On January 21, 2016, FERC issued a Notice of Proposed Rulemaking (“NOPR”) proposing to revise the $1,000/MWh cap on supply offered in day-ahead and real-time markets run by regional transmission organizations (“RTOs”) and independent system operators (“ISOs”). Specifically, FERC proposes to revise the offer cap in RTO/ISO markets to the higher of $1,000/MWh or that resource’s verified cost-based offer.

Currently, offers are capped at $1,000/MWh under the tariffs for all RTOs/ISOs except PJM’s, which has a $2,000/MWh offer cap on cost-based incremental energy offers used for purposes of calculating Locational Marginal Prices (“LMPs”) (see December 21, 2015 edition of the WER). Although the current offer cap for each RTO/ISO restricts incremental energy offers, the offer cap does not limit LMPs to the level of the offer cap because the LMP can exceed the offer cap due to congestion and loss components of the LMP, scarcity pricing, and emergency purchases. In addition to the offer cap, a resource’s incremental energy offer is subject to market power mitigation provisions for each RTO/ISO.

In the NOPR, FERC found that the current offer cap may no longer be just and reasonable for several reasons. First, FERC stated that the offer cap may unjustly prevent a resource from recouping its costs by not permitting that resource to include all of its short-run marginal costs within its supply offer. Second, FERC found that the offer cap can suppress LMPs to a level below the marginal cost of production. Third, FERC stated that, because of the offer cap, a resource with short-run marginal costs above the cap may choose not to offer its supply to the RTO/ISO, even though the market may be willing to purchase that supply. Finally, FERC determined that, when several resources have short-run marginal costs above the offer cap but are unable to reflect those costs within their incremental offers due to the cap, the RTO/ISO is unable to dispatch the most efficient set of resources because it will not have access to the underlying costs associated with the multiple incremental energy offers above the offer cap. FERC found that these issues run counter to two of FERC’s goals in the price formation process: (1) clearing prices in the energy and ancillary services markets should ideally “reflect the true marginal cost of production, taking into account all physical system constraints”; and (2) LMPs should “ensure that all suppliers have an opportunity to recover their costs.”

To remedy these potential issues, FERC proposes three requirements to the revised offer cap. First, a resource’s incremental energy offer used for purposes of calculating LMPs must be capped at the higher of $1,000/MWh or that resource’s cost-based incremental energy offer. The cap would apply to incremental offers in both the day-ahead and real-time markets. Second, the costs underlying a resource’s cost-based incremental energy offer above $1,000/MWh must be verified by the Market Monitoring Unit or the RTO/ISO before that offer can be used for purposes of calculating LMPs. If a resource submits an incremental offer above $1,000/MWh and the costs underlying that offer cannot be verified before the market clearing process begins, that resource’s incremental offer in excess of $1,000/MWh may not be used to calculate LMPs. Under that scenario, a resource would be eligible for a make-whole payment if that resource clears the market and the resource’s costs are verified after-the-fact. Third, all resources, regardless of type, are eligible to submit cost-based incremental offers in excess of $1,000/MWh. To implement the revision, FERC proposes to make the offer cap applicable to all RTOs/ISOs through a rulemaking to avoid exacerbating seams issues that might arise if one RTO/ISO has an offer cap that materially differs from a neighboring RTO/ISO’s offer cap.

In the NOPR, FERC also rejected alternatives to its proposal. Specifically, FERC rejected a floating offer cap that would change with natural gas prices, finding such a cap would be unduly preferential to natural gas-fueled resources. Furthermore, FERC argued that setting the offer cap for all resources based on the price of natural gas would allow non-natural gas resources to submit offers above $1,000/MWh and below the natural-gas based offer cap with no cost basis for doing so, thereby potentially allowing these resources to exercise market power when natural gas prices rise but when these resources’ costs do not similarly rise. In addition to the floating cap, FERC rejected raising the offer cap to a higher fixed level because, according to FERC, a higher fixed offer cap could still limit a resource’s incremental energy offer below its short-run marginal cost and potentially suppress LMPs if that resource’s costs rose above the fixed offer cap. FERC also argued that, like the floating offer cap, a higher fixed offer cap could raise market power concerns.

Going forward, FERC is seeking comment on several aspects of the proposal, including whether to adopt a hard cap on cost-based incremental offers used for purposes of calculating LMPs and, if so, what the hard cap level should be. Comments on the NOPR are due 60 days after publication in the Federal Register. A copy of the NOPR can be found here.