Forward Clean Energy Markets: A new solution to state-RTO conflicts

Source: By Sam Newell, Kathleen Spees and Johannes Pfeifenberger, Utility Dive • Posted: Tuesday, January 28, 2020

The Federal Energy Regulatory Commission’s recent order on PJM’s Minimum Offer Price Rule (MOPR) will subject state-mandated or state-supported nuclear and renewable generation resources to offer-price floors in the PJM capacity auctions. This may prevent them from clearing in the auctions and being paid for the capacity value they provide. It will increase the cost of clean-energy resources, hinder the industry’s transformation to clean energy, and result in PJM committing more resources than what is needed for reliability, incurring unnecessary costs.

The prospect of this outcome has already forced states, consumer groups and environmental groups to contemplate exiting organized capacity markets, for example, by means of PJM’s Fixed Resource Requirement(FRR) option.

That would be a loss. The capacity markets have historically provided economic efficiencies in meeting resource adequacy requirements at surprisingly low prices through broad participation, intense competition, and the ability to complement resources’ other value streams in a largely technology-neutral design. Defections from the organized capacity markets would harm customers and competitive producers alike. Customers would lose the benefits associated with meeting capacity needs at low prices; competitive producers would likely face a dwindling organized market size, low prices, and the eventual elimination of the merchant business model.

These disappointing outcomes could be avoided if the markets were set up to complement clean-energy policies rather than reject them.

This could be achieved by adding carbon pricing and/or competitive clean energy attributes to the current suite of unbundled wholesale electricity markets for energy, ancillary services and capacity. Under this more comprehensive suite of wholesale markets, capacity markets can recognize clean resources’ environmental value stream as a legitimate offset to the net cost of providing capacity — similar to the way capacity markets already recognize energy and ancillary services offsets. The result would be a more comprehensive and robust wholesale market design that can meet all reliability needs and policy goals at the attractive low prices we have come to expect from competitive markets.

Carbon pricing

Carbon pricing is often advocated as the purest solution that would internalize carbon policy objectives directly into the market so that the market can identify the least-cost sources of carbon emission abatement and most reward those that displace the most emissions. We agree that adding carbon pricing to organized wholesale power markets should be pursued, whether through carbon taxes, carbon charges or cap-and-trade. To achieve the most economic outcome, carbon prices would ideally be set at the ascribed value of carbon abatement consistent with policy goals, applied uniformly across a broad multi-state or national footprint, applied uniformly across all economic sectors, not just electricity.

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Realistically, though, the federal government is not close to implementing any carbon pricing, and few states are considering imposing carbon prices that are high enough to meet their goals. Achieving a uniform and appropriately high carbon price across both jurisdictions and economic sectors is unlikely in the near term. And a patchwork of different prices across states can create “leakage” by increasing the output of carbon-emitting resources from outside the carbon-pricing region, absent border adjustments as proposed by the New York Independent System Operator, but not yet addressed by the Regional Greenhouse Gas Initiative (RGGI). Further, depending on the policy environment, carbon prices can sometimes be perceived by investors as having too much “stroke of the pen” risk to support major investments.

Forward Clean Energy Market

This is why, even with some carbon pricing, investment in clean energy sufficient to meet state and customer preferences will likely continue to rely on payments for clean energy attributes that durably recognize their policy value. With that in mind, we have developed the concept of a Forward Clean Energy Market (FCEM) that would competitively procure clean energy commitments in a technology-neutral fashion that can complement other wholesale power market products, including capacity.

The FCEM could be administered by an individual state, an existing market operator (such as PJM) or an interstate entity (such as RGGI). The FCEM would procure Clean Energy Attribute Credits (CEACs), a product similar to RECs but drawing on best practices and experience with modern market design. The FCEM:

  • Qualifies a broad set of resources and technologies to maximize competition;
  • Uses a three-year forward procurement to allow for competition between existing and new resources and provide more certainty in market revenues;
  • Incorporates a downward-sloping curve for aggregate demand from both state mandates and green energy demands of retail customers, buying more CEACs and accelerating the transition to clean energy when they are cheap (and buy less when not), to reduce price volatility, and mitigate market power;
  • Uses uniform-price auctions to encourage cost-based offers, transparently award winners at competitive prices, and attract innovative solutions and low-cost technologies to enter the market;
  • Offers a multi-year price lock-in to support the financing of new resources;
  • Offers advanced features to dynamically vary payment rates for CEACs based on the realized carbon abatement at any point in time and avoid negative-priced energy offers; and
  • Avoids the need for border adjustments in carbon pricing regimes to prevent the “leakage” of carbon emissions.

Avoiding MOPR’s inefficiencies

Adopting an FCEM can avoid the inefficiencies of imposing MOPR on clean-energy resources, by recognizing the in-market payments for environmental attributes that would otherwise be excluded from organized wholesale electricity markets. The CEAC products would more effectively complement the grid services that are rewarded in organized markets through the existing energy, ancillary and capacity products.

With the introduction of an FCEM, no special MOPR treatment of clean energy resources would be needed or be appropriate because it would be clear that CEAC payments are a competitive means of meeting clean energy goals. It would be clear that the FCEM procurement would in no way be associated with any intention to suppress capacity prices paid to conventional resources, or to do anything other than internalize environmental externalities, just like carbon pricing.

FCEM and capacity markets can also incorporate technology-specific carve-outs for targeted resource types, such as offshore wind, to meet special policies aimed at advancing R&D and commercialization. MOPR should not apply to such resources either: with any premium representing a down payment on future cost declines, they should not be considered “uneconomic” (per the original MOPR). Moreover, as long as they also qualify for the base product toward meeting the state’s overall clean energy objective, they are displacing base resources and effecting little or no net impact on capacity prices.

Avoiding a painful transition to less cost-effective constructs

Why bother with all this? If implementing a broad MOPR denies clean energy resources access to wholesale capacity markets for the resource adequacy benefits they provide, the affected states may simply leave the PJM capacity market. States could force load serving entities or integrated utilities into PJM’s Fixed Resource Requirement option, such that they have to contract bilaterally for capacity; or states might even consider reverting to partial or full re-regulation of all capacity resources. This could involve a costly and painful transition to less competitive and less cost-effective market and regulatory constructs.

Compare bilateral contracting and RFPs to multilateral organized markets with multiple products: the competitive scope of an RFP for, say, wind generation is only new wind plants. In contrast, the scope of competition in organized product markets is much wider as all technologies (and both existing and new plants) are forced to compete. In addition, the shorter price lock-in (contracting period) and unbundled product-specific procurement (energy, ancillary services, capacity and CEACs) leave more of the market, technology and financing risks with the bidders and project developers, who are in a better position to assess, control and mitigate these risks than retail customers. In contrast, the 10-20 year contracts for specific new resources leave much more of these risks with customers, including plant-specific risks.

Our hope is to see a future in which organized wholesale power markets will continue providing the now-well-documented benefits of: (1) optimizing reliable grid operations at low cost; (2) attracting investments at low cost; and (3) keeping more investment risks with suppliers, rather than customers. To achieve that outcome, we believe the organized markets will have to offer state policymakers and customers a market design that aligns with and can help achieve their clean energy goals. The FCEM and carbon pricing offer that solution.

Alongside the traditional energy, ancillary services and capacity markets, the FCEM can help signal when any particular attribute is valuable or scarce and which resources and technologies provide the best bundle of multi-attribute values to meet overall system needs — whether the supply is coming from conventional, renewable, nuclear, storage, demand response or interchanges. Such well-designed, unbundled product markets are the most economically efficient path to solving the challenging problem of decarbonizing the electricity industry while keeping the lights on.

FERC’s order does not provide an easy path for making all of this work, particularly for reconciling state clean energy policies with organized wholesale capacity market participation. Nevertheless, we are hopeful that, even with FERC’s order, FCEM is different enough and sensible enough that it can offer a workable path forward.