Volatile Capacity Markets
A significant risk facing AEP’s competitive generation business is the outcome of annual Reliability Pricing Model (RPM) capacity auctions. This auction runs every May and sets the capacity price for a one-year period, three years in advance. The auction is conducted by the PJM Interconnection, the regional transmission organization (RTO) that coordinates the movement of wholesale electricity in all or parts of 13 states and the District of Columbia. The auction matches anticipated capacity needs with what is being offered by power generators, demand response (DR) and energy efficiency resources. Capacity payments represent an important portion of a plant’s income. AEP Generation Resources is particularly vulnerable because the revenues and earnings potential of its fleet of newly competitive plants are tied to fuel and power prices, including PJM’s capacity auction.
AEP's Conesville Plant in Ohio is affected by the capacity auctions as it is now part of AEP’s competitive generation business.
The May 2013 auction covered the delivery period June 2016 through May 2017. During the 2013 auction, the capacity price cleared at $59.37 per megawatt-day, down from $136/MW-day the prior year – a 56 percent drop in price. This sent shockwaves through the investment community and created a great deal of uncertainty in the market. Without sufficient capacity pricing to pay for the plants to operate, companies such as AEP are faced with financial loss or premature unit retirements. We have deep concerns about the viability of this process and the resulting negative reliability impacts it will have over the long term.
The auction should create long-term price signals for all resources and compensate generators for investing in generation capacity. We believe the PJM auction process for capacity resources has not worked properly and must be reformed. The current rules actually encourage volatility and speculation. This volatility, combined with continued price suppression, does not provide the revenue needed to support the cost to operate existing power generation or encourage the construction of new plants. It was among the reasons AEP chose to retire its Muskingum River Unit 5 instead of converting it to natural gas. This decision resulted in a $154 million asset impairment charge in 2013. We were not being adequately compensated by the market to proceed with the capital investment needed to convert the unit to gas.
The capacity price for all demand response resources in the 2016-2017 auction was the same as the price paid for generation despite lower performance requirements and lower penalty provisions for demand response than for generators. PJM has taken some steps to try to improve this disparity. More work will be done in 2014 in the PJM stakeholder process. The existing energy and capacity markets have created a situation whereby nearly all new capacity is in the form of demand response, imports, energy efficiency, wind and gas resources. In the case of demand response, most of these resources receive the same capacity clearing price as physical generating resources, even though the vast majority of demand response is available during the summer only.
AEP has formed a coalition to resolve some of these flaws by the next auction in May 2014. Coalition members include Duke Energy, Dayton Power & Light and FirstEnergy. These companies agree with AEP that non-competitive practices resulting from market design flaws foster volatile auction results that push prices to be artificially low. To address these matters, the coalition made two regulatory filings in December 2013 and two more in the first quarter of 2014. The coalition made these filings in response to PJM’s filings with the FERC as PJM attempts to close some of the loopholes before the next auction.
Market reforms that must occur include limiting the amount of capacity from outside PJM’s territory that can be bid in to the auction; placing reasonable caps on the amount of demand response that can be bid in to the auction; preventing speculative bidding that keeps prices artificially low; and requiring demand response resources to be subject to the same financial repercussions that generators face if they fail to meet the market requirements.