Outside Compensation Affects Competitive Electricity Prices: What Can Be Done?

In Order No. 2000, the Federal Energy Regulatory Commission (FERC) encouraged formation of Regional Transmission Organizations (RTOs) to operate competitive region-wide wholesale electricity markets. Such markets are intended to provide incentives for development and retention of economically efficient generation resources sufficient to maintain the reliability of the interconnected electric system while protecting customers from excessive charges.

Most of the capacity and energy needed by load-serving entities within RTOs is supplied by generators that compete on the basis of price in auctions administered by each RTO. Generators that bid successfully into such auctions are compensated for supplying capacity and energy on the basis of the market clearing prices achieved in such auctions.

However, some generators receive additional compensation for their role in helping to achieve state policy objectives. Accordingly, the FERC may have to adopt rules to accommodate market participation by generators who receive compensation outside of competitive wholesale electricity markets.

Financial Incentives Support Policy Objectives

The recently released Department of Energy report on electricity markets and reliability described various benefits derived from specific power plants, such as jobs, low emissions resilience, and energy security. However, such benefits are not explicitly rewarded in competitive wholesale electricity markets. Therefore, some states offer out-of-market financial incentives to support reliance on generation resources that provide such benefits.

In April 2016, the U.S. Supreme Court ruled that the specific financial incentives offered by Maryland to encourage construction of new generation facilities within the state were pre-empted by the Federal Power Act. In the decision, the court emphasized that it was not addressing “the permissibility of various other measures States might employ to encourage development of new or clean generation, including tax incentives, land grants, direct subsidies, construction of state-owned generation facilities, or re-regulation of the energy sector. Nothing in this opinion should be read to foreclose Maryland and other States from encouraging production of new or clean generation through measures ‘untethered to a generator’s wholesale market participation,’ ” it said.

Both New York and Illinois provide out-of-market revenue to owners of nuclear power plants within those states through the sale of zero emission credits. Such revenues are intended primarily to support continued operation of those plants and enjoyment of associated non-power benefits. Federal courts have concluded that such programs are permissible because they are designed to achieve legitimate state objectives, and revenues are not tied directly to the price of electricity sold by such generators. Other states may be encouraged to provide similar financial incentives to achieve state policy objectives.

Generators receiving out-of-market revenues may continue to participate in competitive energy and capacity markets. However, they need only to offer their capacity and energy into such markets at a reduced price in order to recover their costs. Ultimately, such generators may depress the price of electricity in the markets in which they participate to the detriment of other market participants.

FERC Consideration of Non-Price Policy Objectives

The FERC has recognized that when generation facilities are compensated through out-of-market revenues to support state policy objectives, it “must balance two considerations. The first is its responsibility to promote economically efficient markets and efficient prices, and the second is its interest in accommodating the ability of states to pursue other legitimate state policy objectives.”

In August 2015, when the Environmental Protection Agency adopted the Clean Power Plan in an effort to reduce greenhouse gas emissions, FERC Commissioner Cheryl LaFleur observed that the FERC would “need to ensure that the energy markets we regulate successfully adapt to changes driven by carbon regulation.” Because states have jurisdiction over development of generation resources, the FERC has evaluated proposed rules for integrating the output of generation resources being compensated to help achieve state policy objectives into the competitive wholesale electricity market on the basis of whether the participation of such generation resources would unreasonably suppress prices.

Further Action Is Needed

In recognition of the challenges presented by a desire to maintain efficient wholesale electricity markets while accommodating state policy objectives, the FERC convened a two-day technical conference in May 2017 to explore “how the competitive wholesale markets can select resources of interest to state policy makers while preserving the benefits of regional markets and economic resource selection.” The record developed during that technical conference should assist the FERC to evaluate market rules designed to maintain efficient wholesale electricity markets while accommodating state policy objectives affecting development of electric generating resources.

States will continue to provide out-of-market payments to generators that help to achieve certain policy objectives. Ideally, stakeholders within each region will propose market rules that will achieve a reasonable balance between the principles of operational and economic efficiency of generators operating within the region and the attainment of such policy objectives. However, unless participants in these markets can achieve that balance, the FERC may adopt an approach that leaves no participant pleased. ■

James K. Mitchell is a partner at Davis Wright Tremaine in the practice’s Washington, D.C. office.