PJM Interconnection

PJM Interconnection LLC (PJM) has been worried that certain state subsidies harm the competitiveness of capacity auctions within its territory.  PJM serves as the grid operator for all or parts of Delaware, Indiana, Illinois, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.  Its service area spans nearly a quarter million square miles, and a population of 65 million -- roughly 20% of the country.  

In an April 9, 2018 filing submitted to the Federal Energy Regulatory Commission (FERC), PJM proposed two mutually exclusive options to protect capacity auctions from the impacts of these subsidies.1 Capacity repricing would increase the market clearing capacity price paid to all bidders that clear by adjusting bids to account for subsidies received by certain generators, though would not alter which specific bidders cleared. A second option, MOPR-Ex would adjust the bid price for subsidized resources prior to evaluating their competitiveness, changing the mix of facilities that would clear the capacity auction.  In part because of the scale of PJM's service area, and in part because of the precedential nature of the case, FERC's decision on this matter can be expected to have national implications on the relative competitiveness of different energy resources and the direction of future investment.

"Fixing" subsidies requires systematic capture of all mechanisms of support

Earth Track analyzed the details of the filing to evaluate potential gaps in how subsidies were defined and whether those gaps might have unequal impacts on different fuel cycles.  The review incorporated updated information on state-level supports to fossil fuels compiled by the OECD; state and local subsidies to local industry compiled by Good Jobs First, a DC-based organization; and other resources. 

Earth Track's summary report to Sierra Club can be accessed here.  The full comments by Sierra Club and others2 can be accessed here.  The full comments to FERC include not only the Earth Track report, but some interesting analysis on how generators might game the new capacity bidding structures in a manner that drives up costs and reduces pricing transparency. 

PJM’s proposal describes the types of subsidies that would be “actionable” under its proposals, including policy types, materiality, and exclusions. Their description of which subsidies are actionable initially seems broad enough to capture most types of potential subsidy. However, exclusions added just a few paragraphs later winnow down coverage in ways that are likely both material and unequal in how they affect different fuel cycles.

These exclusions will likely impede PJM’s core objective of ensuring competitive, nondiscriminatory auctions in the wholesale capacity market. Because subsidies flow to all forms of generation, and nearly every upstream and downstream stage of each power-related fuel cycle as well, a comprehensive review process is needed if PJM is to address these subsidies in a neutral way.  Key findings of our analysis include:

  • Blanket exclusion of federal and many state and local subsidies will reduce the accuracy of subsidy screening significantly. PJM excludes all federal subsidies, and any state or local support that is in place for regional economic development or to convince a plant to locate (or stay) in a particular region. Federal subsidies can be both large and highly targeted to an industrial facility. State and local subsidies excluded on the basis of their stated purpose can also be very large. They may represent multiple state programs, originating from more than one agency – some of which may be excluded and others not based on the PJM proposal. In all of these areas, it is the scale of support rather than the justification for granting it that will drive capacity market distortions.
     
  • Revenue-based metrics for actionable subsidies need to be broadened to incorporate cost- and risk-reducing subsidies. Subsidies operate using three main levers: boosting revenues, reducing costs, and reducing the volatility of expected return by absorbing or capping credit, liability, or other business risks. The PJM proposal, as currently worded, focuses only on revenues and as a result will not treat different power sources equally. If a policy of mitigating subsidies is to be pursued, then the materiality test should shift from 1% of revenues to “a subsidy equal in magnitude to one percent of revenues” to incorporate the broad array of subsidy mechanisms.
     
  • Purchase mandates are one technique of many that governments use to transfer value to the energy sector; subsidy screening needs to incorporate all of them. Not every form of electrical power has the same cost structure. Some are capital-intensive, rolling out new technologies, or face long or uncertain build times. Others require complex fuel supply chains, have risks of severe accidents, or significant and complex post-closure concerns. Still others have variability in their ability to produce electricity. As a result of these differences, the importance of particular types of subsidy support varies significantly across fuels, and rules that by definition or effect limit review to a small subset of subsidy approaches will materially disadvantage some energy resources over others.
     
  • PJM’s current focus almost entirely on purchase mandates will understate the level of subsidies to other forms of energy. In addition, where interventions are focused on internalizing environmental or health externalities that are not being addressed in other ways, PJM needs to evaluate the impact on efficiency using more than just generator costs of operation.
     
  • Large subsidies to upstream or downstream fuel cycle steps need to be addressed to determine when a subsidy should be actionable. These types of supports are most relevant regarding subsidies to coal and natural gas extraction and transport; coal mine land reclamation; large state support to ancillary infrastructure to move or process fuels; or state subsidy for high risk, long-term parts of the nuclear fuel cycle.
     
  • Subsidy combinations matter. If there are multiple subsidies flowing to the same beneficiaries that in total exceed PJM’s action threshold of support equal to 1% of revenues, these should be reviewed as a group for action even if individually they don’t hit 1%. Subsidy “stacking” is common across the world, and it is the joint effect of multiple subsidies that will drive the distortions in market behavior.
     
  • Test case illustrates the importance of a more systematic inclusion of subsidies as potentially subject to PJM action. A test case relating to tax exemptions for coal in the state of Pennsylvania indicates that more subsidies than just purchase mandates would exceed the PJM’s proposed revenue threshold. Additional analysis would likely illustrate a similar situation in multiple other parts of PJM, though this one example is useful in illustrating why a narrow focus on purchase mandates will be insufficient in addressing potential distortions.
  • 1. [1] PJM, Capacity Repricing or in the Alternative MOPR-Ex Proposal: Tariff Revisions to Address Impacts of State Public Policies on the PJM Capacity Market,” filing before the Federal Energy Regulatory Commission, April 9, 2018, pp. 1,2 citing ISO New England, Inc., 162 FERC ¶ 61,205 at P21 (2018) (“CASPR Order”).
  • 2. The filing was submitted by the Sustainable FERC Project, Sierra Club, Natural Resources Defense Council, and Environmental Defense Fund

Energy Subsidies within PJM: A Review of Key Issues in Light of Capacity Repricing and MOPR-Ex Proposals

In its proposed tariffs to remove potential distortions caused by subsidies in capacity markets, PJM includes a number of limitations and exclusions that appear to result in unequal evaluation of subsidies across different fuel cycles. This will likely impede PJM’s core objective of ensuring competitive, nondiscriminatory auctions in the wholesale capacity market.

PJM Interconnection is a regional transmission operator (RTO) serving more than 60 million customers in 13 states and the District of Columbia.  The service region is centered in the mid-Atlantic region of the United States. Incumbent base load generators within PJM have complained that subsidies to renewable resources have been cutting their ability to win capacity market auctions, stripping them of revenue, and harming them competitively. They have been proposing adjustment factors that would improve their competitive position by adjusting bid prices to exclude the subsidy.

These proposals have been contentious, and PJM established the Capacity Construct/Senior Policy Task Force to work through them. From my perspective, two features of conventional generators are problematic for their case. The first is that while renewables play a growing role in energy markets, they are still quite small in capacity markets. Competitive pressures, such as from new gas plants, have been much more significant.

The second is that government subsidies to energy -- at all levels of government -- have been around for a very long time.  Indeed, many of these very same conventional energy resources have also received significant subsidies for their entire operating lives. For some, subsidies helped them to reduce plant construction costs. Others have reduced their cost of input fuels, a significant cost factor in fossil plants. Still others have shifted the long-term costs of fuel extraction or refining, accident risks, or managing toxic wastes from the power plant to taxpayers or plant neighbors.  Risk shifting is particularly important with regards to coal and nuclear.

To demonstrate the complexity of the situation, working with the Natural Resources Defense Council, I assembled an initial listing of state-level subsidies to conventional energy within PJM states. Data compiled by the OECD in Paris, and by Good Jobs First, an NGO, were extremely helpful inputs.

Although the timeline was short and it was impossible to capture everything, the listing is nonetheless long. The figures are sometimes quite big as well.  The unfunded cost to remediate abandoned coal mine sites within PJM states, for example, exceeds $8 billion and the region comprises nearly 80% of the national total.

The list is available here or on the PJM website (file in Excel).  If you know of big ones we are missing, please email me.

For more on the general issues before PJM, Jennifer Chen of NRDC has a blog post and statement before FERC that summarizes it well.  A recent paper by Amory Lovins at the Rocky Mountain Institute challenges some of the claims by coal and nuclear plants that they deserve special subsidies because of their provision of baseload dispatchable power. 

The PJM task force has proposed a structure to identify relevant subsidies to power markets in the region.  Since the most important subsidies to particular forms of energy can vary tremendously, unless one captures all categories the results can be highly skewed.  Part of the work for NRDC was to evaluate potential areas where PJM might miss important policies.  The results were summarized in the table below.

Mechanisms of Value Transfer to the Energy Sector
     
Intervention category Description How Characterized in PJM State Action Listing?
     
Direct transfer of funds  
Direct spending Direct budgetary outlays for an energy-related purpose. 8. Grant Programs, though PJM category not necessarily capturing spending on energy-relevant activities by the state, rather than through grants to a private party.
     
Research and development Partial or full government funding for energy-related research and development. 8. Grant programs
Tax revenue forgone* Special tax levies or exemptions for energy-related activities, including production or consumption; includes acceleration of tax deductions relative to standard treatment. 9. Tax incentives captures most of this, although the current workgroup description focuses on tax exemptions and tax credits. There is another whole class of support through more rapid deductions (generating a time-value benefit) and organizational structures (such as Master Limited Partnerships) that are not being picked up. In addition, the inventories at present are not capturing the pass-through of federal subsidies into the state tax code (e.g., percentage depletion allowances, or preferential tax rates on earnings from Nuclear Decommissioning Trusts). States can and sometimes do deviate from federal rules and require adjustments to the federal Adjusted Gross Income values flowing from federal returns, so when this is not done and federal subsidies flow through for incremental benefits at the state level, a subsidy does exist.
Other government revenue forgone  
Access* Policies governing the terms of access to domestic onshore and offshore resources (e.g., leasing auctions, royalties, production sharing arrangements). Not captured. Most relevant in PJM states with significant levels of fossil fuel extraction.
Information Provision of market-related information that would otherwise have to be purchased by private market participants. Not captured. Examples would include geological surveys for mineral location or siesmic risks to energy infrastructure; or data and statistics collection of relevance to producers.
Transfer of risk to government  
Lending and credit Below-market provision of loans or loan guarantees for energy-related activities. 7. Loan programs, though PJM definition also includes lending of physical property on favorable terms. PJM also seems to cast net very narrowly by requiring programs to target a specific resource. In practice, powerful industries within a state will capture large portion of more general loan programs as well.

Advanced Cost Recovery or CWIP schemes act as interest-free loans from customers to utilities, and would fit well within this category. Particularly if CWIP rules differ by source, or result in large subsidies to generation assets that are selling into the broader PJM market (advanced cost recovery is most valuable for the highest risk projects).
Government ownership* Government ownership of all or a significant part of an energy enterprise or a supporting service organization. Often includes high risk or expensive portions of fuel cycle (oil security or stockpiling, ice breakers for Arctic fields). 10. State takeover, though this is defined quite narrowly, and misses large areas of government involvement, such as municipal utilities or state responsibility for ensuring private market safety (e.g., mine inspections).
Risk Government-provided insurance or indemnification at below-market prices. Not captured (would be captured by added category NEW2: Risk or reclamation).
Induced transfers    
Cross-subsidy* Policies that reduce costs to particular types of customers or regions by increasing charges to other customers or regions.  
Purchase requirements* Required purchase of particular energy commodities, such as domestic coal, regardless of whether other choices are more economically attractive.  
Regulation* Government regulatory efforts that substantially alter the rights and responsibilities of various parties in energy markets or that exempt certain parties from those changes. Distortions can arise from weak regulations, weak enforcement of strong regulations, or over-regulation (i.e. the costs of compliance greatly exceed the social benefits). Partially captured in category 11 (Rate-based Cost Recovery for Certain Resources) -- though PJM definition limits relevant rate basing to DSM and efficiency resources. What about high cost/high risk generation (coal with CCS, nuclear, offshore wind)? What about excess allowable return rates in regulated markets, an issue of contention for years particulary as interest rates fell?
Added category NEW1: Preferential regulation, would capture other aspects of this issue.
Costs of externalities Costs of negative externalities associated with energy production or consumption that are not accounted for in prices. Examples include greenhouse gas emissions and pollutant and heat discharges to water systems. PJM captures this in item 2 (Emissions tax) and item 3 (cap-and-trade), though there may still be residual negative externalities not being well captured even after these carbon constraints are incorporated.
Notes:    
* Can act either as a subsidy or as a tax depending on program specifics and one’s position in the marketplace.
The categorization in this sheet is the work of Doug Koplow.  For additional detail see: Doug Koplow, written comments submitted to the Subcommittee on Energy of the Committee on Energy and Commerce, U.S. House of Representatives for a hearing on Federal Energy-Related Tax Policy and its Effects on Markets, Prices, and Consumers, March 29, 2017.
http://docs.house.gov/meetings/IF/IF03/20170329/105798/HHRG-115-IF03-20170329-SD063.pdf