Enhancing energy price formation will help build a resilient system

By Stu Bresler, senior vice president – Operations and Markets

Proper energy pricing is vital to accurately reflecting the resources needed to maintain a reliable grid and attracting the optimal mix of resources necessary to build a resilient system going forward.

Locational marginal pricing – the cornerstone of our market design – has worked well for the past 20 years, continuing to drive the efficient entry and exit of resources as the industry has evolved. Recently, however, limitations of the LMP calculation that previously were masked by certain market forces have become evident.

PJM has a plan to enhance energy price formation – including shortage pricing – that will incent resource flexibility and ensure that all resources needed to serve load are properly compensated.

We are committed to the stakeholder process and adequate discussion and evolution of our plan.

Proposed Enhancements to Energy Price Formation, our recently posted paper, is the culmination of months of study, discussions and simulations on why and how to change the way prices are formed in the energy market and how we can strengthen shortage pricing.

PJM’s approach recognizes that the way we price energy has been somewhat limited in valuing resource flexibility – a key attribute for efficient grid operations. Other regional grid organizations, such as MISO and ISO New England, already are using a similar approach tailored to their fuel mixes.

Ours will go further because it needs to accommodate a more diverse fuel mix than other grids have. The PJM plan is fuel-agnostic and would enhance an existing market mechanism that is transparent and fair.

This enhanced approach is warranted because, in recent years, we’ve observed a major revenue shift from the energy market to the capacity market, a flattening of the supply curve and less differentiation in pricing of resources – these conditions have highlighted the flaws in the current LMP calculation.

It is crucial to address this market phenomenon because PJM relies on resources to follow dispatch instructions to ensure the supply of and demand for electricity is always in balance.

If there is little incentive to follow PJM’s instructions, fewer flexible resources will be available, grid control will become more difficult and efficiencies would be reduced.

To this end, in late spring, we posted a set of thought papers to begin vetting ideas around energy price reform, and we presented our ideas at a Federal Energy Regulatory Commission technical conference.

PJM’s proposal enhances energy price formation, refines shortage pricing and incents performance.

We believe our approach is the best way to form price. It is about appropriately valuing the resources on the system that are relied upon to serve demand and ensuring we are incenting the resource flexibility we need in the system. The net impact of the proposed changes is an increase in combined energy and capacity market costs of between two percent and five percent.

If we don’t value these attributes, we will lose them. Now is the right time to make sure we don’t.