PJM Auction a Strong Indicator America Needs More Electricity

By Raymond Gifford

Among any teen reprobate’s fabled pranks is to take a brown paper bag full of dog poo, light it on fire on the porch of your victim, ring the doorbell, run, and wait for the stinky hilarity to ensue.

And then there are the recent results from the PJM Capacity Auction.

Though not as stinky or juvenilely funny, the capacity auction results promise to trigger a political, regulatory, and consumer conflagration that no ring-and-run joke can match. What’s more, if exogenous forces outside of the PJM regulatory construct—such as permitting delays, policy hostility to dispatchable resources, and financing challenges—intervene, the capacity price increases will leave consumers paying for nothing while still not solving the capacity shortfall.

First, the results: The RTO Zone clearing price rose nearly tenfold from $28.92 to $262.92 per MW-day. Meanwhile, the Baltimore zone cleared at $466.35 per MW-day, up from $73.00 in the prior auction, and the Dominion zone cleared at $444.26 per MW-day. While corks may be popping for some of the generators active in PJM, customers are in for higher electric bills as PJM tries to induce more capacity into its market for 2026 delivery.

While PJM’s top-down engineered price formation bears only a passing resemblance to true bottom-up price emergence from willing sellers to willing buyers, the massive jump in capacity prices sends a blaring signal: PJM is glaringly short of capacity. This shortage means electricity prices will be much higher in the region as consumers are ultimately on the hook for these new capacity payments. Nonetheless, when capacity prices reveal this much volatility, it raises two questions for customers and regulators:

1.   Will these new capacity auction prices succeed in inducing new generation into the market?

2.   Will policymakers and customers tolerate the jarring capacity price volatility shock, or will they push for regulatory and political changes?

The question of whether the capacity auction results will succeed in inducing new generation into the market (or convincing older, inevitably thermal assets to stay in the market) is tough. The mismatch between capacity markets looking forward three years and new asset investments lasting 20, 30, or 40 years has always been a challenge for capacity market designers.

As an investor, do I sink hundreds of millions or billions of dollars into an asset whose capacity payment is only assured for three years? Particularly for dispatchable thermal resources, would high-capacity payments in three years trigger a commitment of capital to be earned back over decades when policies and political forces aim to strand that asset sooner rather than later? For new nuclear investments, the market viability for existing nuclear units in RTOs has been so precarious that many states opted to subsidize their nuclear generation. Even for hybrid renewable/storage generation projects, with the lowered accredited capacity values and historic capacity market price volatility over the years, does the project pencil financially?

To be sure, there are different risk appetites among investors. Perhaps the rich capacity payments awaiting generators from this auction will induce new generation onto the system. But even those with the risk appetite will be tempered by the practical impediments to getting projects completed in the PJM footprint.

The political economy of the auction outcome promises to be just as volatile. Though the entire PJM footprint will face higher prices, Maryland and Virginia, in particular, are in for vertiginous rises in the cost of capacity. These two states have embraced state policies to ‘correct’ what have been viewed as PJM shortcomings, and Virginia periodically alludes to exiting PJM altogether. The political economy of soaring electric rates is predictably bad for incumbent politicians. Ask former governors Bob Ehrlich (MD) and Gray Davis (CA) how electric rate shock worked out for them.

A final question on the political economy of the auction results lands at FERC’s doorstep. Chairman Phillips and Commissioner Christie are former regulators within PJM’s footprint. Does FERC accept the auction’s price results as “just and reasonable” because the market, such as it is, has spoken? Or do they open the hood on the auction to see if the money being drawn from consumers’ pockets will induce the new capacity and hence result in just and reasonable outcomes?

There are no easy answers to PJM’s capacity crisis. The auction results are so jarring that a good Marxist would celebrate the result as “heightening the contradictions” so that a revolution can come along. For the non-Marxist analysts among us, we can hope that some serious scrutiny and deliberation can help extinguish the flaming bag of poo left on the porch of the PJM footprint.

Raymond Gifford previously served as Chairman of the Colorado Public Utilities Commission and is the managing partner in the Denver office of the law firm Wilkinson Barker Knauer. 

This article was originally published by RealClearEnergy and made available via RealClearWire.