PJM members may consider changing the rules of the PJM capacity market to eliminate arbitrage opportunities between the Base Residual and Incremental auctions.

The Market Implementation Committee voted March 6 to endorse a problem statement, sponsored by David Pratzon on behalf of Calpine and LS Power, to consider changes.

Because clearing prices in Incremental Auctions (IAs) are usually lower than those in the Base Residual Auction (BRA), participants can profit by over-committing in the BRA and buying out their commitments in the IAs.

Monitor’s Report

The Market Monitor reported in December a substantial level of buy outs of BRA positions through IAs and other replacement mechanisms. The monitor said such buyouts could undermine system reliability and suppress the price of other capacity resources – a particular concern of the PJM Power Providers (P3), a group of generation owners that requested that the Monitor study the issue. Although the P3 group asked for a study of only Demand Response (DR) providers’ behavior, the Monitor broadened the study to include all capacity resources.

Since the 2009/2010 delivery year, the Monitor found, DR resources were far more likely than generators to replace BRA capacity. DR replacements jumped in 2009, when the formula for computing penalties was changed and reduced deficiency charges. It fell in 2012 with the elimination of the interruptible load product. (See chart.)

FERC Order

About 40% of DR replacement megawatts for the 2012/2013 Delivery Year came from the selling company’s portfolio, suggesting that it was a result of a 2012 FERC order changing measurement and verification methods. Excluding that, replacement capacity represented about 27% of cleared DR capacity, still much higher than that for generation.

In 2012, only seven generation companies, 7% of the total, replaced 50% or more of their commitments. Six DR companies, 13% of the total, replaced half or more of their commitments. In all years studied, more than half of DR replacement capacity came from incremental auctions.

No Evidence

Although the Monitor reported that two DR providers replaced 100% of their BRA capacity in each of the last three years, it said it had no evidence that any CSPs are “are purely financial entities … with no intention of providing a physical resource.”

Capacity market rules do not require sellers to identify the reasons for purchasing replacement capacity. The Monitor noted that while generation has a lead time about equal to the three-year horizon of RPM auctions, DR providers do not receive commitments from new customers until much closer to the delivery year.

Premature

John Farber, public utilities analyst for the Delaware Public Service Commission, said the problem statement “is at best premature” given other changes PJM is considering through its DR Plan Enhancements initiative to address potential abuse.

James Wilson, an economist who represents consumer advocates in several states, said PJM should not make changes that could hurt market efficiency. The Monitor’s report “identified a phenomenon not a problem,” he said.

Scope Too Narrow

Others said the scope of the inquiry was too narrow and should be broadened to include possible market design flaws. “Why are generators willing to accept much lower prices in the IA than BRA? Why is that?” asked Bruce Campbell, director of regulatory affairs for
EnergyConnect, Inc.

Pratzon said the inquiry will not focus on bidders’ intent but on the economic consequences of the buybacks. Although buy outs have not resulted in reliability deficiencies to date, Pratzon said the current capacity surplus could disappear as a result of generator retirements and load growth.

The problem statement was approved with nine objections and 36 abstentions.