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The High Cost of "Free" Capacity

Fickle behavior by LSEs threatens to destabilize organized markets.

Fortnightly Magazine - May 2008

It is naive to think that energy services can be obtained for free. But the recent withdrawal of Duquesne Light Co. from PJM, along with market-reform proposals presented by industrial consumers and public power utilities to address what they believe is an absence of just and reasonable prices in wholesale energy markets, are nothing more than attempts to obtain free electric services—especially generating capacity needed to ensure reliability.

Not all industrial consumers are dissatisfied with organized competitive markets. FERC has received numerous comments in support of the current market-based approach, including one submitted by the COMPETE coalition together with 81 other parties—which included industry experts, Nobel laureates and such large customers as Wal-Mart.

Nevertheless, to the degree policymakers begin accepting proposals from parties opposing competitive market constructs like PJM’s, wholesale electricity markets might turn down a perilous path of reduced reliability and higher costs. The end result would be a return to the old and onerous paradigm of vertically integrated utilities that these same customer groups so vigorously wished to escape in the early 1990s.

Return to Cost-Plus

Last November, Duquesne filed with FERC an application requesting termination of its membership as a transmission owner and load-serving entity (LSE) in PJM. FERC conditionally approved the withdrawal on January 17, 2008. The request explicitly was predicated on Duquesne’s desire to avoid capacity charges under PJM’s new reliability pricing model (RPM).

Duquesne is located on the seam between the Midwest ISO (MISO) and PJM and, therefore, can transition to the MISO—whose capacity market is under development, and its future structure is unknown. MISO requires LSEs to satisfy capacity requirements through owned generation and bilateral arrangements—including short-term capacity purchases currently available at low prices.

In a different FERC proceeding focused on potential reforms to organized wholesale electric markets, some industrial groups called for radical changes to the structure of current wholesale markets. In some cases, consumer groups have presented proposals that attempt to micromanage both energy and capacity markets. While not necessarily intentional, the inevitable result of such proposals would be a return to full re-regulation of electricity markets. For example, under the sophistry of a “forward resource commitment auction process,” a group of industrial consumers proposed a cost-based mechanism in which generating units would be eligible for unit-specific revenue recovery over the long term—through a FERC tariff—and energy bids would be subject to must-offer requirements under the old-fashioned cost-plus approach.

Other market participants have presented more innovative market design alternatives. The American Forest & Paper Association (AF&PA), which embodies some of the largest consumers of electricity in the country, submitted an innovative—albeit fundamentally flawed—proposal called “financial performance obligations” (FPOs). Similar positions have been hotly contested during the development of

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