Commissioner James Danly Statement
April 15, 2021
As I have made clear from the orders for which I have voted and by the explanations I have provided in my separate statements, I have long believed that the establishment and retention of a robust minimum offer price rule is necessary to ensure the integrity of our capacity markets. A minimum offer price rule prevents the price suppression inevitably caused by subsidies to certain generation resources, thereby ensuring that capacity markets can provide the critical missing money necessary to retain generation in necessary quantities thereby advancing our goal of ensuring resource adequacy.
The minimum offer price rule has also ensured the legal integrity of our markets. It has prevented the anti-competitive effects of price suppression which, if allowed in our markets, would undermine the principle that forms the basis for the Commission’s departure from cost-based ratemaking as our markets have developed. FERC has found, and the courts have agreed, that prices resulting from competitive markets satisfy the Federal Power Act’s just and reasonable standard. Should our markets be designed in such a way as to produce uncompetitive prices, that theory will no longer hold true and the rates produced in our markets will no longer satisfy the mandates of the Federal Power Act.
Having said that, I recognize the tension between the objective of maintaining competitive market outcomes through the use of a minimum offer price rule and the objective of fully accommodating the states’ undisputed right to select the generation resources constructed and operated within their borders, even when the cost of that capacity is higher than the clearing price that results from the RTO capacity markets.
In recognition of this impasse, I am offering for consideration and discussion a State Option to Choose Resources (SOCR) proposal intended to achieve all of the most important goals currently at issue in our review of the capacity markets. This proposal is designed to: (1) establish the right of states to choose preferred capacity resources to achieve state policy goals; (2) eliminate double payments by the states for the capacity they choose; (3) allow RTOs to avoid procuring capacity that will not be needed because state-supported resources will be constructed (even if not given awards in the capacity auction); and (4) prevent price suppression in the capacity markets that results from allowing subsidized resources to submit below-cost offers. The SOCR proposal is similar in some respects to ISO-NE’s CASPR program, with a major difference being that it gives states the unfettered right to substitute their preferred resources for resources that clear in a capacity auction.
In order to accommodate these conflicting objectives, this proposal, of necessity, does not provide the full advantages of a minimum offer price rule. At the same time, it seems to me that it could represent the basic framework by which to approach the problem of structuring a capacity market that accommodates the most important goals articulated among the various competing positions. It is my sincere hope that my colleagues, FERC staff, the markets and the public offer their thoughts regarding this proposal. If industry participants believe the proposal has merit, I hope that it can be considered in the various RTO stakeholder discussions. I am aware that this proposal has flaws, but with sufficient discussion, deliberation, and alteration those flaws may be mitigated or overcome.
I. Outline of SOCR Proposal
1. As a first step, the RTO would conduct its capacity auction under expanded minimum offer price rules designed to ensure that resources are offered into the market at their actual costs. Given that the costs of most renewables are declining and already are at competitive levels, I anticipate that these rules likely would not affect the ability of most renewables to clear the auction. Nevertheless, some such resources (such as off-shore wind resources) likely will have costs above the market-clearing price and therefore will not clear. In any event, the effectiveness of the SOCR proposal does not depend on the assumption that any particular amount of renewable resources would or would not clear the capacity auction.
2. The second step of SOCR implements the states’ option to choose the resources they prefer. After the capacity auction is conducted to determine the capacity price, but before capacity awards are made, the states (acting through state-regulated LSEs) may designate any resource whose offer was above the clearing price (Supported Resource) to be given a capacity award. The designation would not be limited to renewable resources but could be any resource the state wants to support for any reason. This option allows the states to direct which capacity resources are placed in service and used to satisfy the capacity requirements in that state. Such designations would be subject to the following conditions:
a. The owner of the Supported Resource would be given a capacity award that would entitle it to payment for its capacity at the market-clearing price established in Step 1. Because, as explained below, Supported Resources are substituted for resources that clear the capacity auction, the total amount of capacity payments made by the RTO does not change and, therefore, the capacity costs allocated to each state remains the same whether or not it makes a Supported Resource designation.
b. The owner of the Supported Resource would be required to agree to take on the same capacity obligations applicable to all resources receiving a capacity award in terms of a must offer obligation in the energy markets, capacity performance requirements, payment of penalties for non-performance, etc.
3. In the third step, the RTO calculates the total capacity of all the Supported Resources designated by all LSEs. This capacity is then subtracted from the total amount of capacity whose offers cleared the capacity auction. Capacity awards would only be given in an amount equal to this reduced amount of capacity. Resources with the highest offers that cleared (Replaced Offers) would not be given awards. This prevents the RTO from procuring capacity in the auction that is not needed because state-supported capacity is constructed even without a capacity award. However, no adjustment would be made to the capacity price as a result of this reduction in capacity awards.
a. Adjustments to the amount of capacity reduction and/or which units do not receive awards likely will be needed to ensure that all internal import and export constraints for each LDA is respected.
i. Special rules may need to be developed to address the situation where it is not possible to fully comply with all of the states’ Supported Resources designations and satisfy the applicable LDA internal import/export constraints
b. It is possible that a Replaced Resource could have been designated by a state as a Supported Resource. If so, there would be an iterative process of designations and identification of new Replaced Resources until all resources the states want to support have either cleared the auction or have been designated as Supported Resources.
II. Illustrative Example
The following example illustrates how SOCR would work. A New Jersey LSE has a load of 1,000 MW. The capacity auction, applying an expanded minimum offer price rule, establishes a capacity price of $100/MW for 100,000 MW of capacity in PJM. The costs of a 1,000 MW offshore wind resource with a capacity value of 400 MW are $120/MW, so it does not clear.
The LSE then designates the off-shore wind capacity resource as a Supported Resource, and the owner of that resource receives a capacity award in exchange for its agreement to take on a capacity obligation.
If the off-shore wind resource was the only Supported Resource in PJM, then PJM would subtract that resource’s 400 MW of capacity from the 100,000 MW of capacity that cleared the auction, and give capacity awards to the remaining 99,600 MW of resources that cleared the auction plus the off-shore wind resource that was designated as a Supported Resource. The owners of the 400 MW of capacity with the highest offers that cleared the auction would not receive capacity awards.
III. Analysis
SOCR is a proposal that attempts to harmonize the competing goals of accommodating state policy choices and preserving the competitiveness of the RTO capacity markets. The ability of the states to select their own resources for any policy reason is achieved by allowing them to designate any quantity of Supported Resources that do not clear in the auction. States do not double pay for Supported Resources that do not clear the auction because Supported Resources are substituted for Replaced Resources and the states are not required to pay for both. And the RTOs do not procure unneeded capacity because the quantity of resources receiving capacity awards is reduced by the capacity of Supported Resources. Finally, SOCR protects the capacity auction price from price suppression caused by state subsidies because of the application of minimum offer price rules to the capacity price, which helps to ensure resource adequacy.
It also should be noted that SOCR should be relatively easy to implement. SOCR does not change how RTO auctions currently are conducted, how capacity payments are determined, or how the costs of capacity are allocated among the RTO’s LSEs. The only material change is that states now would be given the option to designate preferred resources as Supported Resources, which would be substituted for Replaced Resources. The only new calculation required to implement the proposal is the calculation required to identify the Replaced Resources and to determine their effect on LDA import and export constraints. However, this calculation would be substantially similar to the first run of the capacity auction used to determine the market-clearing price.
It is not possible, however, to completely harmonize the two competing goals of accommodating state policy choices and preserving the competitiveness of the RTO capacity markets. SOCR’s approach to address this conflict is through its creation and treatment of Replaced Resources. This provision of SOCR represents a downside for owners of conventional resources not supported by the states. Replaced Resources—which by definition will be resources that have not been designated as Supported Resources—will not receive capacity awards even though their offers were at or below the market-clearing price. However, Replaced Resources will be the least efficient, highest cost resources that cleared, and thus the choice of these resources to be replaced by Supported Resources represents the economically efficient way to allow states to substitute their supported resources for resources that clear the capacity auction but in fact will not be needed for resource adequacy because of the capacity provided by Supported Resources.
SOCR’s provision retaining the market-clearing capacity price established by the offers of Replaced Resources that then do not receive capacity awards appropriately mitigates the effects on the capacity price of substituting Supported Resources for Replaced Resources. Supported Resources have higher costs than the Replaced Resources; otherwise they would have cleared in the auction and would not have been designated by the states. If the capacity price were recalculated based on the costs of the Supported Resources, the revised capacity price would increase over the market-clearing price established from the costs of the Replaced Resources.
It is true that the capacity price under SOCR would be reduced if the costs of Supported Resources were not taken into account and the market-clearing price was recalculated based on the highest cost resource remaining after Replaced Resources are removed from the calculation. But this would eliminate the entire point of the SOCR proposal. I take the states at their word that they are providing support to renewable resources to support their public policy goals, and not simply to suppress prices. SOCR accommodates all of the objections that the current minimum offer price rules interfere with state policy choices: (1) SOCR allows the states to ensure that their preferred resources are used to serve their loads; (2) SOCR prevents states with supported resources from being required to double pay for their capacity; and (3) SOCR prevents RTOs from procuring capacity that is not needed because state supported resources will be place in operation even with a capacity award. The only remaining reason to eliminate a minimum offer price rule would be to allow state subsidies to suppress the capacity auction price by allowing supported resources to submit below cost offers. To the extent a state intends for its support of a resource to suppress market prices, then that price suppression would constitute the exercise of buyers side market power that minimum offer price rules legitimately should prevent.
I believe there is a reasonable possibility that there will not be a large number of Supported Resource designations. As explained above, most renewable resource technologies are cost competitive and should receive capacity awards even when subjected to a minimum offer price rule. If so, there would be a relatively small number of Replaced Resources, and the issues associated with SOCR’s treatment of such resources would be minimized. However, I believe that SOCR would be viable even if there are a large number of Supported Resources.
IV. Other Capacity Market Design Issues
Finally, I observe that there have been a number of other important issues raised with respect to capacity market design. These include such issues as the relationship between capacity prices and energy and ancillary services prices, establishing the appropriate capacity value provided by intermittent resources, determining the appropriate level of demand to ensure reliability, and the appropriate shape of the demand curve. The SOCR proposal does not make any assumptions regarding these issues, and its effectiveness should not depend on the answers ultimately reached for those issues.
V. Request for Feedback
I am still considering the relative merits of the SOCR proposal as opposed to other capacity market designs, including the minimum offer price rule I have supported in the past. I would be interested in hearing criticisms of this proposal both with respect to its economic viability and its legality. I am also interested in hearing the ways in which this proposal could be improved to better harmonize the competing objectives that various parties have advanced for the capacity markets.
Any comments or thoughts on this proposal that you want to bring to my attention should be directed to Matt Estes at Matthew.Estes@FERC.gov.