How will the new FERC MSOC rules impact the PJM capacity market?
In the PJM capacity market, the Market Seller Offer Cap (MSOC) is designed to prevent the economic withholding of capacity by requiring resources to justify their offer prices. Resources can justify their offers through a unit-specific review process or can elect to use a default MSOC value.
On September 2, 2021, FERC ordered PJM to implement new rules for determining the MSOC. These new rules set the MSOC at the unit-specific net Avoidable Cost Rate (ACR), with the default MSOC values calculated using default gross ACR values for each resource type in place of a unit-specific review. This is effectively a return to the offer cap system that predates the outgoing MSOC rules.
Despite concerns over low default MSOC values given the low default gross ACR values for some resource types, this new rule does not actually change any underlying market economics. Therefore, it should (in theory) have no impact on market prices, provided that all resources are offered competitively. If anything, reports from the IMM indicate that recent market prices are too low for many coal and nuclear resources to recover their ACRs, which suggests that market prices might increase even with this rule change. However, this rule change may require a large portion of resources to go through the unit-specific review process to justify their bids, which has not been necessary in recent auctions. While this should better serve to mitigate market power concerns, it is unclear how it may shift bidding strategies for different resources, which may have some impact on market prices in the immediate term.
Previous MSOC rules
The previous MSOC rules were developed as part of the Capacity Performance changes. Under these rules, the MSOC was set at the opportunity cost of accepting a capacity obligation, based on the expected performance bonuses for an energy-only resource. As a result, the MSOC value heavily depended on the amount of Performance Assessment Intervals (PAIs) assumed during the calculation.
It became evident that there was a disconnect between the MSOC values calculated under the previous rules and the market reality. All five Base Residual Auctions (BRAs) conducted under the previous rules cleared substantially below the MSOC values. These high MSOC values also resulted in extremely few offers being subject to unit-specific review by the IMM. For example, the IMM reports that only 0.7% of offers were subject to unit-specific offer caps in the 2021-2022 BRA, compared to 10.5% of offers in the 2017-2018 BRA, which was held under the older rules.
Following complaints by the IMM and several PJM consumer advocates, FERC found the existing MSOC rules to be unjust and unreasonable, in particular highlighting the PAI assumptions used that have resulted in inflated MSOC values, thus preventing the MSOC from effectively serving its purpose of mitigating the potential exercise of sell-side market power.
New MSOC rules
The new MSOC rules require any non-zero offers to be justified based on the unit-specific net ACR for each resource. The net ACR is calculated as the gross ACR minus any expected net revenues from participating in the energy and ancillary services (E&AS) markets. This approach is conceptually based on the competitive offer for a capacity resource based on the underlying economic logic of the capacity market.
The unit-specific net ACR calculation is subject to review by the IMM. In lieu of a unit-specific gross ACR, resources may elect to use the default gross ACR values that were recently approved by FERC in the MOPR proceeding, in combination with a unit-specific net E&AS revenue value calculated by the IMM.
These new rules go into effect immediately. The first auction under these rules will be the Base Residual Auction for the 2023-2024 Delivery Year, which is scheduled to be held in December 2021.
While the new MSOC rules represent a departure from the prior approach, they effectively are a return to the offer cap system that was in place prior to the Capacity Performance changes.
Avoidable Cost Rate
The ACR has a particular meaning as defined in the PJM tariff. The tariff specifies which costs are eligible to be included when calculating the ACR for each resource. The full ACR definition can be found in Section 6.8 of Attachment DD to the PJM tariff.
In the FERC docket, market participants raised several concerns regarding the switch to an MSOC based on the unit-specific net ACR. Concerns included the potential complexity of the unit-specific review process, particularly when including risk-based components, and the potential administrative burden associated with handling numerous review requests. However, FERC dismissed these concerns, and reiterated that market participants can request FERC action if they are unable to reach an agreement with PJM and the IMM during the unit-specific review process.
Default gross ACR
The default gross ACR values that were previously approved in the MOPR process will also be used in the MSOC calculations. Some of these values are notable for being relatively low compared to typical expectations for those resource types.
For example, the default gross ACR values indicate that a $80/MW-day capacity price should be more than sufficient for a representative coal resource, particularly as the gross ACR values exclude any net E&AS revenues. Meanwhile, there have been numerous coal retirements in recent years with further retirements expected in the near future, despite RTO capacity prices averaging $106.26/MW-day over the previous five auctions. In presentations from the development process of these default gross ACR values, it is noted that any “necessary and routine expenditures to maintain performance” were assumed as variable costs and not included in the gross ACR. Thus, an $80/MW-day gross ACR for a representative coal plant is justifiable, provided that the resource also has variable costs of $9.56/MWh. It is unclear whether this cost treatment reflects the operating reality for many existing resources.
Takeaways
The new MSOC rules do not impact the underlying economic fundamentals of the capacity market, nor do they impact the actual costs that resources need to recover to remain economic. From this perspective, there is no inherent reason to expect that the new MSOC rules will impact the market prices, provided that resources are willing to undergo the unit-specific review process.
In practice, it remains to be seen whether the unit-specific review process imposes any significant burden on market participants. FERC highlighted that market participants should already have a detailed understanding of their costs, and thus summarizing these costs and providing the underlying assumptions and data should not require significant effort. Market participants are also incentivized to undergo the unit-specific review process where necessary to ensure that their resources only accept capacity obligations at prices that allow them to recover their costs. However, the prompt timing of the upcoming auction could prove challenging, given that offers need to be finalized and submitted by early December 2021.
Regardless of any potential impacts of adapting to the new MSOC rules in the immediate term, we do not believe that this rule change will impact the market in the long term. As mentioned previously, nothing in the MSOC rules impacts the underlying resource economics of the system, which are ultimately the primary driver of the long-term market prices.
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