Washington — PJM Interconnection recently made key changes that could push capacity prices lower, but observers say those impacts could be offset or exaggerated depending on how federal regulators decide to address the effects of state subsidies in the grid operator's capacity market.

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The interplay between the two policies is significant because it shows yet another thread of complexity involved in the ongoing effort to fix PJM's capacity market.

The Federal Energy Regulatory Commission in April accepted changes to PJM's variable resource requirement (VRR) curve, which determines the amount of capacity needed to meet PJM's reliability requirements.

The curve is anchored by the Net Cost of New Entry (CONE), which is the cost of a theoretical new power plant, minus the money that plant would earn selling energy and ancillary services in PJM's other markets. Net CONE represents the capacity revenue a new generator needs to enter the market.

VRR CURVE UPDATE

The changes to the VRR curve did two main things: reduced Net CONE by basing it on a newer, more efficient combustion turbine; and undid a shift in the VRR curve to reflect the fact that PJM is less worried about increased generator retirements driven by environmental regulations and cheap gas.

All else being equal, the changes are expected to have a bearish impact on capacity prices, said Kieran Kemmerer, an analyst with S&P Global Platts Analytics. Had it been in place during the last auction, the updated VRR curve could have reduced capacity clearing prices by $30-$40/MW-day, according to a recent S&P Global Platts Analytics special report on the issue.

PJM capacity prices will also be heavily dependent upon other pending reforms, Kemmerer said. "Whether it will be exacerbated or offset by capacity market reforms concerning the treatment of subsidized resources remains to be seen," he said.

PJM last fall proposed to expand its minimum offer price rule (MOPR) to subsidized resources, with few exceptions. The grid operator outlined a couple of options to address the impact of state-subsidized resources on the capacity market (EL16-49).

The resource carve out, or RCO, option would allow subsidized resources to clear the capacity auction at a price of zero, but they would not receive capacity payments. The extended RCO option would add a step to restore the residual market clearing price closer to where it would have been if subsidized resources had not cleared at a price of zero.

MARKET IMPACTS

PJM's RCO proposal could further suppress clearing prices by $10-$20/MW-day, Kemmerer said. But the extended RCO option could lead to a $10-25/MW-day increase in the auction clearing price, which could offset reductions from a change in the VRR, he said.

PJM says that in isolation from any other variables, the VRR curve changes would tend to have a downward pressure on prices. "But as one of many factors that influence capacity prices we could not predict the overall impact on capacity prices from last year to this year," PJM spokesman Jeff Shields said Friday.

Absent any other factors, the RCO option would tend to lower capacity prices and the extended RCO is intended to correct this suppressive effect, Shields said.

STAKEHOLDER CONCERNS

While the VRR curve changes will reduce procurement, environmental groups have urged FERC to do more to address over procurement in PJM. In the VRR curve proceeding, they wanted Net CONE to be based on a combined-cycle gas plant, rather than a combustion-turbine gas plant, a change that would have further reduced Net CONE.

FERC action to address state-subsidized resources could exacerbate over procurement, Casey Roberts, a senior attorney at the Sierra Club Environmental Law Program, said in an interview. "If there is no carve-out, that will cause capacity prices to go back up and would outweigh the slight benefit that FERC handed consumers here," she said.

Sierra Club plans to ask for rehearing of FERC's decision on the VRR curve, Roberts said.

But merchant generators say the 25%-30% reduction in CONE in the VRR curve is alarming and ignores the fact that private equity investors have different expectations from their investments than publicly traded companies. While there is a lot of capacity in PJM right now, some resources on the edge of economic viability and VRR curve changes could push these plants to retire, said Glen Thomas, who represents the PJM Power Providers Group.

"Anytime you have a tightening of the market like this, it will put pressure on the units that are on the bubble," he said. "And to the extent units are teetering on the financial edge, this could push them over." Regarding state-subsidized resources, P3 has urged FERC to apply the MOPR with no carve-out.

-- Kate Winston, kate.winston@spglobal.com

-- Edited by Matt Eversman, newsdesk@spglobal.com