Authored by: Jason Parker

Just the other day, one of our national clients asked me, ‘Why have our rates in the Northeast and Midwest increased so much recently?’  I immediately pointed out that states like Pennsylvania, New Jersey, Massachusetts (ISO-NE), Ohio, Illinois (ComEd) and Maryland are all part of the PJM RTO (Regional Transmission Organization), and PJM is what is referred to as a “Capacity Market.”  More specifically, PJM calls its market the Reliability Pricing Model (RPM) because any capacity market’s purpose is to ensure there is enough juice to meet demand—and then a little more (reserve margin).

NOTE: The purpose of this post is purely educational and meant to help readers understand the basic concept of capacity in energy markets and how it factors into their power cost.  The argument for or against a capacity market is complicated at best—political and ideological at worst.

How it Works   

First, it’s important to understand the distinction between energy and capacity.  For the purpose of our discussion, energy is the power a generator IS currently producing; capacity is the power it CAN reliably commit to producing in the future.

RTO’s and ISO’s (Independent System Operators) in capacity markets hold an annual auction (Base Residual Auction) where generators bid on the opportunity to deliver power based on estimated demand three years in the future (last May’s auction was for June 2017-May 2018).  Each year up to the delivery date, there will be incremental auctions to ensure the “winners” can still meet their obligations.

Cost Impact

All bids are at the resource’s total cost of operation.  Therefore, existing generation sources with capital investments that have been paid off can bid into the auction at a lower price.  What we’ve seen over the past few years (Figure 2) is these older and less expensive resources are being forced out of the generation stack, or their operating costs are increasing (retrofits) due to stricter EPA air quality regulations, which means newer and more expensive generation must fill the gap.

Consumers in capacity markets need only look at their energy bills to see who, ultimately, is paying the price.

Figure 1: Capacity makes up a significant part of your overall energy cost.

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Figure 2: Capacity Costs Have Risen Sharply in Recent Years

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