White Paper: Commissioner James Danly on the Requirement that Competitive Markets be Protected from the Exercise of Market Power Applied to RTO Capacity Markets

Commissioner James Danly Statement
June 17,  2021

On May 20, 2021, our office issued a White Paper explaining why, under the law, RTO capacity markets cannot produce just and reasonable rates absent mechanisms that protect the market against the exercise of both seller-side and buyer-side market power, including buyer-side market power exercised by the states.  We have received a great deal of feedback from many stakeholders and sincerely appreciate the engagement.  One comment that we have received several times is that state action to subsidize resources cannot constitute the exercise of buyer-side market power because the states are not acting as buyers of power as their subsidies generally go to sellers, not buyers.

We are providing this supplement to our White Paper to address that comment.  As explained below, it might perhaps be more accurate to describe state subsidies as providing incentives to owners of generation resources to exercise seller-side market power to reduce capacity market clearing prices.  In any event, regardless of how one characterizes state subsidies: (1) the Commission and the courts have long found that it is appropriate to mitigate the price suppressive effects of state actions to subsidize generation; (2) it is necessary for RTO capacity markets to mitigate the price suppressive effects of state subsidies in order for capacity market prices to be just and reasonable; and (3) the intent of the states and the legitimacy of their reasons for offering subsidies is irrelevant to the question of whether the subsidies affect the justness and reasonableness of RTO capacity market prices.

We are interested in hearing reactions to this supplement.  Please contact Matt Estes at matthew.estes@ferc.gov if you would like to discuss this further.

1. STATE SUBSIDIES PROVIDE INCENTIVES TO GENERATION OWNERS TO EXERCISE SELLER-SIDE MARKET POWER TO REDUCE CAPACITY MARKET CLEARING PRICES

It is of course true that states do not directly purchase power.  Furthermore, the fixed demand curves used in RTO capacity auctions make it very difficult for any purchaser of capacity to directly influence capacity prices.  That being the case, it is worth pausing to consider exactly how it is that state subsidies suppress RTO capacity market prices.

The answer is that the price suppression occurs through offers submitted into the auctions by subsidized sellers of capacity.  As a general matter, an unsubsidized generation owner has an incentive to submit a capacity offer at a price close to its marginal cost.  Otherwise, the owner would run the risk of receiving a capacity award at a clearing price below its marginal cost that would obligate the owner to operate its facility at a loss.[1] 

By contrast, state subsidies make sellers indifferent as to whether they receive a capacity award priced below their marginal costs because the subsidy makes up any shortfall in market revenues earned by the seller.  Therefore, owners of subsidized units have an incentive to offer below their marginal costs because their subsidy ensures that they will not operate at a loss even if the capacity market clears at a price below their marginal costs.  Indeed, the entire objection to RTO minimum offer price rules (MOPRs) is that they prevent owners of subsidized generation resources from offering into capacity markets at prices below their marginal costs.

It is the price suppression caused by the submission of below-cost offers by sellers that has led RTOs, with the Commission’s approval, to implement MOPRs that apply to offers by sellers of capacity from state-supported resources.  In New Jersey Board of Public Utilities v. FERC, for instance, the Third Circuit accepted FERC’s justification for such application of a MOPR by PJM:

[T]he actual prospect of thousands of megawatts of new generation, developed under arrangements that would explicitly subsidize the resources regardless of Auction price, potentially being offered into the Reliability Market at a zero bid brought into focus the distortive effect—no longer “theoretical”—that the state exemption could have on market prices for all capacity.[2]

Whether state subsidies that create incentives for thousands of megawatts of below-cost capacity offers by sellers is properly characterized as the exercise of “buyer-side market power” is beside the point.  If the price suppression is not caused by buyer-side market power, it is caused by seller-side market power.  Either way, state subsidies artificially and unreasonably suppress capacity prices in an unduly preferential and discriminatory manner that must be mitigated to protect the integrity of a capacity market premised on competition.

Currently, the capacity markets in PJM and ISO-NE are deemed to be uncompetitive, and therefore market power mitigation is applied to all offers by all generation resources into their capacity markets.[3]  This mitigation must prevent both the exercise of market power to artificially increase capacity prices and the exercise of market power to artificially suppress capacity prices.

2. THE COMMISSION AND THE COURTS HAVE LONG FOUND IT NECESSARY TO MITIGATE THE PRICE SUPPRESSIVE EFFECTS OF STATE ACTIONS TO SUBSIDIZE GENERATION

Regardless of how state subsidies are characterized, both the Commission and the courts have consistently recognized that the price suppressive effects of such subsidies must be mitigated.  And the Commission’s orders to this effect have consistently been upheld on appeal.

For example, in 2008, the Commission upheld NYISO’s application of a MOPR to state-supported resources, finding that “uneconomic entry can produce unjust and unreasonable prices by artificially depressing capacity prices and NYISO’s proposal provides a reasonable means to deter that uneconomic entry.”[4]  The Commission concluded that, “at this time, the NYPSC has provided inadequate justification either for a general exemption [from the MOPR] or for a finding that the appropriate mechanism for supporting its goals is, in fact, an exemption from the price floor for new capacity.”[5]

In 2011, the Commission approved PJM’s proposal to eliminate the exclusion of state-supported resources from its MOPR.[6]  The Commission explained that:

The mounting evidence of risk from what was previously only a theoretical weakness in the MOPR rules that could allow uneconomic entry has caused us to reexamine our acceptance of the existing state exemption, which we approved as part of the 2006 RPM Settlement Order.  For these reasons, we accept as just and reasonable PJM’s proposal to eliminate the current state exemption.[7]

As noted above, on appeal to the Third Circuit, the court accepted the Commission’s reasoning that application of the MOPR to state subsidies was reasonable because of “the distortive effect—no longer ‘theoretical’—that the state exemption could have on market prices for all capacity.”[8]

The Commission similarly refused to categorically exempt state sponsored resources from ISO-NE’s MOPR, holding that “[w]e will accept [ISO-New England’s] MOPR proposal that applies mitigation to all new resources offering into the FCM, including renewables that are procured pursuant to state policy initiatives to meet Renewable and Alternative Portfolio Standards.”[9]  This holding likewise was upheld on appeal by the D.C. Circuit in a section of its opinion titled “Buyer-Side Mitigation.”[10]  The court concluded that “FERC’s considered conclusion that certain resources, by definition, depress capacity prices falls within its duty of ensuring that rates are just and reasonable.”[11]

Since that time, the Commission has held on numerous occasions that it is appropriate to implement measures to mitigate price suppression resulting from state subsidies.  Today, PJM, ISO-NE, and the NYISO all continue to apply mitigation in their capacity markets to state-supported resources whose subsidized offers otherwise would distort the competitiveness of the capacity auctions.[12]

It is not credible to assert that more than ten years of consistent Commission precedent requiring mitigation of price suppressive subsidies can now be ignored simply because the states themselves are not purchasers of power.

3. RTO CAPACITY MARKETS MUST MITIGATE THE PRICE SUPPRESSIVE EFFECTS OF STATE SUBSIDIES IN ORDER FOR CAPACITY MARKET PRICES TO BE JUST AND REASONABLE

In section III of the White Paper, we explained why, consistent with voluminous court precedent, competitive electric markets must be free from the exercise of both seller-side and buyer-side market power in order for the resulting prices to be just and reasonable.  As we explained, the courts have held that market prices cannot be found to be just and reasonable without some mechanism to eliminate market power, but that “[i]n a competitive market, where neither buyer nor seller has significant market power, it is rational to assume that the terms of their voluntary exchange are reasonable, and specifically to infer that the price is close to marginal cost, such that the seller makes only a normal return on its investment.”[13] 

This argument—that states are not purchasers—has been made in an attempt to distinguish the price suppressive effect of state subsidies from the situation described above by the D.C. Circuit.  According to this argument, because states are not buyers of capacity in the RTO capacity markets, the provision of state subsidies to sellers cannot represent the exercise of buyer-side market power and the resulting capacity market prices are therefore free from buyer-side market power.

Although the term “buyer-side market power” may be arguably inapposite to the market-distorting effect of state subsidies, that terminology has come to be employed as a convenient shorthand.  While language matters, the essential point is that state subsidies distort and suppress capacity market prices, as the Commission has repeatedly held.[14]  And no court would ever conclude that the precedent on market-based rates could support a finding that state subsidies causing distorted, suppressed market prices are just and reasonable so long as the state does not purchase capacity and thus does not directly exercise buyer-side market power.  Rather, as explained in section III of the White Paper, the Commission has the statutory duty to mitigate such price suppression—whatever term is applied to describe it—to ensure that capacity market prices are just and reasonable.[15]

4. A LACK OF STATE INTENT TO SUPPRESS PRICES AND THE LEGITIMACY OF STATE POLICY CHOICES DO NOT EXCUSE THE COMMISSION FROM ENSURING THAT RTO CAPACITY MARKET PRICES ARE JUST AND REASONABLE

Finally, it is important to emphasize that the White Paper neither suggests that, nor examines whether, any state intends to suppress prices through the subsidies provided to its favored resources.  Nor do we suggest that state policies to favor a particular type of generation resource are illegitimate, should be discouraged, or that the Commission has any jurisdiction over state generation resource choices.  Fundamentally, the intent of a state in enacting its subsidy regimes, to the extent that there can be said to be such a thing and it can be discovered, is irrelevant to the obligations faced by the Commission in the face of the mandates of the Federal Power Act and unvarying court precedent.

Instead, the White Paper explains that, as part of the Commission’s statutory obligation to ensure that RTO markets yield just and reasonable rates, the Commission must act to mitigate state actions that artificially suppress, or increase, RTO capacity market prices to any significant degree.  State policy choices that have such effects on RTO capacity markets are not illegitimate, but the Commission is nevertheless obligated to mitigate those effects in order to ensure that markets subject to its exclusive jurisdiction are just and reasonable.[16]  To the extent that the Commission determines that it is appropriate to accommodate these policy choices, such accommodation must be arrived at by some means other than by permitting market price suppression in jurisdictional capacity markets.