At its November Open Meeting, the Federal Energy Regulatory Commission (FERC or the “Commission”) issued a Final Rule (Order No. 831) directing the Regional Transmission Organizations and Independent System Operators (RTO/ISO) to raise their existing caps on energy market offers, allowing electric generators and other market participants to submit higher-priced offers to supply energy, and allowing those higher-priced offers to set market clearing prices in certain instances. These directives may result in higher market clearing prices and increased market revenues for electricity generators, but they will require RTOs/ISOs to adopt additional procedures for cost verification before such higher clearing prices can occur.
As we previously reported, in January of this year, FERC proposed to require each RTO/ISO to change its currently existing cap on a generation resource’s incremental offer into the energy markets to the higher of each resource’s specific cost-based incremental energy offer and $1,000/MWh (the current cap in most RTOs/ISOs). FERC also proposed to allow cost-based energy offers above $1,000/MWh to set the Locational Marginal Price (LMP) received by all generators that clear the market. However, under FERC’s proposal, the Market Monitoring Unit (MMU) or the RTO/ISO would be required to verify the costs comprising such a cost-based incremental energy offer before that offer could be used to calculate LMPs.
In Order No. 831, FERC adopted all of these proposals, directing each RTO/ISO to revise its current market rules to cap each resource’s incremental energy offer at the higher of $1,000/MWh or the resource’s MMU or RTO/ISO-verified, cost-based incremental energy offer. FERC also required that such offers, if verified by the MMU or RTO/ISO, be used to calculate the market clearing price received by all resources supplying energy.
In an important change from the proposed rule, however, FERC also directed the RTOs/ISOs to adopt a “hard cap” on cost-based incremental energy offers at $2,000/MWh. While the regulations adopted in Order No. 831 still allow generators to recover any verified costs that they incur above $2,000/MWh, the hard cap will prevent those resources from setting the market clearing price. If dispatched, such generators would instead receive an uplift payment to recover the difference between the market clearing price and their verified costs.
Order No. 831 is arguably FERC’s most significant step to date in its ongoing efforts to improve “price formation” in the RTO/ISO markets. FERC states that its final reforms to the offer caps will “make it more likely” that market clearing prices will reflect the true marginal cost of production when short-run marginal costs exceed the $1,000/MWh caps currently in place in most RTOs/ISOs. The Commission acknowledges that the inclusion of the $2,000/MWh hard cap may “diminish the ability [of the Final Rule] to address the shortcomings of current offer caps,” since it sets a limit on the ability of market prices to rise above that level even when generators with higher marginal costs are dispatched to provide energy. But FERC nonetheless concludes that the limits of the cost verification process – in particular, the practical difficulties of reliably verifying costs in advance in all circumstances – require that a cap be in place to protect customers.
As noted above, these reforms should allow the energy market clearing prices received by all generators (and other resources providing energy) to rise when the marginal unit’s costs exceed $1,000 per MWh. How often that occurs, and how much additional overall revenue will accrue to electric generators (especially the merchant generation sector), remains to be seen. In addition, how the RTOs/ISOs each implement the required cost verification processes will be critical and will bear watching closely, since cost verification is required for the higher marginal cost offers to set the clearing price. Order No. 831 leaves the details of such processes – which could, like other market mitigation issues, prove controversial – to the RTOs/ISOs to develop in the first instance in their compliance filings.
Order No. 831 will become effective 75 days after it is published in the Federal Register. RTO/ISO filings to revise their tariffs to comply with the rule will be 75 days after it becomes effective.