By Rich Heidorn Jr. and Suzanne Herel

The Federal Energy Regulatory Commission on Tuesday approved PJM’s dramatic restructuring of its capacity market, saying the changes were justified by “the combination of deteriorating resource performance and the ongoing change in the resource mix in the PJM region.”

The proposal, a response to the poor generator performance during the January 2014 polar vortex, increases reliability expectations of capacity resources with a new Capacity Performance product. It is intended to result in larger capacity payments for the most reliable resources (including performance bonus payments for overperforming participants) and higher penalties for non-performers (non-performance charges).

The changes will be phased in beginning with the 2018/19 and 2019/20 delivery years, when PJM hopes to make at least 80% of capacity procured Capacity Performance, with the remainder “Base Capacity” subject to lower performance expectations. The transition will be complete for 2020/21, when PJM expects 100% of capacity to be Capacity Performance resources. PJM also is changing energy market rules regarding operating parameters, force majeure and generator outages under a “no excuses” policy.

PJM’s Board of Managers filed the proposal Dec. 12 following its first-ever “enhanced liaison process,” under which it accepted comments on the proposal but made no attempt to reach stakeholder consensus.

Although it rejected some of PJM’s related proposals for changes to the energy market, the commission otherwise approved the RTO’s changes with only limited modifications (EL15-29, ER15-623). (See related story, What is Changing in PJM’s Proposal?)

The commission cited evidence of increased generator forced outage rates since 2007, saying that capacity resources “are not being properly incented to make the investments required to perform reliably, including during extreme weather conditions.”

It accepted PJM’s prediction that resource performance will continue to worsen without changes as the RTO sees much of its coal fleet retire, replaced largely by natural gas-fired generation.

The commission rejected the arguments of opponents who said the changes were not necessary because generator performance improved last winter following more modest changes, including testing of seldom-used units.

“While encouraging, this does not assuage the long-term reliability concerns raised by historical unit performance,” the commission said. “Moreover, it is not uncommon for performance to improve after an event, only to trail off later. PJM has shown that, although its capacity market construct has been successful in procuring commitments three years in the future, it has not been successful in ensuring that resources actually perform when called upon.”

Stocks for PJM’s largest generators traded higher Wednesday following news of the ruling. Dynegy’s share prices jumped almost 9%, while NRG Energy and Exelon prices rose about 4%. As of Monday morning, NRG Energy had given back most of its gain, up 1% from before the order.

Bay Dissents

Chairman Norman Bay issued a stinging dissent, raising objections that are likely to be cited in any court challenges. Bay said the proposal will continue to allow generators to profit from poor performance while potentially saddling ratepayers with billions in excessive capacity costs annually.

“The majority today accepts a flawed, complex, highly technical market construct in which there is a potential mismatch between incentives and penalties [and] in which mitigation has largely been eliminated in a market characterized by structural non-competitiveness,” he wrote. (See related story, Bay’s Dissent: ‘Two Carrots and a Partial Stick.’)

PJM CEO Terry Boston, attending the Mid-America Regulatory Conference in Milwaukee, said he was “very pleased” by the ruling.

Exelon also applauded the ruling, saying it “will result in hundreds of millions of dollars in investments across the PJM fleet to harden power plants to operate — and reduce outages — during extreme weather.”

America’s Natural Gas Alliance, which represents independent exploration and production companies, said it was happy that the order provides way for combined-cycle generators to recover costs for securing fuel and investing in infrastructure.

Ruth Price, deputy Delaware Public Advocate, said the changes are unnecessary. “Last winter shows that we can get by without CP,” she said. “Clearly it’s going to be a cost burden on” ratepayers.

Dan Griffiths, executive director for the Consumer Advocates of PJM States, said the group was reviewing the order and had no immediate reaction.

Two Dockets

PJM made its proposal Dec. 11 in filings that totaled nearly 1,300 pages in two dockets.

One, EL15-29, filed under sections 205 and 206 of the Federal Power Act, contained proposed changes to PJM’s Operating Agreement and Tariff to correct “deficiencies” regarding resource performance in PJM markets.

The second, ER15-623, filed under section 205, outlined changes to the Reliability Pricing Model rules in the Tariff and Reliability Assurance Agreement. (See What You Need to Know about PJM’s Capacity Performance Proposal.)

FERC responded with a deficiency notice March 31 questioning 10 areas of the proposal. PJM’s answers largely satisfied the majority, although FERC’s order required the RTO to make a compliance filing within 30 days incorporating changes on some details.

Base Residual Auction

The new rules, which will be phased in over five years, will be reflected in the Base Residual Auction for the 2018/19 delivery year, which will begin Aug. 10.

“We are obviously still digesting the order,” senior vice president for operations Mike Kormos told the Market Implementation Committee on Wednesday. But he said he saw nothing in the ruling that would keep PJM from going ahead with the BRA as planned on Aug. 10.

“We fully expect to make the compliance filings as we were directed,” he said. “We will do that within 30 days, sooner if we can.”

Manual changes to accommodate the new product will be discussed at a special meeting of the Markets and Reliability Committee being planned for June 18, time and location to be announced.

Training will be held June 24, and the MRC will be asked to endorse the manual changes June 25.

PJM also released a schedule for deadlines leading up to the BRA.

Need for Change

FERC agreed with PJM that current capacity rules subject poorly performing resources to minimal penalties, placing most of the risk of under-performance on load. During the 2013/14 delivery year such penalties totaled less than $39 million, 0.6% of total capacity revenues. “Without more stringent penalties, PJM has shown there is little incentive for a seller to make capital improvements or increase its operating maintenance for the purpose of enhancing the availability of its unit during emergency conditions,” FERC said.

PJM’s rules also limited capacity resources’ ability to recover costs needed to improve performance, allowing recovery of capital costs for dual-fuel capability but denying expenses for natural gas firm transportation contracts.

“PJM has shown that its existing payment features not only inadequately incent resource performance, but may perversely select less reliable resources over more reliable resources because a capacity seller’s decision to forego investments that would improve resource performance allows it to offer in PJM’s capacity market at a lower price and be paid the clearing price while providing less reliable service,” FERC said.

The commission was not persuaded by opponents who argued that PJM could provide incentives for improved performance through changes to energy and ancillary services rules. “For example, although better alignment of electric market and natural gas pipeline scheduling deadlines would improve operations, it would not provide capacity market sellers the incentive to perform,” it said.

Fixed Resource Requirements

Although some intervenors argued that Fixed Resource Requirement entities are already subject to strong performance incentives from state regulators, the commission approved PJM’s decision not to exempt them from Capacity Performance penalties. “While Fixed Resource Requirement entities do not procure their capacity commitments through PJM’s capacity auctions, the ability of these resources to perform is equally critical to system reliability,” the commission said. It rejected an argument by the Organization of PJM States Inc. (OPSI) that PJM’s proposal infringed on state authority by effectively eliminating states’ choice to opt out of the capacity auction process.

The commission did, however, require PJM to modify how it calculates penalties for FRR entities.

Eliminating 2.5% Holdback

FERC approved PJM’s controversial proposal to eliminate its 2.5% capacity holdback effective with the Base Residual Auction for delivery year 2018/19. PJM said the change, which the Market Monitor has long urged, will ensure that it has obtained committed capacity and is not reliant on short-term procurement.

The commission rejected consumer groups’ contention that the holdback should be retained as a counter to PJM’s consistently overstated load forecasts.  “We are not persuaded that a holdback requirement is necessary to address load forecast errors, or that the historical overstatements experienced to date are unavoidable or likely to recur at a level that requires mitigation,” the commission said.

It also rejected the Pennsylvania Public Utility Commission’s argument that the holdback is necessary to incent demand resources’ participation, saying it was “not convinced that the benefit of any incremental demand resource participation resulting from retaining the holdback requirement will necessarily outweigh the economic efficiency benefit of no longer withholding demand from the Base Residual Auction, an action that can suppress market clearing prices.”

Force Majeure

FERC approved PJM’s changes to its force majeure rule, under which a resource will be excused for non-performance only “in the event that all, or substantially all, of the electric transmission or fuel delivery infrastructure in the PJM region is incapacitated.”

“Without a replacement provision narrowing the reach of a force majeure event to excuse performance only in the most unforeseen and catastrophic circumstances, a market participant would be able to escape its obligations under circumstances not contemplated by the design of PJM’s markets,” the commission said.

FERC rejected arguments that the new definition was too narrow. “The risk of capacity resource non-performance must be borne by either capacity suppliers or consumers, and capacity suppliers are in the best position to assess and price the performance risk associated with their resources, including performance risks beyond a resource owner’s control, such as weather-related outages,” it said.

Accommodations to Demand Response

FERC approved PJM’s proposal to replace its current demand response products with an annual product that meets Capacity Performance requirements. Most of PJM’s current DR is available only in summer, including limited DR, which is available for only six hours daily up to for 10 days.

The commission required PJM to modify its proposal consistent with its response to the deficiency notice, which clarified that storage, intermittent resources, energy efficiency and DR may submit capacity offers based on their average expected output during peak hours.

FERC said it was permissible for PJM to allow such resources to make offers based on aggregate capacity while limiting traditional resources to unit-specific offers.

“The aggregated offer allowance is designed to provide an avenue to Capacity Performance participation by resources that otherwise may be unable or unwilling to participate on a stand-alone basis because no reasonable amount of investment in the resource can mitigate non-performance risk to an acceptable level,” the commission said. “Generally speaking, other resource types do not face this same limitation.”

The commission rejected the Market Monitor’s complaint that PJM’s proposal discriminated in favor of DR.

The Monitor contended that DR resources should have their output metered in five-minute intervals rather than estimated and be dispatched nodally to ensure that all capacity is performing as required. The commission said PJM’s concessions are “minor but reasonable accommodations” that allow DR to participate in the capacity market.

FERC also rejected the Monitor’s contention that DR should be subject to a must-offer requirement in the day-ahead energy market. The commission said PJM’s plan to exempt intermittent resources, storage, energy efficiency and DR from the must-offer requirement was reasonable because “they do not raise the same physical withholding concerns as do existing generation resources because their ownership is not concentrated.”