By Vince Duane and Tony Clark

Vince Duane

Our July whitepaper, Stretched to the Breaking Point:  RTOs and the Clean Energy Transition, emphasized the point that if an RTO was going to clear a centralized auction to form a single marginal price payable to all megawatt hours generated, then that RTO had better “get the price right.” Everything else (and we mean that literally) flows from getting price right: reliable operations, demand response and efficient consumption decisions, generator investment and retirement, accurate transmission planning, and an efficient financial transmission rights regime to manage congestion. Textbook economics instructs that the “right” price is a function of the cost of production and supply and demand.

In the real world, prices are rarely perfectly “right.” Distortions of various types are introduced. Not to mention the perfectly competitive conditions required to form the “right price” do not always exist. In the realm of RTOs, the term conceding this reality — a description one used to encounter more frequently in FERC orders and RTO commentary — was to aspire to “workably competitive” markets.

The question of price in RTOs surfaced again recently in the commission’s split decision on PJM’s “focused” minimum offer price rule (MOPR) filing. Last week, FERC Chairman Richard Glick and Commissioner Allison Clements published a joint statement comprehensively explaining why they support the PJM MOPR proposal (the “Joint Statement”). Regardless of whether one agrees with the ultimate conclusion in the Joint Statement, the broader question about RTO market design and its durability to handle industry transformation would benefit from reaching a shared understanding on key points. (See related story, ‘Good Riddance’ to Old PJM MOPR, Glick Says.’)

Tony Clark

The first such point is dismissing those that complain about state subsidies that support particular generation as wedded impractically to what the Joint Statement terms an “abstract concept of market integrity.” What the Joint Statement calls “market integrity” is what we call “getting the price right.” It’s hardly an abstraction. As we’ve pointed out, it’s the heart of the engine that drives RTO markets and it deserves thoughtful consideration.

The second and related point involves state actions that affect this engine and the nature of these actions. More specifically, it is the need to distinguish actions which are problematic “distortions” from actions that, while they affect price, create no problem for RTO markets. By noting that all manner of public and private action affect price, including actions that increase (as opposed to suppress) price, the Joint Statement essentially throws up its hands and concludes there is no “principled distinction” to be drawn and any effort to do so would result in “arbitrary and burdensome line-drawing.”

There is a point here. Toward the goal of “workably competitive” markets, throughout its history at PJM, MOPR tried to separate actionable subsidies from those that could be ignored, or had to be accepted, while conceding all subsidies created price suppression. We fear the Joint Statement gives up too quickly and justifies surrender based on a false equivalence of subsidy compared to a cost imposed by tax or regulation.

Again, price starts with cost. As noted by the Joint Statement, “Siting policies, tax rules, and labor regulations, for example” or a carbon tax all work to increase the cost of production that will be captured in the generator’s offer and ultimately inform the marketplace of the full and true cost of generating a megawatt hour. However, imposing a cost through regulation on a negative externality, be it lost workdays in the labor context or carbon in the climate context, is very different from subsidization. Different not just in approach, but in outcome.   

For example, the superior efficiency and environmental outcomes that result from putting a cost on carbon as opposed to subsidizing carbon-free activity are well accepted. Undoubtedly, however, the commission’s job is not to disfavor subsidies compared to alternatives that economists find preferable. But the commission is an economic regulator and it should be worried about the different economic consequences that a subsidy will cause to market structures it has sanctioned as compared with regulations or taxes that price the externality.  

And here is where we believe the Joint Statement falls short. The commissioners are not wrong to accept that states will prefer certain resources and will take actions to support those resources, regardless of what type of MOPR is in place. But once subsidy is accepted as a given, then the commission must ask whether the RTO market structure, predicated on a single-clearing marginal price, remains able to function as intended — and if not, what changes must occur. This gets to the very heart of the commission’s statutory duty to ensure wholesale rates remain just and reasonable.

The fact that RTO markets wholly depend on “getting price right” means offers must reflect accurate costs of production. The Joint Statement appears to contort subsidies as a kind of reduction in the cost of production to then conclude that a market riddled with subsidy “will provide accurate price signals … by allowing capacity market sellers to include state support in their offers.” In reality, what is meant by “include” here is that subsidized sellers will be able to exclude actual costs of production from their offers.

Nobel prize winning economist William Nordhaus extensively details the economic distortions that separate a subsidy from a regulatory tax or cost in his book, A Question of Balance: Weighing the Options on Global Warming Policies. The distortions from subsidy that he identifies in general markets relative to policies that impose cost by way of tax or regulation also show up, perhaps more acutely, in the designed, single-clearing price RTO markets. Though the Joint Statement’s conflation of hand outs and imposed regulatory costs weakens its argument, what we find more troubling is the risk that needed changes to RTO market design — changes we argue will be profound and foundational — may be ignored at the very moment when they most require attention.

Former FERC Commissioner Tony Clark is a senior adviser at Wilkinson Barker Knauer.  Vincent Duane is principal of Copper Monarch and the former SVP for law, compliance and external relations for PJM.