By Rich Heidorn Jr.

Washington, DC (March 14, 2013) – Market Monitor Joseph Bowring released the 2012 State of the Markets report with a call for changes to the capacity market, demand response and operating reserves.

The report showed that average LMP prices fell 23% to $48.55, the lowest levels in more than a decade, as energy demand remained modest and cheap coal was displaced by even cheaper natural gas. Capacity prices fell 37% while congestion costs dropped by nearly half. Peak load dropped 2.3% from 2011 (a 5.7% drop if load from the Duke Energy Ohio/Kentucky transmission zone, which joined PJM in the first quarter of 2012, is excluded).

“It was a very favorable year for prices but there’s no reason to expect that dynamic to continue,” Bowring said at a news conference at which he summarized the 499-page report.

While energy and capacity prices were down, transmission service charges increased 17% and day-ahead operating reserve charges jumped 90%.

Recommendations Repeated

For those who have read previous editions, this one will no doubt be familiar. Bowring estimated two-thirds of his 58 recommendations were repeated from last year’s report.  The capacity market, operating reserves and demand response accounted for more than two-thirds of the monitor’s proposed reforms.

As in 2011, the monitor continued to find all but one of PJM’s markets competitive in performance if not in structure.

The regulation market, which failed in 2011 also was judged not competitive in 2012, although it received an “indeterminate” grade for the fourth quarter.  The market structure was judged not competitive for the year because at least one pivotal supplier failed the three pivotal supplier (TPS) test in 43% of the hours in 2012. The market performance was judged not competitive in the first three quarters,  despite competitive participant behavior, because the calculation of the opportunity costs resulted in prices greater than the competitive price in some hours and less than the competitive price in others.

The monitor said it was too soon to determine the impact of a new market design introduced in the fourth quarter. Parts of the design remain to be decided by FERC.

Generation Shifts

Coal-fired generation dropped 7.4%, with coal’s market share falling to 42%.  Natural gas made up the slack, with a nearly 40% jump in generation pushing it to nearly 19% market share. Combined cycle plants are increasingly called on as baseload resources, Bowring said.

Wind generation increased by nearly 15% and solar power output quadrupled but they remained small contributors (1.6% and less than 1%, respectively). Nuclear power’s share remained virtually unchanged with a 35% share.

The shift from coal to gas contributed to a 47% drop in congestion costs, to $529 million versus nearly $1 billion in 2011. Congestion costs also were reduced by revenues from Auction Revenue Rights and Financial Transmission Rights, which offset more than 80% percent of congestion costs for the year.

The monitor’s analysis identified 3,725 MW of generation at risk of retirement because of their inability to cover avoidable costs from total market revenues. This is in addition to 21,000 MW already forecast to retire. Still, coal’s market share “won’t go dramatically lower than” 40%, Bowring said.

Operating Reserves

Operating reserve charges in the day-ahead market spiked dramatically in September, resulting in an 87% increase in total charges for the year. The increase resulted after PJM increased the number of “must run” units in the Day-Ahead Energy Market because the units were regularly needed for reliability in real time.

Bowring made a dozen recommendations to address the issue, noting that the charges are not subject to competition, and cannot be hedged against. The charges were paid to a small number of units, with the top 10 units, representing less than 1% of PJM’s generator fleet, receiving 23% of credits and the top 10 organizations collecting almost 82% of the total.

The monitor said PJM needs to be more precise in defining why it pays operating reserves. “The goal should be to have dispatcher decisions reflected in transparent market outcomes to the maximum extent possible and to minimize the level and rate of operating reserve charges,” the report said.

The monitor also called for a review of the allocation of operating reserve charges to ensure that such charges are paid by all responsible for incurring the charges, including those participants using up-to congestion (UTC) transactions. PJM’s deviation rate for the year would have been reduced by 59% if up-to congestion transactions had been included in the calculation of operating reserve charges, the report said.

Summary of Recommendations

Capacity market

• Eliminate 2.5% demand reduction.
• Eliminate limited and summer unlimited products.
• Improve performance incentives.
• Eliminate OMC outages.
• Require same modeling assumptions for all MOPR projects.

Energy market

• Eliminate FMU/AU adders.

Operating reserves

• Improve process of identifying reasons for paying credits and allocating charges.
• Use operating schedule to calculate energy LOC.
• Treat start up and no load costs as costs.
• Require up to congestion transactions to pay operating reserve charges, after analysis.

 Demand response

• DR should be classified as economic and not emergency program.
• Improve measurement and verification and compliance reporting.

Planning

• Remove projects from the queue if not viable.

Ancillary

• Implement consistent treatment of marginal benefits factor in the Regulation Market.
• Use operating schedule to calculate LOC.

Transactions

• Require UTC to pay a fee during evaluation of operating reserves issues.
• Implement rules to prevent sham scheduling.

FTRs

• Correct the reporting of payout ratio.
• Eliminate portfolio netting.
• Ensure symmetric treatment of counter flow FTRs for payout.