By Rich Heidorn Jr. and Ted Caddell

Exelon shareholders shed no tears last week over the news that five of the company’s nuclear units failed to clear PJM’s base residual auction.

In fact, analysts say the company will earn almost $150 million more in capacity revenue from planning year 2017/18 than it would have if all of the company’s capacity had cleared: The additional supply would have reduced the clearing prices.

Exelon confirmed that its Oyster Creek plant in New Jersey, as well as Byron Units 1 and 2 and Quad Cities Units 1 and 2 in Illinois, failed to clear the auction. Other plants that may not have cleared include two NRG coal-fired plants in Maryland, Chalk Point and Dickerson. (See related story, Capacity Results: Who’s in, Who’s Out?)

Prices cleared at $120/MW-day for most of PJM, doubling the RTO-wide clearing price of $59 for planning year 2016/17. Other owners of generation within PJM also benefited from the higher capacity prices, as total capacity revenues will increase from about $3.6 billion in 2016/17 to $7.3 billion in 2017/18.

Investors responded by bidding up shares of Exelon, FirstEnergy, PPL and NRG Energy by more than 5% last week, with Exelon leading the pack with a gain of 7.85%.

Meanwhile, the failure of Exelon’s nuclear plants to clear allows the company to continue making its case for changes to the capacity market rules that would benefit nuclear plants. FERC and PJM officials have indicated support for a “firm-fuel premium” or “clean” energy portfolio standards to ensure nuclear plants’ continued operation.

As the nation’s largest nuclear operator, Exelon is arguably better positioned than any company to capitalize on the carbon emission rules proposed yesterday by the EPA. The new rules seek to reduce U.S. greenhouse gas emissions by 30% from 2005 levels by 2030 — a target that would be much more difficult, if not impossible, to meet if the U.S. loses a substantial portion of its nuclear fleet, the largest carbon-free source of baseload capacity. (See related story, Carbon Rule Falls Unevenly on PJM States.)

“You can’t maintain the current emission level unless you keep the nuclear units viable today. And you surely can’t reduce if you start taking them off,” Exelon CEO Chris Crane told the Sanford C. Bernstein Strategic Decisions Conference last week. “So we think we’re uniquely positioned to be able to … work through a state-level design that will compensate the assets adequately” for their contributions to fuel-secure capacity and carbon reductions, Crane said.

A Good Quarter

Exelon shareholders have had a rough few years.

The company cut its dividend by 41% last year as its share price, which peaked at $90 in 2008, fell below $30.

But things have brightened considerably since January, when energy prices and demand spiked during the frigid winter. The company reported first-quarter earnings of $90 million, versus a loss of $4 million for the same period last year. Revenue rose to $7.24 billion, from $6.08 billion. Electric futures prices at PJM-West Hub are up by about 25% since November.

In addition, fuel supply problems that hampered production from coal- and gas-fired generators have PJM and Federal Energy Regulatory Commission officials talking about the possibility of adding a “fuel security” premium to the capacity market that would benefit nuclear generators.

FERC officials last week also talked about states supporting nuclear plants through “clean” energy portfolio standards similar to those that have supported renewable power. (See related story, ‘Clean’ Energy Portfolios Could Save Nukes, FERC tells NRC)

Hitting the Sweet Spot

As for the capacity auction, Exelon couldn’t have played its hand any better, said analysts from UBS Securities.

UBS said Exelon’s ideal strategy was to “withhold” 4,457 MW of its 25,000 MW PJM fleet — almost exactly the 4,225 MW of capacity that failed to clear. UBS Securities calculated that Exelon will earn $148 million more in capacity revenues in 2017 than it would have earned had all of its capacity cleared.

Eliminating 4,457 MW reduces daily revenue by $267,000 but increases clearing prices by $33/MW-day, UBS said. With the higher clearing price, the remaining 20,543 MW fleet earns $148 million more in revenue than had the entire portfolio cleared at the lower price. (See graphic.)

Utility rate analyst Paul Chernick agreed with UBS’ math. “If you had another 4,000 MW in there at the prices they must have bid in, it would have almost certainly pushed it below the $70 level,” said Chernick, president of Resource Insight Inc., a Massachusetts consulting firm whose clients include the Maryland Office of People’s Counsel.

UBS said Exelon’s “maximum benefit can be obtained by withholding just enough supply to drive prices received for the remaining fleet up without eliminating too much revenue and reducing the overall benefit.

“Given that only a relatively small portion of the fleet is required to be withheld for maximum benefit, we would conclude that [Exelon], at any rate, has more than adequate market power to drive auction results through an aggressive bidding strategy,” UBS said.

UBS analysts calculated the revenue gains from “hypothetical withholding scenarios,” hastening to add “we do not intend to imply that this behavior took place as described.”

Indeed, refusing to bid the plants into the auction would violate PJM rules and likely federal antitrust law. But with new PJM rules limiting imports and demand response, and with economics and the EPA’s Mercury and Air Toxics Rules forcing as much as 14 GW of PJM coal capacity into retirement, Exelon felt confident in offering its nuclear plants at maximum price it was allowed — the Avoided Cost Rate less net energy revenue.

Bowring: No Rules Broken

Market Monitor Joe Bowring said in an interview Friday that all generation offers were screened by his staff and PJM to ensure market power was mitigated by offer caps. That included a determination that no generator with market power could offer at a price higher than ACR less net energy revenue. “We do not believe market power was exercised in the capacity market,” Bowring said.

UBS noted that “the outcome is highly dependent on the initial assumption for where the auction would have come out at without any withholding. Lower baseline assumptions generally incentivize more withholding since less revenue is removed by the withheld assets (less risk in the strategy) while overall net uplift increases as well.”

“While outright strategic collusion is prohibited, participants may have been `telegraphing’ their intentions to each other more subtly in public comments from more than one company regarding potential retirements, seeking higher Avoided Cost Rates (ACR), etc.,” UBS said.

Chernick said that with imports and demand response limited by new rules in the 2017 auction, there was little risk to Exelon’s bidding strategy. “I think you could get a pretty good sense that this change in supply was enough to drive the price up,” he said. “It wasn’t like you could get huge amounts of [supply] zooming in.”

Crane seemed to confirm the analysts’ conclusions in his remarks at the Strategic Decisions conference last week, saying that although five units failed to clear, “overall the clearing price was beneficial to the total fleet.”

In its presentation to the conference, Exelon said its PJM capacity revenues will increase by $150 million in 2017 versus 2016. The company also expects a $250 million increase in 2017 capacity revenues from the New England capacity auction, held in February.

Crane said generators exhibited more “discipline” in their bidding this year.

“In the last auction, over two-thirds if not about three-quarters of the participants in the auction took themselves in as a price taker, which means they bid zero [and] not their full Avoided Cost Rate,” he said. “… The way that the RTO cleared, there is much more discipline in bidding, where people did bid their full ACR as we did on our plants.”

Retirement Threat

Crane said the failure of the Illinois nuclear plants to clear “gives us an opportunity to work with the state and work with the RTO on the value that they provide not only as a firm fuel during any weather event, but also provide a clean energy source that, if taken away, would be very difficult to meet the new [greenhouse gas] mandates.”

Earlier this year, Exelon warned Illinois legislators that low energy prices and renewable energy subsidies could force them to shut down three nuclear plants in the state. Exelon lobbyists reportedly named the Quad Cities and Byron plants in addition to the Clinton plant in southern Illinois (part of MISO) as those most at risk. (See Exelon in Lobbying Push to Save Ill. Nukes.)

Oyster Creek is scheduled to retire in 2019 under an environmental settlement with New Jersey officials. Exelon spokesman Paul Adams said that plan is unchanged.

Exelon said it has agreed not to make any retirement decisions about its Illinois plants before June 2015. The Illinois House introduced a resolution (HR1146) that calls for changes to recognize nuclear power’s reliability and environmental benefits. The resolution urges FERC, PJM and MISO to “expeditiously adopt market rules and policies, including transmission expansion rules and policies, that will ensure the continued operation” of the nuclear fleet. It also urges the EPA to make nuclear power a central part of compliance with the greenhouse gas rules.

GHG Rules to Benefit Nukes

Crane predicted last week that Illinois will seek a clean energy standard that would provide nuclear plants clean energy credits it can sell, similar to renewable energy credits (RECs).

A second path to compliance is the cap-and-trade approach used by California and the nine-state Regional Greenhouse Gas Initiative, which includes Maryland and Delaware.