Commissioner Richard Glick Statement
May 21, 2020

Docket No. EL19-58-000
Order: E-3 PDF

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Dissent Regarding PJM Proposed Revisions to the Tariff and Operating Agreement (Reserve Market Proposal)

Today’s order grants PJM’s complaint seeking to significantly overhaul its markets for energy and ancillary services.  It does not, however, meet either of the conditions precedent for approving that sweeping overhaul:  It fails to show that the existing rate is unjust and unreasonable or that the replacement is just and reasonable.  Instead, the Commission unquestioningly defers to PJM’s contested assertions while casually dismissing the detailed and well-reasoned protests.  In so doing, the Commission approves a proposal that will impose billions of dollars of additional costs on consumers.  That is yet another abdication of our responsibility to protect consumers and to comply with the requirements of the Federal Power Act (FPA).

Although I am obviously disappointed in this outcome, I cannot say that I am surprised.  It is just the latest in a series of PJM proceedings that have gone against consumers as the Commission has prioritized high prices over efficient markets.  In its order accepting PJM’s Variable Resource Requirement Curve (VRR Curve), the Commission approved a proposal to establish a “demand curve” for the capacity market that will systematically over-procure capacity, significantly raising rates for customers. 1  Similarly, in its order radically expanding PJM’s Minimum Offer Price Rule (MOPR), the Commission effectively modified the “supply curve” for the capacity market by prohibiting some resources that receive state support from participating in the market while forcing others to bid above administratively determined levels 2—again all at customers’ expense.  Today’s order is just more of the same.  It will further distort PJM’s markets—this time the energy and ancillary service markets—handing yet another windfall to generators and leaving customers to pick up the tab.  That is not just and reasonable.  

The Commission Fails to Show that the Existing Tariff Is Unjust and Unreasonable

Reserves play a critical role in our electricity system as they, quite literally, help keep the lights on.  As a result, properly valuing reserves is an integral part of ensuring reliable electricity service at just and reasonable rates.  Shortage pricing helps to achieve that by providing efficient price signals when the system is short on reserves.  During a reserve shortage, the energy price is increased by the administratively determined cost of falling below the reserve requirement.  And this upward administrative adjustment sends a strong price signal to both load and supply to respond to the shortage condition.  Those basic principles are, for all intents and purposes, beyond dispute. 

What is in dispute is whether PJM must effectively impose shortage pricing when there is no shortage.  The essence of PJM’s argument in this proceeding is that, without shortage pricing in non-shortage periods, its Tariff is unjust and unreasonable because it does not sufficiently compensate generators.  PJM argues that, instead of paying the marginal cost of providing the reserves in question, it must 3 pay all generators an administratively determined price above marginal cost even when there is no shortage.  That theory finds no support in Commission precedent or common sense and it should have been easily rejected. 

The same goes for the various purported problems to which PJM points in support of its complaint.  Simply put, none of the record evidence regarding low prices, uplift, market actions, or the growth of renewable resources shows that the existing energy and reserve market is unjust and unreasonable.  The only thing revealed by a careful review of the record, is that PJM has failed to satisfy its burden of proof to show that the existing rate is unjust and unreasonable. 4

PJM principally contends that its Tariff is unjust and unreasonable because it does not price reserves in a manner that reflects the operational value of the flexibility that they provide. 5  But that argument overlooks—or ignores—that an efficient market prices a service at, or at least near, the marginal cost of producing it. 6  As the Independent Market Monitor explained, the marginal cost of providing reserves will often be zero.  For example, when a resource is online and operating below its maximum output, it will be providing cost-free reserves equal to the MW difference between its current operating level and its maximum output.  That is common because, as the Independent Market Monitor explains, “zero cost reserves often exceed the reserve requirement because some generating units are inflexible and must be scheduled for hours ahead of and beyond the time at which they are needed to produce energy.” 7 

Those reserves surely have value.  If a resource trips offline or if demand unexpectedly surges, they could help pick up the slack.  But the fact that those costless reserves provide value to the system does not mean that PJM’s market is sending inefficient price signals just because it is not paying high prices to a resource that is providing reserves by operating at a profit-maximizing level that happens to be below its maximum output.  The Commission itself repeatedly explains that reserve prices should reflect the marginal cost of providing reserves, 8 but then utterly fails to square its finding that PJM’s Tariff is unjust and unreasonable because reserves prices are too low with the fact that the marginal cost of providing reserves will often be at or near zero. 9 

In an effort to illustrate what it sees as the problem with PJM’s current Tariff, the Commission points to a stretch of cold weather in January 2019. 10  It suggests that there must be a design flaw because the reserve prices were low during those frigid conditions. 11  But the record suggests that, from the perspective of the grid, the conditions were not actually that challenging:  PJM was operating with a reserve margin above 25 percent during the peak hour of that cold snap. 12  Nothing in PJM’s complaint—or today’s order—provides any reason to believe that the low reserve prices during that period were due to anything other than market fundamentals or that there is something amiss with those fundamentals.  Although the Commission suggests that the healthy reserve margin may have been due to the operator bias to commit additional reserves, 13 it fails to address the evidence provided by the Independent Market Monitor refuting that argument and explaining that the low prices were the result of an excess supply of resources self-scheduling into the market. 14  If anything, the evidence on this cold snap seems to show that the existing Tariff is more than up to the job, not that it is unjust and unreasonable.

Next, the Commission points to PJM’s contention that the tariff is unjust and unreasonable in part because of uplift payments caused by PJM’s operators taking out-of-market actions to dispatch resources. 15  No one can argue with the general goal of reducing uplift payments.  But, even so, it is not true that any existing tariff provision is unjust and unreasonable just because a change could be made that would conceivably reduce uplift payments. 

Instead, the Commission must show that there is something about these uplift payments in particular that renders PJM’s Tariff unjust and unreasonable—a showing it fails to make in this order.  The Commission points to the Independent Market Monitor’s 2018 State of the Market Report, suggesting that the fact that nearly half of the revenue for synchronized reserves was paid outside the market shows that there is an uplift problem that makes the Tariff unjust and unreasonable. 16  But, as the Independent Market Monitor asserts in disputing that characterization of his report, those uplift costs appear to be the result of issues with the settlements process that are outside the scope of PJM’s complaint. 17  The Commission, however, simply ignores the contrary evidence in the record and claims that the presence of these uplift payments shows that there must be a problem with the market for reserves.  Such conclusory assertions that ignore contrary evidence are not reasoned decisionmaking. 18  

In addition, both the Commission and PJM suggest that the replacement rate will help lower uplift costs.  Maybe, but that certainly does not show that the existing Tariff is unjust and unreasonable or that there is a problem with the current uplift payments.  After all, uplift payments to eligible resources (such as those committed out of merit for an unexpected reliability need) are based on the difference between their cost and the revenue they receive from the market. 19  Higher energy market prices would, all else equal, likely reduce that difference, thereby decreasing uplift payments.  But the fact that we could increase energy prices in order to decrease uplift does not necessarily mean that it would be just and reasonable to do so or, as relevant here, that PJM’s tariff is unjust and unreasonable because the market is yielding low prices, which themselves increase uplift payments. 

PJM and the Commission also argue that the mere presence of out-of-market operator actions is also a reason to find the Tariff unjust and unreasonable.  As with uplift, the goal of minimizing out-of-market actions, and instead pricing the steps operators take to maintain reliability, is a laudable one.  PJM and the Commission contend that, as a result of operator actions, PJM is procuring reserves well in excess of the minimum NERC standards:  In 2018, it carried 34 percent more Synchronized Reserves than the system requirement and 43 percent more Primary Reserves. 20  These out of market actions to procure additional reserves should be transparent and understood and PJM should endeavor to improve its markets’ design to incorporate those actions, at least to the extent justifiable.  

But, again, as with uplift, the fact that the underlying goal is laudable does not show that the existing Tariff is unjust and unreasonable.  Indeed, some out-of-market actions are inevitable, and, accordingly, proving that a Tariff is unjust and unreasonable requires reasoning quite a bit more thorough than simply pointing out that operator actions occur. 21  In addition, where the record contains conflicting evidence—as this one certainly does—section 206 requires the Commission to wrestle with the contrary evidence, not simply defer to PJM’s contentions, as today’s order does. 22  And while it may be just and reasonable for regions to take different approaches to procuring reserves beyond the NERC requirement, the Commission should not be so quick to find that procuring reserves consistent with that requirement is itself unjust and unreasonable. 23

Moreover, PJM’s existing Tariff permits it to take additional actions to address these very issues, suggesting that wholesale revisions to the Tariff may not be necessary.  For example, its current Operating Reserve Demand Curve (ORDC) has a two-step design with a “Step 2B” that allows PJM “to extend the reserve requirement when PJM operators [take] actions to schedule additional reserves during conservative operations.” 24  PJM explains that this authority to extend the reserve requirement has never been deployed, but fails to adequately explain why greater use of its existing authority could not go a long way toward remedying the problems that purportedly render the existing Tariff unjust and unreasonable. 25  It stands to reason that an RTO cannot decline to exercise its existing authority and then use that decision to explain why its existing Tariff is unjust and unreasonable. 

Finally, PJM contends that the Tariff is unjust and unreasonable because it will need additional reserves to provide the flexibility required to address the growth of variable resources, such as wind and solar. 26  As an initial matter, PJM has some of the lowest levels of variable resources of any RTO in the country—yet those other RTOs have managed to address the changing needs of their systems without filing complaints against their own tariffs—and, in any case, the Commission’s recent orders are doing plenty to slow down that transition. 27  SPP and CAISO, for example, routinely manage renewable generation levels well above 50 percent of total load without the type of reforms PJM claims it needs. 28  Moreover, with over 40 GW of new, highly efficient, and flexible combined-cycle natural gas turbines PJM has a resource mix that should easily accommodate its relatively slow growth in variable resources. 29 

The bottom line is that none of PJM’s arguments provide a compelling case that its existing Tariff is unjust and unreasonable.  And the analysis, such as it is, in today’s order equally fails to meet that burden.  Most of the Commission’s determination section consists of parroting PJM’s points and then asserting that the Commission disagrees with protestors, without a real explanation why.  Simply put, the Commission’s willingness to uncritically accept the representations in PJM’s complaint makes a mockery out of the well-established proposition that “Section 206’s procedures are ‘entirely different’ and ‘stricter’ than those of section 205.” 30

The Commission Fails to Demonstrate that Its Replacement Rate Is Just and Reasonable

In setting a replacement rate, today’s order largely rubber stamps PJM’s proposal to impose a complex and opaque administrative pricing scheme, which is expected to increase prices by between $500 million and $2 billion per year. 31   That replacement rate will result in pervasive scarcity pricing, even when reserves are plentiful. 32  That result is inconsistent with basic economic theory and, taken seriously, would appear to raise serious questions about how locational marginal prices are formulated in all other RTOs.  Suffice it to say, forcing customers to pay outrageous costs for reserves substantially in excess of the reserve requirements established by NERC and without any evidence of additional benefits commensurate with that additional cost is about unjust and unreasonable as you can get.

As noted, scarcity pricing is an essential element of any market-based approach to managing an electricity system.  It provides an economic incentive for resources to provide services that are in short supply, thereby providing more of those essential services.  But the logic of shortage pricing presupposes that there is a shortage.  Imposing scarcity pricing in the absence of a shortage is a way to generate windfalls for generators, not a just and reasonable response to market conditions.  

Imagine if ride-sharing companies, such as Uber or Lyft, all suddenly began doubling or tripling the cost of rides when there were far more cars on the road than customers using those apps.  Now imagine that those companies had a monopoly on transportation and you had to use those services to get where you want to go.  That would look a lot more like price gouging than a reasonable response to market fundamentals.  And yet, that is distressingly similar to the pricing regime that the Commission is imposing today.  That is a sad state of affairs for an agency whose primary purpose is supposed to be customer protection. 33 

To appreciate the implications of today’s order, we need to start with the shape of the ORDC and what it means both in terms of pricing and price signals.  Today’s order approves a transition from a vertical stepped demand curve for reserves, to a downward-sloping ORDC.  That downward slope supposedly reflects a probabilistic distribution of the likelihood that PJM would fail to meet its minimum reserve requirement for a reserve product when varying amounts of reserves in excess of the minimum reserve requirement are available to the system. 34  As a result, the downward-sloping ORDC extends far beyond the minimum reserve requirement and assigns a positive value to acquiring operating reserves well in excess of that requirement. 35  In particular, this positive value assigns every MW of load served a cost associated with failure to satisfy the reserve requirement.  That cost is the scarcity component that is added to the energy price.

And therein lies the problem.  Today’s order approves PJM’s proposal to procure reserves in excess of the reserve requirement as if it were facing a reserve shortage when it is not.  As the Independent Market Monitor explains, the extended slope of the new ORDCs creates “scarcity pricing at all times rather than when there is an actual shortage.” 36  The record suggests that this permanent shortage approach to pricing reserves will raise energy prices in 85 percent of the hours of the year. 37  The idea that PJM, out of all the RTOs, is facing a near-constant reserve shortage is frankly ludicrous.  

In addition, the record suggests that applying constant scarcity pricing regardless of system conditions can threaten reliability.  As Direct Energy observed, it could be particularly problematic during minimum generation events, when PJM needs to remove excess generation from the system to manage reliability.  With the new downward-sloping ORDC, PJM’s pricing mechanism will incentivize generation to come on to the system (and for load to come off), even as PJM is trying to get resources offline.  This dynamic can threaten reliability as it undermines PJM’s ability to manage a minimum generation event.  And that is particularly concerning here because, as the Independent Market Monitor points out, the extended reserve requirements created by the long slope of the new ORDC increases the likelihood of minimum generation events in the future. 38  

In fairness, a sloped ORDC would not be inherently unjust and unreasonable.  A sloped curve that reflected a realistic risk assessment could well be an appropriate approach to pricing excess reserves.  But that is not what we have here.  The downward sloping portion of the ORDC has no zero crossing point and can be more than twice as much as the reserve requirement. 39  That will result in the procurement of unneeded reserves and could result in prices as high as $12,000/MWh which appears far in excess of the value of lost load. 40  Neither PJM nor the Commission explain how the sloped curve in this order will provide reliability benefits anywhere near the roughly $500 million to $2 billion in annual costs that it will impose on customers. 41 

In addition, by more than doubling the Reserve Penalty Factor from $850/MWh to $2,000/MWh, today’s order also permits PJM to charge far too much for the reserves it procures. 42  PJM’s argument, which the Commission again uncritically accepts, is that the reserve penalty factor should be the same as the maximum price-setting energy offer cap, which, in Order No. 831, the Commission increased to $2,000. 43  But that argument overlooks the fact that offers cannot exceed $1,000/MWh without prior PJM approval of a cost-based offer 44 and the Independent Market Monitor contends that the short-run marginal cost rarely exceeds the current $850/MWh penalty factor. 45  The Commission’s statement that $2,000 is a just and reasonable Reserve Penalty Factor because generation resources can, under certain circumstances,submit cost-verified incremental energy offers up to $2,000/MWh ignores the fact that such prices are unlikely to occur 46 and makes no effort to wrestle with whether customers derive a benefit even remotely close to the incremental cost of such sky-high penalty factors. 47 

Using a $2,000/MWh penalty factor is likely an overstated value for the highest marginal cost resource on the system in all but the rarest of circumstances, but the impact of this is most severe when considering how the multiple products are designed to work together.  The Commission approves PJM’s proposal to make the reserve penalty factors additive across the different products and locational reserve. 48  In English, that means that total Reserve Penalty Factors could rise up to $12,000/MWh. 49  That is almost four times what other RTOs, such as MISO estimate as the Value of Lost Load 50 and even higher than the $9,000/MWh value used in the Electric Reliability Council of Texas’s (ERCOT) energy only market. 51 That $9,000/MWh figure in ERCOT is supposed to raise energy prices above marginal cost as an alternative to a capacity market.  Unlike ERCOT, PJM has a capacity market, albeit a troubled one, which would seem to undermine any justification for cumulative Reserve Penalty Factor thousands of dollars above ERCOT’s figures. 52 

Given the enormous costs imposed by today’s order, I am pleased to see that the Commission is at least requiring PJM to implement a forward-looking energy and ancillary services offset (E&AS Offset).  In theory, that should mitigate some of the enormous costs imposed by this proposal by reducing capacity market prices accordingly. 53  But getting a forward looking E&AS Offset right is no mean feat.  And getting it right is critical to properly establishing the Net CONE value that is used to anchor the VRR Curve 54 and that plays a central role in the sweeping administrative scheme imposed by the Commission’s recent MOPR Order. 55  I strongly urge PJM to consider multiple options for developing this forward-looking offset and provide the relevant details to the PJM stakeholders as transparently as possible.  Any proposal PJM makes on compliance must be properly vetted by PJM’s stakeholders. 

Finally, I note that the implication of the Commission’s adoption of an E&AS offset is that, without such an offset reflecting the changes imposed by today’s order, capacity market inputs that depend on E&AS, including Net CONE, could well be unjust and unreasonable.  Accordingly, it would seem that any offset would have to be in place before the next capacity auction if the results are to be deemed just and reasonable under the Commission’s own reasoning. 

I support changes to more accurately price operating reserves, which, when done well, should reward flexibility and ensure that both demand and supply receive accurate price signals to respond to changing system conditions.  I also support efforts to better define energy market needs that would increase the ability of resources to earn revenues in the energy and ancillary services markets based on the services they provide rather than through the slush fund that has become the PJM capacity market.  I remain open to proposals to improve PJM’s markets along those lines.  

Today’s order does not do that.  The record in this proceeding simply does not support a finding that the current market is unjust and unreasonable.  To be sure, the market is not perfect, but showing that an existing rate is unjust and unreasonable requires more than suggesting that there may be something better. 56  In any case, the replacement rate set by today’s order clearly is not a better approach.  Instead of incentivizing resources to respond to system conditions or improving price formation, it replaces the locational marginal price with an administrative construct that implements scarcity pricing even when there is no shortage.  This is an indefensible rate hike for consumers, not a just and reasonable solution. 

In closing, I am also deeply disappointed by the failure of leadership on the parts of both PJM and the Commission in how they appear to be approaching the changing needs of the grid.  Instead of using the coming growth of variable resources as a scapegoat to justify imposing excessive rates on consumers (and handing yet another windfall to generators), we should be considering how to best incentivize the resources that will provide the services needed to operate the grid reliably in the years to come.  There are many ways that PJM could do that; this just is not one of them.

For these reasons, I respectfully dissent.






                                               

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