Market design can accommodate state policy initiatives and remain competitive

By Stu Bresler, senior vice president – Operations and Markets

A revolution has been occurring in the energy industry in recent years as a result of major changes affecting the economics of electricity supply, presenting new risks to the competitive wholesale electricity market.

Among the changes are abundant natural gas supplies from hydraulic fracturing, innovations in energy efficiency and energy storage and the rise of public policies to promote specific supply resources for reasons beyond simply ensuring resource adequacy at the lowest cost.

PJM has posted three working papers  to spark stakeholder discussion about market reforms to respond to state policies around carbon pricing and generator subsidies. All three papers build from the same underlying idea: market design can accommodate state policy initiatives and adapt to changing conditions to ensure the region continues to reap the benefits of competitive markets.

These papers are not proposals to change public policy; PJM does not set public policy. Rather, they are frameworks for how we might best adapt to changing state policies and the region’s evolving resource mix.

One paper, Advancing Zero Emissions Objectives through PJM’s Energy Markets, explores how a regional or sub-regional carbon price could be reflected in wholesale market prices. Some states have considered subsidizing nuclear units to meet carbon-reduction initiatives. PJM’s draft proposal would allow states to pursue carbon policy objectives through the energy markets. Participating states could agree upon and set a price for carbon that emitting suppliers would reflect in their offers into the energy market. Ultimately, those costs would factor into the locational marginal price.

PJM prefers taking a regional approach but recognizes a sub-regional approach may be more feasible. Either way, participating states would need to agree on a common price to apply to carbon and a method for distributing the funds collected. Non-participating states would not be affected.

The Capacity Market Repricing Proposal explores an approach to accommodating subsidies of generators in the capacity market while ensuring the subsidies don’t distort capacity prices. This proposal is among several solutions being considered by the Capacity Construct/Public Policy Senior Task Force.

The concept would ensure that out-of-market subsidies do not impact the overall competitiveness of the capacity market results and therefore the efficient entry and exit of resources over the long-term. To accomplish this, the capacity auction would be conducted in two stages. The first stage determines cleared capacity, where subsidized resources would offer into the auction. Cleared resources would determine who will receive a capacity commitment.

The second phase determines clearing price. In this stage, when subsidized units are identified, it would trigger repricing. Offers from subsidized units would be replaced with reference price offers for the purpose of determining the final clearing price applied to committed resources from the first stage.

And finally, the Energy Price Formation and Valuing Flexibility paper aims to prompt stakeholder discussion on refining locational marginal price formation to recognize the contribution of all resources, including large, inflexible units, in serving load in a given interval. We’ve raised the question of whether current price formation recognizes the true marginal cost of serving load and transparently signals it to buyers, sellers, asset investors and financial traders.

The range of resources eligible to set price would be expanded to include all units (including inflexible ones) whose output is needed to maintain supply and demand balance while managing transmission constraints. Current rules allow only flexible units to set price, with minimal exceptions. Such reform would be expected to reduce uplift costs and improve price signals to support efficient investment and retention decisions.

We encourage stakeholders to read the papers so they can engage in these important discussions on how our markets will continue to evolve while accommodating increasing state interest in valuing resources differently.