On November 15, 2017, PJM Interconnection LLC (“PJM”) released two proposals to modify how Locational Marginal Prices (“LMPs”) are formed in its wholesale energy market and to enhance compensation for resources providing essential grid services during “shortage” periods.  The LMP proposal seeks to enhance system reliability by expanding the eligibility criteria for setting wholesale energy market prices in the PJM footprint.  Practically speaking, this proposal will allow a wider variety of energy resources, notably less economically flexible generating units such as coal and nuclear generators, to set LMPs and increase their revenue recovery prospects.  Along with the U.S. Department of Energy’s Notice of Proposed Rulemaking currently before FERC (see October 2, 2017 edition of the WER), PJM’s dual proposals represent the latest developments in an ongoing national discussion about whether, and how, organized electricity markets can play a role in ensuring fuel diversity and system reliability through pricing mechanisms.

As PJM argues in its LMP proposal, increasing penetrations of zero-marginal-cost energy resources, declining natural gas prices, and enhanced energy efficiency, are revealing the “shortcomings” in energy pricing mechanisms—namely, according to PJM, that such mechanisms fail to reflect the true incremental cost of electricity and incent the necessary flexibility attributes to maintain a reliable grid.  “The right price in the energy market,” PJM asserts, “should not only reflect the true incremental costs of resources required to serve load, but also drive incentives for pricing the flexibility needed to operate the system, given the constantly changing nature of its conditions.”

To achieve that end, PJM’s proposal sets out an “extended LMP methodology” through which economically “inflexible” units can compete alongside more flexible units to set LMP.  Notably, PJM defines “inflexible” generating units without regard to fuel type: units with declining average costs that are unable to economically produce power within a certain range or require an economic minimum output.

Should the proposal be adopted by stakeholders and approved by FERC, PJM stated that it anticipates that price signals will more accurately reflect the true incremental costs of serving load.  PJM also acknowledged that energy market costs are likely to increase, since the market will compensate resources for providing reliability services that are uncompensated today. In exchange, however, PJM argues that market participants will benefit from improved market transparency and efficiency.

Alongside its price formation proposal, PJM also presented a separate proposal designed to provide clear, transparent pricing signals to incent generators to operate during periods of resource scarcity or “shortage.”  This proposal would create a 30-minute operating-reserve product to supplement PJM’s current 10-minute reserves, and would revise PJM’s current reserve demand curve to value more granular amounts of reserves.  Although not a replacement for its capacity market, PJM explained, a more enhanced shortage pricing mechanism would help prevent an over-reliance on capacity market compensation by allowing generators to collect additional revenue for operating during shortage conditions.

PJM outlined the broad strokes of its proposals in its comments to FERC on the Department of Energy’s proposed rulemaking, but will likely submit them separately for FERC’s consideration and approval.  Meanwhile, PJM stakeholders are expected to have an opportunity to discuss these proposals in the coming weeks.

A copy of PJM’s LMP and Shortage pricing proposals can be found here.