher costs. For nuclear, states will be paying much more, while the cost increase to support renewables will be moderate since these projects aren’t as financially reliant on the capacity market.

For the MOPR, states will have to pay the cost of the subsidy, plus higher capacity prices that result from mitigating the subsidy. Worse yet, the MOPR could result in the subsidized facility failing to clear the auction, frustrating the intent of state policymakers.

For the FRRA, it is even more complicated. The state will have to support the entire capacity cost of the resource, not just the incremental cost of the subsidy. Perhaps something closer to cost-of-service rates. In addition, the state will have to figure out how to remove a comparable amount of load from the capacity market and apportion costs appropriately.  The mechanism by which a restructured state accomplishes this is completely unknown and unestablished, and in my mind will likely require new state statutory authority.

De facto re-regulation of the market. Not only is FERC’s order likely to increase costs to states, some suggest the FRRA option could snowball and lead to the unraveling of competitive capacity markets.

The theory is the FRRA option could enable states to support not just renewables and nuclear, but could also prove to be an attractive option to build other preferred resources – like coal or gas plants – on a rate-regulated basis, without having to go through the headache of passing laws to re-regulate.

The result would be ever-shrinking demand met by competitive resources, reduced merchant investment, and the eventual end of the capacity market.

Markets are still the answer. The intent of FERC’s proposal is to protect markets and comport with cost causation – in this case, meaning the state that causes the cost, bears the cost – both goals I support. However, the proposed solution is complicated, costly, and likely to be very unpopular with the states.

In fact, some states may get so frustrated they may pursue returning to cost-of-service regulation.  But, remember the problems facing PJM markets today are related to competitive prices being low, and losers getting upset.

Yes, there are certainly shortcomings with market design that fails to price externalities. But, there are also many, many issues with cost-of-service regulation…namely higher costs and risks for consumers associated with sub-optimal choice and operation of resources.

So, isn’t there a simpler, cheaper, and more efficient alternative to FERC’s proposal that would maintain competitive markets, enable state policy, and keep costs and risks low for consumers?

Carbon pricing’s resurrection? I know, I know…I’d be the first one to raise my hand and say putting a price on carbon in PJM is politically impossible. But, FERC’s order drastically changes the political calculus.

A carbon price in the energy market is consistent with competitive market fundamentals and is a proven and widely used mechanism that is well understood (as opposed to FERC’s modified FRRA proposal).

Carbon pricing will likely be lower-cost for consumers than the MOPR or FRRA proposals (though more details and analysis are needed to support this theorem). In addition, carbon pricing will improve revenue adequacy for generators that remain in the market by raising the marginal price.

How can carbon pricing theoretically be cheaper for customers and better for generators? Three words…simple, transparent, & efficient.

Replies to FERC. I suspect there will be significant push back on FERC, both to the substance and timeframe of its order. And this is appropriate. What may also be appropriate are proposals for more efficient market-based solutions, like carbon pricing. FERC could inform critical uncertainties regarding internal and external RTO leakage, the minimum requirements for state authorization to establish a carbon price, and other critical questions.

While hard to imagine given today’s political environment, I think carbon pricing’s stock just went up.

States take heed.

 

 

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