PJM Attempts to Bolster Grid Reliability Through Capacity Market Auction Reforms

Originally published for customers February 21, 2024

In October of last year, PJM submitted two related, but independent, filings with FERC in an attempt to reform its capacity market through its existing tariff with the ultimate goal of bolstering grid reliability in the midst of the energy evolution. The first tariff filing focuses on capacity market reforms to help accommodate the energy transition while maintaining resource adequacy. The second focuses on potential enhancements to PJM’s current capacity market rules. PJM’s goal is to use these reforms as the first of (likely) a series to ensure grid reliability to its customers. One of the key changes to the tariff relates to adjusting the methodology and assumptions used for forecasting resource adequacy in light of the changing generation mix and therefore affecting supply requirements, which is not unique to PJM.

Other major grid operators may and should consider some of the changes that PJM is suggesting, especially those that adjust methodologies for forecasting resource adequacy to better consider the potential effects of more renewable resources in their generation mix.

FERC’s Decision

PJM requested that FERC approve these two tariff adjustments together by December 12 so that the reforms could be implemented for the 2025/2026 capacity auction, which was set to open on June 1, 2024.

For those familiar with the timing of FERC decisions, it should come as no surprise that the Commission did not issue a decision by PJM’s requested deadline. The proposal focusing on capacity market reforms was approved in full on January 30. The proposal focusing on potential enhancements, however, was rejected a week later on February 6. PJM’s capacity auction is currently scheduled to be held in June, but the grid operator has submitted a request with FERC to delay the auction to the middle of July to ensure the auction has the proper administration and to ensure stakeholders are adequately educated on the capacity market reforms.

PJM’s Reliability Pricing Model

Capacity markets generally work to ensure that there will be adequate generation capacity available for some specified time period in the future. These markets require oversight by a centralized organization that handles the planning and execution of a capacity auction, where private generators bid for capacity contracts. Once a private generator is awarded one of these contracts, they essentially guarantee that they will be able to provide the specified amount of generation capacity when called upon for the duration of the contract.

PJM’s capacity market, the Reliability Pricing Model (RPM), intends to ensure grid reliability by securing the expected amount of power supply to meet the expected demand three years in the future. According to PJM, the essential elements of the capacity market are as follows:

1. Procurement of capacity three years before it is needed through a competitive auction;
   
   
2. Pricing for capacity that varies to reflect limitations at various locations on the transmission system; and
   
   
3. A variable resource requirement curve, which is the demand formula used to set the price paid to market participants for capacity and the amount of capacity.

The RPM creates a pay-for-performance framework. If resources are unable to deliver on demand, especially during emergencies, they will face significant penalties for non-delivery. This ensures that consumers will be protected against both power outages and large price increases during extreme weather.

Proposed Capacity Market Reforms

The first filing is focused on reforming three main aspects of PJM’s capacity market in order to ensure grid reliability as the landscape of generation changes in the region. It aims to adjust (1) the existing resource adequacy risk modeling and (2) capacity accreditation processes (used to estimate how much load a resource can handle when the system is stressed) to better orient the market’s representation of capacity supply and demand with the expected resource performance and system resource adequacy risks. It also proposes to (3) improve the balance between resource performance and financial incentives by increasing testing requirements of capacity resources and reducing the annual stop-loss limit, which caps the amount a resource can be fined in non-performance charges in a given year.

The changing generation mix is a key driver of the need to adjust the existing resource adequacy risk modeling. PJM has seen a large increase in natural gas-fired generation in the last ten years. As seen in the chart below, gas-fired generation has accounted for almost 50% of the electricity generation in the PJM region in recent years.

The generation mix will continue to evolve moving into the future. Currently, the vast majority of generation projects in PJM’s interconnection queue are either stand-alone renewable or hybrid generation sources. There is a significant amount of existing generation, mostly coal and natural gas, that will be set for retirement in the coming years. However, integrating renewable energy also entails incorporating storage solutions for reliability during periods of low wind or solar output. Unlike renewables, coal and natural gas can be stored more readily. Given the distinct operational characteristics between existing and renewable generation, the assumptions used for modeling resource adequacy must be adjusted accordingly.

Proposed Capacity Market Rule Enhancements

In a second filing, which was rejected by FERC, PJM proposed three major enhancements to the existing capacity market rules. Among these, the most relevant revisions pertained to the capacity performance construct, which addresses the penalties suppliers must pay for non-performance, as mentioned above.

This suggested revision came in the aftermath of Winter Storm Elliott, which we discussed in more detail in PJM Performance During Winter Storm Elliot Shows Many Flaws. Following the storm, many of the producers that were penalized argued that they met the requirements for exemption from these penalties. As a result, PJM is now suggesting a much narrower definition of when a supplier may be exempt from such charges.

FERC denied these suggested tariff filings in their entirety but provided several suggestions for potential changes that could facilitate eventual acceptance, and quite a few of the justifications for the denial centered around the proposal lacking clarity. PJM has already stated that it is considering these suggestions. We expect the tariff changes to be resubmitted, but it is unlikely that they will be enacted prior to this year’s capacity auction.

The Big Picture

In PJM Seeks to Reform Its Generation Connection Queue and FERC Follows Suit, we discussed PJM’s suggested plan to reform its generation interconnection queue. It was the first of the major regional grid operators to suggest significant changes to this process. Similarly, PJM has been the first to suggest such major changes to its capacity market to bolster grid reliability. This isn’t entirely surprising, as PJM covers a large geographic footprint in the mid-Atlantic region of the country, with many of the states having already passed significant clean energy policies.

Each grid operator faces its own set of challenges, but all are grappling with similar issues in maintaining grid reliability in the wake of the energy transition. As seen in the chart above, most regions will be either retiring coal generation, adding renewable sources, or both in the coming decade. In the summer of 2020, California experienced a series of rolling blackouts due to a lack of generation capacity. The use of renewable sources, especially solar, actually shifts the hours of risk to the system. Solar generation capability declines while demand continues to increase in the evenings, leading to outages. While some states have not yet seen this issue, they may, especially if they fail to anticipate and consider these risks well in advance.

If you would like us to analyze similar tariff provisions for other regional grid operators, please contact us.