By Michael Brooks

WASHINGTON — PJM needs to return to “the fundamentals” with market design not “influenced by political whims,” Independent Market Monitor Joe Bowring said last week.

Policymakers should not fear market prices going too high or low, Bowring said in a press conference announcing the Monitor’s annual State of the Market report.

“There’s a million temptations to move away from the basics because somebody might be getting hurt by them,” he said, noting that every sector of the market complains about the rules sometimes. “That’s all good because it’s not supposed to be helping any particular sector; it’s supposed to be reflecting the value of power.”

As in past years, the Monitor found that PJM’s energy, capacity, regulation, synchronized reserve and financial transmission rights markets were all competitive in 2015, as mitigation overcame market power found in all but the FTR market. The Monitor judged the design of the regulation and FTR markets as “flawed” and that of the capacity, day-ahead scheduling reserve and synchronized reserve markets “mixed.”

The Monitor listed 27 new recommendations, 10 of them high priority, for 2015. (See New, High-Priority Recommendations – 2015 State of the Market Report below.) Half of the high priority recommendations relate to the FTR market. (Ten of the new recommendations were listed in prior quarterly reports.)

It also for the first time compiled a list of all recommendations it has made since 1999, listing their status and priority. The report shows that PJM has fully adopted 24% of the Monitor’s recommendations, including 36% of those identified as high priority.

Energy Market

Abundant, cheap natural gas drove down LMPs in 2015, a sign that the energy market is both competitive and effective, Bowring said. “When you have a competitive market, the price of inputs flow through,” he said. “Both price inputs went down — the price of gas primarily — and also load went down. The result is a very immediate decline in prices.”

The average real-time LMP dropped to $36.16 from $53.14 in 2014, when the demand for gas during the January polar vortex resulted in a price spike. Using 2014’s fuel prices, LMPs would have been $41.91, or % higher. Prices were the second lowest since 2002, above only 2012.

Although energy market results generally reflected supply-demand fundamentals, “the behavior of some participants during high demand periods is consistent with economic withholding,” the Monitor said.

Among the new is that PJM define rules for using transmission penalty factors to set LMPs when a transmission constraint is binding and there are no generation alternatives to resolve it.

When system operators allow the limit to be violated, the shadow price of the constraint is administratively set through transmission penalty factors, a form of locational scarcity pricing. Bowring said that there is nothing wrong with PJM doing this, but there are no rules for it in the RTO’s governing documents.

Capacity Market

One of the challenges with this year’s report on the capacity market, Bowring said, was the introduction of Capacity Performance. “The Capacity Performance design incorporated a lot of the recommendations we’ve been making over the last five years, and we think it’s a huge improvement,” he said. “But nonetheless the design that was in place in 2015 was the old design and with all of its flaws. … Going forward, the design has been substantially improved.”

Despite the improvements, Bowring said more needs to be done. For example, PJM’s method for calculating units’ net revenue to determine net cost of new entry “is just wrong,” he said. The Monitor recommends that net revenue reflect the actual flexibility of units to respond to price signals. Bowring also warned against efforts by some stakeholders to dilute the penalties for nonperformance under the new market structure. (See FERC Denies AEP’s Capacity Performance Waiver Request, PJM Generator Risk Proposal Faces Resistance.)

Fuel Mix

Coal declined sharply in 2015, from 72.4 GW of installed capacity on Jan. 1 to 66.7 GW on Dec. 31, making up 37.5% of total capacity. Gas, meanwhile, rose to 60.4 GW, or 34%, by the end of the year. The Monitor expects gas to overtake coal as the dominant resource in PJM this year, according to the report.

Net revenue for new entrant combustion turbines and combined cycle units was more than enough to recover CONE in most zones, while “if you built a new coal plant you would recover, at most, about a third of your total investment,” Bowring said. Nuclear plants did not have it much better. “No rational investor would build either a coal unit or a nuclear unit now in PJM given the recovery of their costs.”

Still, Bowring doesn’t expect coal to disappear completely from PJM, even if EPA’s Clean Power Plan survives legal challenges, because regional carbon trading will allow states to comply without huge coal retirements. The volatility in gas prices means that coal plants that have installed environmentally compliant technology can still make money. “I expect coal to be a very substantial part of PJM for the foreseeable future,” he said.

Renewable resources are doing very well because of federal tax credits and state incentives, Bowring said, with solar recovering 175% of its 20-year costs in the PSEG zone.

Demand Response

The Monitor repeated its recommendation, first made in 2014, that demand response be removed from the supply side of PJM markets. While DR is a key part of the wholesale power markets, it should be moved to the demand side and customers and curtailment service providers should have more granular data so that they can respond better to price signals, according to the report. “The method of incorporating it in the PJM market design … simply doesn’t work and is very inefficient,” Bowring said.

Bowring admitted that this was unlikely to happen — but not because of the U.S. Supreme Court’s decision upholding FERC’s jurisdiction over DR. “The Supreme Court decision was actually a good thing because it got rid of all the uncertainty,” he said. “No one was doing anything about DR because they were so uncertain. Uncertainty’s gone. FERC has authority. Fine, that’s great.

“But the Supreme Court did not order them to pay LMP, and not LMP minus G” — the retail price of power — Bowring said,  “because the Supreme Court doesn’t know the difference between those two things.”

New, High-Priority Recommendations – 2015 State of the Market Report

Energy Market

To ensure effective market power mitigation when the three pivotal supplier test is failed:

• Markup should be constant across price and cost offers, and there should be at least one cost-based offer using the same fuel as the available price-based offer; and
• The operating parameters in the cost-based offer and the price-based parameter limited schedule (PLS) offer should be at least as flexible as the operating parameters in the available non-PLS price-based offer. The price-MW pairs in the price-based PLS offer should be exactly equal to the price-based non-PLS offer.

Demand Response

• PJM should require nodal dispatch of demand resources with no advance notice or, if nodal location is not required, subzonal dispatch of demand resources with no advance notice.
• PJM should eliminate the measurement of compliance across zones within a compliance aggregation area. The multiple-zone approach is less locational than the zonal and subzonal approach and creates larger mismatches between the locational need for the resources and the actual response.

Interchange Transactions

• PJM Settlement Inc. should immediately request a credit evaluation from all companies that engaged in up-to-congestion transactions (UTC) between Sept. 8, 2014, and Dec. 31, 2015. If PJM has the authority, PJM should ensure that the potential exposure to uplift for that period be included as a contingency in the companies’ calculations for credit levels and collateral requirements. If PJM does not have the authority to take such steps, PJM should request guidance from FERC. (PJM traders are awaiting a FERC order telling them whether UTC trades will be charged uplift and made subject to the RTO’s financial transmission rights forfeiture rule (EL14-37). FERC had indicated it would rule by last October, but there has been no word from the commission so far. See FERC Issues Request for Comments in UTC Uplift Docket; Ruling by October?)

Financial Transmission Rights

• The design of FTRs and auction revenue rights should be modified to ensure that all congestion revenues are returned to load.
• All FTR auction revenue should be distributed to ARR holders.
• Historical generation-load paths should be eliminated as a basis for allocating ARRs.
• Counterflow FTRs should be eliminated.
• FTR auction revenues should not be used to buy counterflow FTRs with the purpose of improving FTR payout ratios.