PJM Governance: Can Reforms Improve Outcomes?

Executive Summary

PJM Interconnection (PJM) enables dispatch and transmission of electric power to approximately 61 million people over 13 states and the District of Columbia. Much attention has been paid to the issues, decisions, and outcomes of PJM policy changes. Less attention has been paid to the process by which PJM, a Regional Transmission Organization (RTO), makes decisions about market design, rule changes, and stakeholder engagement, collectively referred to as governance.

Effective governance is a facet of RTO administration critical to navigating contemporary policy controversies and meaningful to maintaining the ongoing legitimacy of the RTO. PJM’s stakeholder system is remarkably effective when issues are less contentious. As can be expected, the system is less effective on the smaller volume of issues that are highly contentious. Contentious issues generally occur when financial stakes are high, when there are questions about allocation of costs and benefits among stakeholders, and when issues concerning the balance of power between stakeholder groups arise. In addition, state policy decisions have the potential to distort PJM markets, prompting the need for rule changes, and promoting stakeholder controversy from outside the governance process.

Since the last governance process revisions were completed in 2011, four significant factors have driven considerable changes to PJM’s market environment and architecture, including:

1. Growth of low priced natural gas and gas capacity resources
2. Capacity market design controversies and frequent changes
3. Flat load growth and increasing renewable energy supply mandates
4. Growth of financial transmission rights (FTR) trade volumes

These drivers of change place stress on the most challenging and controversial questions related to PJM stakeholder governance: financial stakes, balance of power, and allocation of financial costs and benefits. These drivers are also prompting the need to make changes to market design, triggering the obligation to involve stakeholders in policy proposal development and decision-making. However, the controversies are proving difficult to manage within the stakeholder system. For these high controversy issues, it seems the stakeholder process is falling short at exactly the time when stakeholder collaboration and joint problem solving is critical to informing profound questions about market design and the future of competitive markets.

For the stakeholder process, at least two questions arise in light of market changes and controversies:

1. Has the stakeholder system evolved along with the markets?
2. Would an improved stakeholder process result in more efficient and effective outcomes on high controversy issues?

Respectively, the answers are no, and potentially. But, the issues are much more related to concepts of “fairness” within the governance system and much less related to the nuts and bolts of process. System fairness – meaning avoiding bias towards one or more entities or sectors compared to others – is critical to fostering a governance system that has the potential to deliver solutions conducive to competition, rather than discrimination.

The Federal Energy Regulatory Commission (FERC) has provided for flexibility in RTO and Independent System Operators (ISOs) governance decisions, choosing to identify guiding principles rather than designing prescriptive actions. One such principle, related to “ongoing responsiveness” (FERC’s Order 719), requires RTO/ISOs to continually consider customer and other stakeholder needs over time as the market environment and architecture changes, and requires RTO/ISOs to continually examine responsiveness to stakeholder needs and evaluate the need for improvements.

Given profound and rapid market changes and the reality that self-interested stakeholders may be incapable of impartial governance reform, this paper argues FERC should require PJM to evaluate its governance system to ensure it is meeting good governance goals. These goals should include, but not be limited to, ensuring a fair system free from biases that serve to: advantage entities or organizations, discourage competition, and/or inhibit operational evolution.

Furthermore, FERC should consider requiring other RTO/ISO’s to periodically evaluate their stakeholder governance systems in order to identify if improvements are beneficial. Governance reforms may not be able to solve all the controversies and challenges facing RTOs, however, they have the potential to improve decision making outcomes.

Future evaluation and potential reform efforts should consider important information about the RTO’s organizational construct. The RTO is, among other things, a “quasi-governmental” organization. The growth of quasi-governmental organizations was a significant movement in public administration in the late 1980’s and early 90’s.

There is a deep body of research on quasigovernmental organizations—which display characteristics of government and private organizations—that well document the benefits and drawbacks of this organizational construct. With respect to drawbacks, quasi-governmental organizations raise complicated questions about accountability (e.g. political, stakeholder), as well as uncertainties about the ability to ensure public interests are being protected over private interests. The independent nature of the quasi-governmental organization and the RTO construct can give rise to other potential issues. For example, FERC requires RTOs to be independent from market participants, but in theory, the RTO is not immune from self-interested behaviors and organizational biases that may serve to benefit incumbent firms.

States have an incredible amount of influence over PJM markets and have the potential to play an important role in defining, representing, and protecting the public interest. Policy setting over a large geographic region presents challenges to regional markets, as states may have inconsistent or conflicting electricity sector priorities. Complicating this, injecting political values into decisions about market design has the potential to reduce efficient market outcomes.

Nonetheless, for better or for worse, FERC envisioned a role for stakeholders in policy design, and states have the right and ability to enact legally acceptable policy that impacts electricity markets. Failure to effectively incorporate and manage state-based political values with market design may lead to compromises that threaten the legitimacy of the RTO/ISO organization and its markets. For PJM, the question isn’t whether states should be more involved in the stakeholder process, but rather, what is the best method to enhance state involvement in PJM governance? For states, the question is, why aren’t you demanding greater involvement in the stakeholder system?

Four specific topics are presented to provide evidence that fairness and process issues do in fact exist within PJM’s stakeholder system. First, studies indicate that at high level stakeholder committees, market buyers frequently act to block proposals from being approved. Second, PJM Membership has grown by over 31 percent since the last stakeholder reforms were initiated. Most of this growth has occurred in two sectors where new market entrants often vote, raising concerns about inappropriate levels of intra-sector diversity, vote dilution and the ability for these new entrants to have a unique voice, all with the potential to reduce competition. Third, the process of member self-selection of voting sector has long presented opportunities for improvement. Fourth, lower-level committee voting is not transparent and simple majority voting results are not presented by sector, reducing the usefulness of information to higher level committees. It should be noted that some of these issues were identified during the 2009-2011 governance evaluation process, but stakeholder agreement on improvements were not reached.

Owing to fairness concerns raised while exploring the RTO’s organizational construct, the stakeholder process was examined for evidence of incumbentbias. This can be harmful, for example, as incumbent bias can serve to undermine competition from new market entrants. While a clear incumbent bias was not observed, there is evidence suggesting incumbent firms have an advantage in the stakeholder process. Large companies with multiple Affiliates have the ability to collaborate among business segments, using affiliate voting to block (or advance) proposals from reaching higher level committees.

The incumbent advantage is complicated by the concentration of resource ownership. In 2015, six PJM stakeholders in the Transmission Owner sector had ownership interest in non-renewable generation capacity representing over 50 percent of the installed capacity needed to meet PJM’s summer peak capacity. Lastly, participating in PJM’s numerous stakeholder processes requires significant resources—in the form of time, money, and technical expertise— disadvantaging smaller firms.

It should be noted that engaging stakeholders in a review and evaluation of governance processes is a first step in FERC’s potential governance action. The second step is identifying potential improvements. The final step should be negotiating details on improvements and voting to accept or reject such improvements, which may or may not be a requirement of the FERC order. Such periodic review (e.g. every five years, with triggers for more frequent review) could present FERC with a valuable body of evidence and information on the evolution of stakeholder-based governance issues and solutions, informing FERC’s thinking on future governance guidance.

Evaluation of the governance system could include, but should not be limited to, an examination of the items raised in this report, including the following structural and process issues:

Addressing Accountability and Public Interest Concerns of the Quasi-Government RTO. Determine how, when, and how often to define the “public interest” and identify who in the stakeholder process represents the public interest. Such a public interest can be broadly defined to include both buy and sell side interests as well as state-based political priorities. Specifically address the role of the states in defining, representing, and being accountable for protection of the public interest within the stakeholder process. Document the accountability mechanisms available to different stakeholder groups and identify how imbalances can impact outcomes and identify corrective measures, if needed.

Provide Options for Greater State Participation in the Stakeholder Process. States have changing political objectives and the ability to enact policies that can force decisions away from market efficiency and towards political priorities. Managing efficient market design over a large geographic region where states have ever-changing political values may create an unsolvable legitimacy problem for PJM. One potential strategy to help address this problem would be to increase state policy maker involvement within PJM’s stakeholder process when issues are contentious. More research is needed to determine the optimal method to more intimately involve states in the stakeholder process, as the traditional Member-based approach of sector-weighted voting may not be the best solution.

Evaluate Power Balance Dynamics in the Stakeholder Process. The balance of power between Member sectors in PJM has resulted in a portfolio of reasonably expected tensions—given the different goals of each respective group. It is unclear whether differences in the balance of power have resulted in inappropriate advantages or disadvantages in the stakeholder process. Currently available tools to analyze fairness and power dynamics in multi-stakeholder processes should be explored to determine appropriateness for use in the RTO context. Power dynamics should be assessed and documented, and corrective measures developed, if necessary.

Ensuring a Best-in-Class Administrator. While it is important to ensure the RTO is independent from any market participant, recognition should be given to the potential for RTO’s to display self-interested behaviors and organizational biases that may benefit or harm certain stakeholder groups, inhibit competition, or lead to other unintended consequences. It should be determined if appropriate procedures are in place to acknowledge, evaluate, monitor, and correct for organizational biases or self-interested behaviors of the RTO that create preferences or prejudices.

Review Governance Issues Identified. Examine PJM’s Membership and determine if the current five stakeholder sectors accurately and optimally reflect the diversity of PJM’s Members. Any expansion of Member sectors would require discussion of how to adjust sector-weighted voting. Evaluate the sector-self selection process and determine if improvements can be made. Examine and document the benefits and drawbacks of the current non-transparent approach to lower-level voting.

Review Evidence of Potential Incumbent Advantage. Issues identified include: proposal agenda setting (i.e. control) through affiliate voting from large incumbent firms, concentration of resource ownership in a small set of incumbent firms, and the resource burdens (e.g. time, money and technical expertise) to participate in the stakeholder process that may disadvantage smaller non-incumbents. Identify if any of these issues create inappropriate power balance dynamics, inhibit competition, or result in other negative outcomes. Alternatively, justification for such advantage could also be provided.

It is important to reiterate governance reforms cannot fix all the challenges facing PJM and other RTO/ISOs. However, improvements to the process have at least the potential to lead to improved outcomes and greater stakeholder negotiation and joint problem solving. Though governance reforms may prove to be complex and time consuming, reform efforts may prove beneficial to markets, market participants, consumers, and the states over which they operate. PJM is a leader among its peers – from stakeholder engagement to market operations – making it uniquely positioned to advance the evolving field of RTO/ISO governance.

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This report was made possible solely by funding from the Kleinman Center for Energy Policy at the University of Pennsylvania. The author would like to thank the numerous stakeholders that contributed their time and perspectives to this effort, as well as the expert and academic reviewers that helped to improve and refine this work.

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