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No Generator Left Behind

A new theory on capacity markets and the missing money.

Fortnightly Magazine - May 2008

to the cost of new entry, nor even any need for the region to define a value for gross or net CONE. Yet the need remains to avoid double recoupment of the missing money, so the FCM contains a reconciliation step that is roughly parallel to the RPM construct, known in New England as the “ ex post PER adjustment.” By this mechanism, ISO New England deducts peak energy revenues (revenues for sales of energy and ancillary services that exceed the marginal generator operating cost) from capacity payments paid to generators. The PER adjustment is in a way generic; the ISO first calculates the excess peak revenues that would be earned by a hypothetical prototype turbine unit with a given heat rate—a unit of middling fuel efficiency —and puts producers at risk if they cannot match that performance. In other words, producers know, before they bid into the FCM, that they have a chance to earn a windfall in the energy market, but that the ISO eventually may take that windfall away through the ex post PER adjustment. But they can minimize that risk by exceeding the target efficiency of the prototype unit.

Lagging Numbers

The problem in PJM, meanwhile, is that while capacity prices are forward-looking, the ex ante E&AS offset is lagging—based on a three-year historic average of energy market revenues.

An exhaustive 85-page study prepared recently for the American Public Power Association presents evidence showing that producer revenues in PJM’s Energy and AS markets are rising steeply with every passing year—a trend not captured in RPM capacity prices. (See, “ Raising the Stakes on Capacity Incentives: PJM’s Reliability Pricing Model ,” James F. Wilson, LECG consulting, March 14, 2008) Given these forward price adders and lagging price offsets, calls have come for FERC intervention, led by the PJM RPM Buyers group, which includes state regulators and consumer advocates in Maryland, Ohio, New Jersey, Pennsylvania and D.C., plus the PJM Industrial Customer Coalition, the U.S. Dept. of Defense, and Donald Sipe’s American Forest & Paper Association, among many others. (See, RPM Buyers’ Motion for Technical Conference, FERC Docket No. ER05-1410, filed March 19, 2008.)

Of course, power-plant construction costs are rising dramatically. Also, PJM’s capacity market solicits new investment three years down the road, when costs will be higher still. Three months ago, on February 14, Cambridge Energy Research Associates released its latest IHS/CERA Power Capital Costs Index. The new PCCI showed that the cost of new power-plant construction in North American had risen 27 percent in 12 months, and 19 percent in the most recent six months, reaching a level 130 percent higher than in 2000. (See, 2008 .)

The oft-cited Handy Whitman Index suggests a similar trend: A 15 percent increase in gas turbine construction costs from 2006 to 2007. (See, “2008 Update of Cost of New Entry Combustion Turbine Power Plan Revenue Requirements,” Pasteris Energy, Inc., available as attachment to PJM’s proposed RPM revisions, FERC Docket No. ER08-516, filed Jan. 30, 2008.)

All these points fell on deaf ears at FERC, however. In its recent opinion