On February 19, 2009, the Commission ruled that PJM’s three-pivotal-supplier test, used to identify sellers that can exercise market power, was not unjust and unreasonable and rejected complaints to have the test terminated. However, the Commission did require PJM to reform the test’s mitigation measures applied to suppliers who fail the test.

The test, which is also used in PJM’s regulation market (see December 5, 2008 edition of the WER), returns a finding of market power in situations where the power supplied by three suppliers, acting in collusion, is needed to meet market demand. Under those circumstances, the suppliers would be able to withhold supply and drive prices above competitive levels.

PJM will sometimes use offer caps to mitigate market power when the market is not structurally competitive. The Commission removed some of the test’s mitigation exemptions in 2008 because the exemptions would apply to certain generators regardless of transmission constraints. After these exemptions were removed the Commission became concerned that the three-pivotal-supplier test would then use the offer caps more often than it should. After PJM filed a report in September 2008, the Commission allowed for further comments before reaching a decision.

While PJM admitted that the three-pivotal-supplier test could be improved, the Commission ruled that its resulting rates were not unjust and unreasonable. The test is supported by economic literature and because it only compensates suppliers that have failed the test, the Commission was not convinced that it has a negative impact on market outcomes. The Commission went on to hold that what qualifies as available supply is not too restrictive, that the test should not be limited to a pre-determined, fixed geographic market, and that it should not be replaced with another market power screen.

While the test was not terminated, the Commission required PJM to adjust its mitigation measures to account for opportunity costs. Currently, PJM’s tariff provides for a mitigated offer price equal to incremental operating costs plus a 10% adder, but does not provide for opportunity costs in default bids. The Commission found this to be unjust and unreasonable since PJM’s tariff specifically allows for opportunity costs in other markets.

The Commission gave PJM until July 31 to make changes to its mitigation measures. A copy of the order can be found at the Commission’s website under Docket No. ER08-47-000.