Commissioner Danly’s Fair Rates Act Statement on PJM MOPR

I submit this statement in accordance with section 205(g)(1)(B) of the Federal Power Act (FPA).[1]  I voted to deny the proposal.

PJM Interconnection, L.L.C. (PJM) filed revisions to its Open Access Transmission Tariff (OATT) on July 30, 2021, to change the application of the Minimum Offer Price Rule (MOPR) in its capacity market, pursuant to FPA section 205.[2]  On September 29, 2021, the Commission’s Secretary issued a notice stating that due to “the absence of Commission action on or before September 28, 2021, PJM’s proposal became effective by operation of law.”[3]

Accordingly, I provide this statement to explain why PJM’s proposed revisions to its MOPR are unjust and unreasonable and why the Commission should have rejected PJM’s submission in an order denying its FPA section 205 filing.[4]

As an initial matter, it is important to recognize what this case is not about.  It is not about whether PJM’s Expanded MOPR[5]—previously approved by an order of the Commission—is just and reasonable.  Rather, the question before the Commission is whether PJM has demonstrated that its new proposal, the Focused MOPR, is just and reasonable.[6]  No critique of the now-accepted Expanded MOPR, regardless of how convincing or well-reasoned, can inform the determination we are called upon to make here under FPA section 205.  Because this case is about the proposal before us, and not about the Expanded MOPR, the discussions of the claimed deficiencies in the Expanded MOPR made by PJM in its filing (Transmittal), by certain parties in their comments, and by my colleagues, are simply irrelevant.

Further, it is not my contention that the Expanded MOPR represents the only acceptable means by which to establish the necessary safeguards against the price-suppressive effects of state subsidies that are required to ensure a just and reasonable capacity market.  I recognize that at different times the Commission has found, and the courts have upheld, varying approaches to address this price suppression on Regional Transmission Organizations’ (RTO) capacity markets.  In these cases, the Commission approved less comprehensive MOPRs that did not apply to state subsidies as widely as the Expanded MOPR.[7]  Those approaches were upheld, in part, because the Commission balanced competing interests when evaluating those proposals and determined that the exemptions afforded to state subsidies would not have had a sufficiently significant effect on capacity market prices to require mitigation.  Depending on its details, any number of proposals could be offered to replace the Expanded MOPR and still satisfy the FPA’s just and reasonable standard.

However, the precedent approving such approaches in the past cannot be read to support the proposal before us.  By allowing this filing to be accepted by operation of law, the Commission has abandoned its responsibility to mitigate price suppression by state subsidies, which PJM’s filing characterizes as not involving “actual” market power.

Because we need engage in only a narrow inquiry, it is worth dispelling two misunderstandings that have unfortunately crept into the discussion and development of PJM’s Focused MOPR proposal.  First, a conceit has developed that the institution of a MOPR and the consequent mitigation of the offers of state-supported resources somehow represent an unlawful intrusion into the FPA’s reservation of the states’ authority over generation.  As I explain in detail below, the courts of appeals in both the Third Circuit and the District of Columbia Circuit (D.C. Circuit) have unequivocally rejected this assertion in New Jersey Board of Public Utilities. v. FERC,[8] and New England Power Generators Association, Inc. v. FERC.[9]  In light of these decisions, this argument is simply untenable.

The second misunderstanding that has regrettably informed much of the discussion leading up to this submission is the belief that the application of a MOPR to a state subsidy is tantamount to finding the subsidy “illegitimate” and therefore worthy of discouragement.  I take no position on the legitimacy of such subsidies, which is a matter outside the Commission’s jurisdiction.[10]  Instead, the issue we must grapple with is what effects such subsidies—legitimate or not—will have on the wholesale markets within our jurisdiction.  We are, after all, charged with the responsibility for policing wholesale capacity market rates in order to ensure that they remain just and reasonable.[11]

Mitigation of the Price Suppressive Effects of State Subsidies is Required to Ensure that Rates Produced by PJM’s Capacity Market Are Just and Reasonable

There seems to be some confusion as to why a MOPR, or some other mitigation of the price-suppressive effects of state-supported resources and buyer-side market power, is required.  The purpose of a MOPR is not to “deter[ ] state subsidy programs.”[12]  Rather, mitigation is required by our statutory duty to ensure that PJM’s capacity rates are just and reasonable, the fundamental requirement of FPA section 205.  In order to explain why the courts have required such mitigation, a brief description of the development of the Commission’s market-based rate regime is in order.

Judicial Precedent Requires the Commission to Mitigate the Effects of Market Power in Order to Satisfy FPA Section 205’s Just and Reasonable Standard

Rate regulation under both the FPA and the Natural Gas Act (NGA) is governed by the same statutory standard: the Commission can only approve proposed rates that are just and reasonable.[13]  Although the just and reasonable standard is most often thought of as designed to protect consumers from unreasonably high rates, it also protects sellers from being required to provide service at rates that are unreasonably low.  As the Supreme Court put it in its seminal Federal Power Commission v. Hope Natural Gas Co. decision, “[t]he rate-making process under the Act, i.e., the fixing of ‘just and reasonable’ rates, involves a balancing of the investor and the consumer interests.”[14]

The Supreme Court has held on numerous occasions that, under the just and reasonable standard, “the Commission is not bound to any one ratemaking formula.”[15]  Nevertheless, for most of its history, the Commission generally employed a cost-of-service approach, in which service providers were entitled to recover their costs plus the additional rate of return deemed sufficient to attract necessary capital.[16]

In the early 1970s—at a time when the Commission was charged with the formidable task of regulating the prices of all natural gas sold in interstate commerce—the Commission attempted to apply a market-based approach to regulating sales by small producers.  This attempt was soundly rejected by the Supreme Court in 1974 in Federal Power Commission v. Texaco Inc.[17]  The Court’s reasoning was as follows:

For the purposes of the proceedings that may occur on remand, we should also stress that in our view the prevailing price in the marketplace cannot be the final measure of ‘just and reasonable’ rates mandated by the Act.  It is abundantly clear from the history of the Act and from the events that prompted its adoption that Congress considered that the natural gas industry was heavily concentrated and that monopolistic forces were distorting the market price for natural gas.  Hence, the necessity for regulation . . . .  In subjecting producers to regulation because of anticompetitive conditions in the industry, Congress could not have assumed that “just and reasonable” rates could conclusively be determined by reference to market price.[18]

This holding appeared to drive a stake into the heart of market-based pricing under the just and reasonable standard.  More than fifteen years later, however, the Commission turned again to market forces to aid in setting rates and this time met with more success as it sought to reconcile the employment of market forces with its obligations to ensure just and reasonable rates.

The first step came in a case—Tejas Power Corporation v. FERC[19]—that did not actually involve a market-based rate.  There, the D.C. Circuit reviewed a natural gas pipeline rate settlement that had been approved by the Commission on the grounds that all of the pipeline’s local distribution company (LDC) customers had agreed to it.[20]  The court observed that: “[i]n a competitive market, where neither buyer nor seller has significant market power, it is rational to assume that the terms of their voluntary exchange are reasonable, and specifically to infer that price is close to marginal cost, such that the seller makes only a normal return on its investment.”[21]

The court then went on to reject the Commission’s approval of the settlement because it had not determined whether the pipeline had market power.[22]  Absent that determination, there was no basis for the Commission to conclude that the LDCs’ voluntary agreement could show that the settlement rates were just and reasonable.[23]  The court’s observation that market-based rates could be just and reasonable “where neither buyer nor seller has significant market power”[24] suggested a means by which market-based rates might be consistent with the Supreme Court’s holding in Texaco that “the prevailing price in the marketplace cannot be the final measure of ‘just and reasonable’ rates.”[25]  The Supreme Court’s holding had been grounded on the then-prevailing market conditions, where “the natural gas industry was heavily concentrated and . . . monopolistic forces were distorting the market price for natural gas.”[26]  Where, however, the Commission took steps to show that neither buyers nor sellers had significant market power, demonstrating that monopolistic forces were not distorting market prices, the prevailing market price would not be the “final measure,” and the use of market-based rates could satisfy the just and reasonable standard.

Viewed in isolation, Tejas Power may appear to have had little value in advancing the progression from cost-based to market-based rates.  But the import of this decision does not lie in its substantive ruling on the proposed settlement, but rather in the language quoted above, which paved the way for today’s market-based rate regime.  This part of Tejas Power has been cited in almost every subsequent court decision addressing the legitimacy of the Commission’s market-based rate orders.[27]

In order to meet the requirements of Tejas Power, the Commission’s subsequent orders granting market-based rates have relied upon a finding that the participants in the market either do not have market power or that any market power they possess has been mitigated.  For example, in Elizabethtown Gas, the D.C. Circuit described in detail the market analysis conducted by the Commission before approving Transcontinental Gas Pipe Line Company’s (Transco) request that its merchant function be permitted to sell natural gas at market-based rates.  From this, the court concluded that the Commission’s analysis “provides strong reason to believe that Transco will be able to charge only a price that is ‘just and reasonable’ within the meaning of [section] 4 of the NGA.”[28]

Order No. 697,[29] in which the Commission issued its regulations governing market-based rate sales in the electric industry, similarly focuses on ensuring that market prices are not distorted by market power.  Under Order No. 697, the Commission analyzes whether a seller has market power and, if so, whether that market power has been mitigated.[30]  The Commission recognized that monopsony power could also be an important issue, but there was insufficient evidence to confirm what was—at the time—a theoretical problem, and the Commission reserved taking action until monopsony power issues were raised in a market-based rate proceeding or in a complaint.[31]  On appeal, the United States Court of Appeals for the Ninth Circuit upheld the general principle that market power must be mitigated in order for competitive markets to be just and reasonable.[32]  “By screening for market power before authorizing market-based rates, and by continually monitoring sellers for evidence of market power, FERC has adopted a permissible approach to fulfilling its statutory mandate to ensure that rates are just and reasonable.”[33]

As the Supreme Court has made clear, “the prevailing price in the marketplace cannot be the final measure of ‘just and reasonable’ rates.”[34]  Instead, in order for sales at a market-based rate to be just and reasonable, the sales must be made in a market “where neither buyer nor seller has significant market power.”[35]  Where buyers or sellers do have market power and that market power is not mitigated, market-based rates cannot satisfy the just and reasonable standard.

It is true that none of the cases I cite above involve mechanisms designed to mitigate the price-suppressive effects of state subsidies in capacity markets, but I do not raise them for that purpose.  Rather, their relevance to this proceeding is that they establish a fundamental principle: that competitive markets—such as PJM’s capacity market—cannot be deemed just and reasonable unless measures have been taken to ensure that they are free from the exercise of both buyer-side and seller-side market power.  We need not argue from principles, however.  There is Commission and court precedent that specifically addresses the need to mitigate the price-suppressive effects of state subsidies.

The Exercise of Buyer-Side Market Power in RTO Capacity Markets Through State Subsidies

As the Supreme Court has explained, buyer-side market power, more commonly known as monopsony market power,[36] “is market power on the buy side of the market.”[37]  The Court went on to observe that “monopsony is to the buy side of the market what a monopoly is to the sell side and is sometimes colloquially called a ‘buyer’s monopoly.’”[38]  Further, “[m]onopoly and monopsony are symmetrical distortions of competition from an economic standpoint.”[39]

In most markets, buyer-side market power is exercised through the prices offered by the buyer of a product.  For example, the claim examined by the Supreme Court in Weyerhaeuser was that a buyer with monopsony power artificially raised the price it paid for saw logs, thereby raising the market price for the logs and driving a competing lumber company out of business.[40]  Such a tactic is known as “predatory bidding.”[41]

Buyer-side market power in RTO capacity markets, while similarly distorting competition, is exercised in a completely different manner.  This is because of the relative inability of buyers to directly influence capacity prices through the submission of offers to purchase at a particular price.  Instead, the demand curves used by RTOs to set capacity prices are administratively established by the RTOs.  Such administrative processes are necessary because there is very little price-elasticity in demand for capacity in the RTO markets, especially during the peak periods used to determine the level of demand in the capacity auctions.[42]

Buyer-side market power is exercised in RTO capacity markets not through altering the price offered for purchases by a buyer, but rather by subsidizing or otherwise paying owners of generation to submit below-cost offers to sell capacity into the RTO capacity markets.  The submission of below-cost offers into a capacity auction can artificially suppress the resulting price for capacity in one of two ways: (1) if a subsidized resource would have submitted the marginal cost offer had it not been subsidized, offering that resource’s capacity below its marginal cost would cause the market clearing price to be lowered to the price offered by the next highest cost offer; or (2) if the cost of a subsidized resource is higher than the market clearing price, then offering the resource below its cost will lower the supply curve, thereby lowering the point of intersection of the supply curve and the demand curve and lowering the resulting capacity price.

The Commission and the RTOs recognized the potential for the exercise of buyer-side market power to reduce capacity prices almost from the first RTO capacity auctions.  For example, PJM’s Reliability Pricing Model (RPM) was approved in 2006 and subsequently modified.  The RPM forms the basis for PJM’s capacity market today.  The Commission approved PJM’s proposed MOPR—intended to mitigate buyer-side market power—finding the MOPR to be “a reasonable method of assuring that net buyers do not exercise monopsony power by seeking to lower prices through self supply.”[43]

The Commission also approved buyer-side market power mitigation provisions in early versions of the ISO New England, Inc. (ISO New England) and New York Independent System Operator, Inc. (New York ISO) capacity markets.[44]

The first iteration of PJM’s tariff governing the RPM capacity auction did not apply the MOPR to generation resources subsidized by states, as opposed to the potential monopsony power of load-serving entities.  The Commission did not base its approval of this exclusion on a finding that state subsidies did not represent a form of buyer-side market power.  Rather, the Commission approved the exclusion because it “enables states to meet their responsibilities to ensure local reliability.”[45]  This did not, however, constitute a finding that it was somehow inappropriate to mitigate price-suppressive effects of state subsidies.

The Commission made this clear in 2011, when it approved PJM’s proposal to eliminate the exclusion of state-supported resources from its MOPR.[46]  The Commission explained that:

The mounting evidence of risk from what was previously only a theoretical weakness in the MOPR rules that could allow uneconomic entry has caused us to reexamine our acceptance of the existing state exemption, which we approved as part of the 2006 RPM Settlement Order.  For these reasons, we accept as just and reasonable PJM’s proposal to eliminate the current state exemption.[47]

In reaching this conclusion, the Commission found that “we are statutorily mandated to protect the RPM against the effects of such entry.”[48]

The Commission’s approval of the elimination of the exemption for state-supported resources was upheld on appeal to the Third Circuit.[49]  The court found that the Commission’s decision to apply the MOPR was reasonable because the Commission explained that:

[T]he actual prospect of thousands of megawatts of new generation, developed under arrangements that would explicitly subsidize the resources regardless of Auction price, potentially being offered into the Reliability Market at a zero bid brought into focus the distortive effect—no longer “theoretical”—that the state exemption could have on market prices for all capacity.[50]

The court also rejected the claim that the Commission does not have jurisdiction to apply a MOPR to state-supported resources because the FPA does not give the Commission jurisdiction over generation:

After reviewing the FERC Orders at issue here and the relevant case law, we conclude that FERC did not exceed its jurisdiction in eliminating the state-mandated provision.  Under the FPA, FERC has jurisdiction over rules affecting the rates of the transmission or sale of energy in interstate commerce.  See 16 U.S.C. § 824d.  Here, it is undisputed that New Jersey and Maryland’s plans to introduce thousands of megawatts of new capacity into the Base Residual Auction would have had an effect on the prices of wholesale electric capacity in interstate commerce.  See Mississippi Power & Light Co. v. Mississippi, 487 U.S. 354, 374, 108 S.Ct. 2428, 101 L.Ed.2d 322 (1988) (holding, among other things, that FERC had jurisdiction over power allocations that affect wholesale rates, and stating that “[s]tates may not regulate in areas where FERC has properly exercised its jurisdiction to determine just and reasonable wholesale rates or to insure that agreements affecting wholesale rates are reasonable.”) (emphasis added); Municipalities of Groton v. FERC, 587 F.2d 1296, 1302 (D.C. Cir. 1978) (rejecting jurisdictional challenge to FERC’s authority to levy deficiency charges on utilities that failed to procure generating capacity sufficient to meet its load requirements, and stating that, “[i]t is sufficient for jurisdictional purposes that the deficiency charge affects the fee that a participant pays for power and reserve service, irrespective of the objective underlying that charge.”).[51]

The D.C. Circuit reached the same conclusion later that year in an appeal of ISO New England’s buyer-side market power mitigation provisions.[52]  The petitioners in that case similarly argued that “the orders serve to dictate which resources a utility must use to satisfy its capacity obligations, in violation of the FPA,” and that “FERC’s orders impermissibly determine the makeup of a state’s resource portfolio.”[53]  In response, the court held:

Out-of-market resources—whether self-supplied, state-sponsored, or otherwise—directly impact the price at which the Forward Capacity Market auction clears.  As the price of capacity is indisputably a matter within the Commission’s exclusive jurisdiction, FERC likewise has jurisdiction to mitigate buyer-side market power as to out-of-market entrants.  We agree with the Commission’s finding that it has jurisdiction over mitigation matters “affecting or relating to wholesale rates” under FPA § 201 and 206.  Third Order ¶ 220 (emphasis omitted) (citing Conn. Dep’t of Pub. Util. Control, 569 F.3d at 478, 481).  We stress that FERC’s mitigation measures here do not entail direct regulation of facilities, a matter within the exclusive control of the states.  See 16 U.S.C. § 824(b)(1).  The Commission also found that uneconomic entry, regardless of resource and regardless of intent, “can produce unjust and unreasonable prices by artificially depressing capacity prices.”  Id. ¶ 170.  As it is FERC’s statutory obligation to ensure that rates are appropriate, we must respect its decision to maintain just and reasonable rates through curbing or mitigating buyer-side market power.[54]

It is true that these cases do not represent a mandate for the imposition of any particular mitigation regime.  In some cases, the Commission has approved certain limited exemptions from the MOPR for state-supported resources on the grounds that the limited exception would not lead to significant price suppression.[55]  And in reviewing those orders, the courts have found that the Commission “reasonably acted to balance competing interests.”[56]

This precedent does, however, instruct us that PJM’s proposal is not just and reasonable.  I am unaware of the Commission ever finding it appropriate to grant a blanket exemption to state-supported resources from the buyer-side market power mitigation provisions applied to RTO capacity markets.  Such a blanket exemption would fail to prevent the exercise of market power, and would thus fail to ensure that capacity market prices are just and reasonable.  The Commission’s refusal to grant a blanket exemption has been upheld for this very reason.[57]

RTO Capacity Markets Must Be Protected Against Both Seller-Side and Buyer-Side Market Power in Order for the Resulting Capacity Prices to be Just and Reasonable

As the above discussion makes clear, RTO capacity markets must be protected against the exercise of market power.  It is not optional.  The market-based prices derived from the RTO capacity markets are just and reasonable only when those prices are unaffected by the exercise of market power.  That means that markets must not only include provisions to mitigate seller-side market power, but also buyer-side market power.  RTO capacity markets must be markets “where neither buyer nor seller has significant market power.”[58]  Otherwise, it would not be “rational to assume that the terms of their voluntary exchange are reasonable,” or “to infer that [the] price is close to marginal cost.”[59]

And, because state subsidies to generation owners distort market clearing prices to below competitive levels, RTO capacity markets must have provisions to mitigate the effects of such subsidies, as the Commission has held on numerous occasions.  This is not a requirement based on an attempt to discourage renewable resources, as PJM implies.  Rather, the Commission has consistently held—and the courts have consistently affirmed—that RTO capacity markets must have provisions mitigating the price-suppressive effects of state subsidies.  Without mitigation, the prices that result from those markets cannot—as a legal matter—be deemed just and reasonable.  The Commission has stated that it based “its decision to require [an Independent System Operator] to implement a renewable resources exemption on the Commission’s duty to ensure just and reasonable rates pursuant to the FPA,” and not on whether the exemption is consistent with federal, state, and municipal renewable energy policies.[60]

Some have argued that the assertion that the Commission must address “price suppression” is based on a misreading of caselaw and that the Commission has discretion to determine what conduct is anti-competitive and unjust and unreasonable.  While the Commission may have considerable discretion, any Commission action will be reversed under the Administrative Procedure Act (APA), regardless of the subject matter at issue, if it is arbitrary and capricious.[61]  This means that the Commission “must examine the relevant [considerations] and articulate a satisfactory explanation for its action[,] including a ‘rational connection between the facts found and the choice made.’”[62]  No such explanation can be found in the approval of PJM’s proposal by operation of law, which, as noted, is an “order” only insofar as it is legally decreed to be so for the limited purposes of establishing rehearing and appeal rights.  Putting that aside, no order could ever survive judicial review under the APA’s arbitrary and capricious standard if it held that no action whatsoever were required to mitigate the known and significant price-suppressive effects of state subsidies.  It simply would not be possible to square such an exercise of discretion with years of Commission and court precedent holding that the Commission is statutorily obligated to address and mitigate the price-suppressive effects of such subsidies.[63]

PJM’s Proposal is Unjust and Unreasonable and it is Bad Policy

PJM’s proposal includes lengthy provisions addressing the imposition of a MOPR.  However, these provisions do not evince a careful or balanced attempt to ensure the mitigation of market power (including that created by state support of resources).  Rather, PJM’s tariff provisions are structured so as to ensure that it is virtually certain that the MOPR will never be applied to any generation resource.  These provisions are so deliberately ineffectual that their approval violates our statutory duty to ensure that PJM’s capacity market produce just and reasonable rates.[64]

PJM’s Proposed Changes

PJM’s current Expanded MOPR[65] applies to the following: (1) new natural-gas-fired resources; and (2) resources that receive or are eligible to receive State Subsidies,[66] subject to certain exemptions.[67]  PJM’s proposed revisions to section 5.14 of Attachment DD of its OATT alter the application of the MOPR in PJM’s capacity market.  In doing so, PJM proposed several newly defined terms.  Two main aspects to PJM’s Focused MOPR proposal are: (1) changes regarding what PJM calls “actual” buyer-side market power mitigation; and (2) the definition of “Conditioned State Support.”

PJM proposes to define “Buyer-Side Market Power” as “the ability of Capacity Market Sellers with a Load Interest to suppress RPM Auction clearing prices for the overall benefit of their (and/or affiliates) portfolio of generation and load.”[68]  Further, PJM proposes to define the “Exercise of Buyer-Side Market Power” as the

anti-competitive behavior of a Capacity Market Seller with a Load Interest, or directed by an entity with a Load Interest, to uneconomically lower RPM Auction Sell Offer(s) in order to suppress RPM Auction clearing prices for the overall benefit of the Capacity Market Seller’s (and/or affiliates of Capacity Market Seller) portfolio of generation and load or that of the directing entity with a Load Interest as determined pursuant to Tariff, Attachment DD, section 5.14(h-2)(2)(B).  A bilateral contract between the Capacity Market Seller and an entity with a Load Interest with the express purpose of lowering capacity market clearing prices shall be evidence of the Exercise of Buyer-Side Market Power.[69]

PJM proposes that Conditioned State Support be defined as

any financial benefit required or incentivized by a state, or political subdivision of a state acting in its sovereign capacity, that is provided outside of PJM Markets and in exchange for the sale of a FERC-jurisdictional product conditioned on clearing in any RPM Auction, where ‘conditioned on clearing in any RPM Auction’ refers to specific directives as to the level of the offer that must be entered for the relevant Generation Capacity Resource in the RPM Auction or directives that the Generation Capacity Resource is required to clear in any RPM Auction.[70]

Under PJM’s revised tariff provisions, the scope of the prohibition against Conditioned State Support is virtually coterminous with the prohibitions established in Hughes v. Talen Energy Marketing, LLC and the restriction on Buyer-Side Market Power is now limited to those entities with a load interest that intend to exercise market power.[71]  In addition, a generation resource may be subject to the Focused MOPR, if PJM, with the advice and input of the IMM, has a reasonable basis to believe that the sell offer is a result of an exercise of buyer-side market power.  Under PJM’s proposal, capacity market sellers may reflect all state support in their offers provided that the support is not Conditioned State Support.  The proposed revisions also include a self-certification requirement and provisions to allow PJM and the IMM to conduct further inquiry when appropriate.

PJM’s proposal also includes a “non-exhaustive list of circumstances that would not support an inquiry into or a determination that a resource may be used in an Exercise of Buyer-Side Market Power”:

(a) the Generation Capacity Resource is a merchant generation supply resource that is not contracted to an entity with a Load Interest;

(b) the Generation Capacity Resource is acquired by or under the contractual control of the Capacity Market Seller through a competitive and non-discriminatory procurement process open to new and existing resources; or

(c) the Generation Capacity Resource is owned by or bilaterally contracted to a Self-Supply Seller and such resource is demonstrated as consistent with or included in the Self-Supply Seller’s long-range resource plan (e.g., a long-range hedging plan) that is approved or otherwise accepted by the [Relevant Electric Retail Regulatory Authority (RERRA)], provided that any such plan approval or contracts do not direct the submission of an uneconomic offer to deliberately lower market clearing prices or for the Capacity Market Seller to otherwise perform an Exercise of Buyer-Side Market Power . . . .[72]

PJM explains in its Transmittal that “[t]he Expanded MOPR tests for whether a state-subsidized Capacity Resource offer is below a competitive level and—if it is—resets the offer to a higher level that excludes the economic benefit of any state support or subsidy[,]” and “[i]f that higher offer price does not clear the auction, the resource is not committed to provide capacity to the PJM Region, and its capacity is not counted towards meeting reliability requirements in PJM.”[73]  In justification of its proposed revisions, PJM asserts that “the Expanded MOPR’s broad reach and expanded definition of subsidies poses an increased risk that resources receiving such perceived subsidies will not clear the market, resulting in either (1) frustration of the state policy objective or Load Serving Entity (‘LSE’) resource strategy; or (2) customer payment for duplicative resources.”[74]  Therefore, PJM states, the consequence is a double payment for consumers in the states where the subsidies originated, i.e., a payment for the excluded resource (the one that did not clear the auction and received a state subsidy) and the resource committed by clearing the auction.[75]

PJM also asserts that “the evidence indicates that states and Self-Supply entities are more likely to exit the capacity market to meet their policy and business objectives, rather than remain in the capacity market and curtail those objectives.”[76]  Further, PJM submits that, because the Expanded MOPR results in capacity prices that do not reflect actions taken by states and by Self-Supply Entities to support resources, capacity prices will create incentives for resources to be built that are not needed to maintain reliability.[77]  PJM also acknowledges that implemented states’ policies that favor certain generation resources may result in a reduction in capacity clearing prices but asserts that such reduction should not be viewed as harmful to other states.[78]  I disagree with these assertions.

The Focused MOPR Fails to Protect the Wholesale Capacity Market from Buyer-side Market Power

Let me begin with the Focused MOPR provisions applicable to state-supported resources.  Those provisions do not even purport to protect the market against the price-suppressive effects of market power.  The Focused MOPR applies only to generation resources receiving “improper” state support, which PJM describes as “material benefits from a state policy in exchange for the sale of a FPA-jurisdictional product and such support is conditioned on either the resource clearing an RPM Auction or the seller offering the resource at a specific price level.”[79]

As PJM acknowledges, this is the same standard established by the Supreme Court for finding that state support for a resource is preempted by the FPA.[80]  In Hughes, the Supreme Court held that because Maryland’s program “condition[ed] payment of funds on capacity clearing the auction,” its program suffered a “fatal defect that render[ed] [its] program unacceptable.”[81]  Therefore, the Supreme Court rejected Maryland’s program on the basis that it “disregard[ed] an interstate wholesale rate required by FERC.”[82]  But the Constitutional standard animating the preemption-based prohibitions set forth in Hughes is absolutely irrelevant to the statutory standard the Commission must apply under FPA section 205, which is to ensure that PJM’s capacity market prices are just and reasonable.[83]

I question the need for the incorporation of Hughes into PJM’s proposed definition of Conditioned State Support because the courts are more than capable of providing relief to plaintiffs bringing preemption claims.  I would not object to its inclusion as part of a set of provisions establishing an adequate program of market-power mitigation, but there is nothing else within PJM’s proposal.  And this single provision is inadequate protection against the price-suppressive effects of state subsidies.  A just and reasonable capacity market must protect against all market-power driven price suppression, not just the price suppression caused by a small subset of “improper” state subsidies.  Simply put, it is the just and reasonable standard, not preemption, that applies to PJM’s jurisdictional wholesale market.

PJM does at least acknowledge the obligation to mitigate the exercise of buyer-side market power by load-serving market participants.[84]  However, rather than a straightforward mitigation of these entities’ buyer-side market power, PJM proposes a number of additional inquiries leading to off ramps from mitigation.[85]  The number of off-ramps is so extensive that it is exceedingly unlikely that any offer from a load-serving market participant ever will be mitigated.  For example, mitigation can be avoided by a market participant’s self-certification that does not intend to exercise market power—this is an off-ramp that no market participant will fail to exploit.[86]

PJM’s Focused MOPR also fails to satisfy the FPA’s just and reasonable standard by not applying the MOPR to demand resources and energy efficiency resources.  As noted by the IMM, PJM’s proposal to exclude energy efficiency resources from the MOPR has previously been rejected.[87]  The IMM recognized in its protest that PJM is incorrect in asserting that “these resources tend to be ‘small scale and low cost.’”[88]  I agree with the IMM.  In my view, demand resources and energy efficiency should not be excluded from the MOPR.

The Proffered Justifications for Approving the Focused MOPR Are Unconvincing

First, PJM’s proposal does not further efficient market outcomes by allowing subsidies of renewable resources to suppress capacity market prices.  To the contrary, subsidies of renewable resources by their very nature distort the efficient integration of such resources into PJM’s energy and capacity markets.  That subsidies result in market inefficiencies is beyond cavil.  And while I do not question the right of the states to grant such subsidies to encourage the construction of certain favored resources, it simply is not possible to justify such subsidies on the claim that they enhance market efficiency.

Second, we must dismiss misguided arguments that we should “allow capacity market sellers to reflect all state support in their offers”[89] on the grounds that capacity market signals no longer are important.  One such argument would have it that:

States are playing a more active role in shaping the resource mix—including both entry and exit—than they were at the time the Commission issued previous orders addressing the scope and purpose of PJM’s MOPR.  Consequently, the relative importance of capacity market price signals in guiding resource entry and exit, a key consideration when PJM’s capacity market was first developed, has declined and likely will continue to decline in the future, further tilting the balance against the sort of extreme mitigation imposed by the Expanded MOPR.[90]

There is a logical flaw here.  The following two propositions cannot both be true at once: 1) that state subsidies are reducing the importance of capacity market signals needed for efficient entry and exit decisions; and 2) that elimination of the tariff provisions mitigating the effect of state subsidies leads to more efficient market outcomes.  If indeed states subsidies are masking capacity market signals, that means that the market is under more threat than it was in the past.  The only conclusion to draw is that the Commission’s role to ensure just and reasonable rates is that much more important.

Finally, I am not persuaded by the argument that the adoption of PJM’s proposal is necessary because its adoption would have made states and Self-Supply entities less likely to exit the capacity market.[91]  In my view, this argument appears to be greatly exaggerated, particularly in light of the results of PJM’s most recent auction.[92]  Those results reflect that a combined 3,239.7 MW of wind and solar resources cleared the 2022/2023 Auction, out of approximately 11,761 MW of installed wind and solar capacity.[93]  This constituted a combined approximate 63% increase (1,253 MW) over the wind and solar capacity awards in the previous auction for the 2021/2022 delivery year, [94] which was not conducted under the Expanded MOPR rules.  Moreover, almost all renewable resources that offered into the auction at their minimum offer price received capacity awards.  These results demonstrate that renewable resources were cost competitive even though the clearing prices in the 2022/2023 Auction were significantly lower than those in previous auctions.[95]

It is worth noting that different PJM states have different policies and different favored resources.  We would do well to understand that the Focused MOPR itself could cause different states to consider leaving PJM.  This risk apparently is going unheeded.[96]

In any event, the possibility that a state or a Self-Supply entity may leave PJM if its policy objectives are not accommodated in the capacity market cannot serve as a basis for the Commission to disregard its obligation to ensure just and reasonable rates.  By default, it is the privilege of states and utilities to participate in the organized markets as they see fit.  It is a state’s prerogative to leave an RTO if and when it comes to believe that the costs of membership outweigh the benefits.  The markets, however, are not an end in themselves and we cannot abandon our core statutory duty in our zeal to preserve them.

Mitigation of Buyer-Side Market Power is Not an Impermissible Intrusion Upon Reserved State Authority

Arguments that market-power mitigation impermissibly invades the states’ prerogatives under the FPA are directly contrary to judicial precedent.  The Third Circuit recognized that states “are free to make their own decisions regarding how to satisfy their capacity needs, but they ‘will appropriately bear the costs of [those] decision[s],’ . . . including possibly having to pay twice for capacity.”[97]  States may decide how to manage their capacity needs; the Commission, however, does not need to accommodate those policies at the expense of ensuring adequate mitigation of buyer-side market power.  New Jersey tried to argue that the Commission interfered with its rights under the FPA saying: “‘FERC here interferes directly and materially with state efforts to sponsor new capacity resources precisely because those efforts could affect market prices.’”[98]  The court determined that New Jersey was wrong.[99]  The court explained that “what FERC has actually done here is permit states to develop whatever capacity resources they wish, and to use those resources to any extent that they wish, while approving rules that prevent the state’s choices from adversely affecting wholesale capacity rates.  Such action falls squarely within FERC’s jurisdiction.”[100]

The D.C. Circuit similarly rejected an argument that the Commission, in imposing buyer-side market power mitigation measures, “improperly regulat[ed] ‘facilities used for the generation of electric energy.’”[101]  In finding that the Commission acted within its jurisdiction, the court explained that “states remain free to subsidize the construction of new generators, and load serving entities to build or contract for any self-supply they believe is necessary,” and the Commission acted within its authority in “regulat[ing] the ‘price constructs that result in offers into the capacity market from these resources that are not reflective of their actual costs.’”[102]

In light of this case law, arguments that the Commission’s market-power mitigation regimes violate the states’ reserved powers under the FPA are doomed to fail.

The Commission Cannot Rely Upon PJM’s Attempt to Define A Way Out of the Commission’s Obligation to Mitigate the Effects of Price Suppression

What is “actual buyer-side market power”?  PJM proposed to define a narrower category of buyer-side market power, creating a new category (so-called “actual” buyer-side market power) as opposed to all of the other, well-recognized and equally deleterious exercises of price-distortive market power that the Commission and the courts have long held require mitigation.  PJM defines this new, narrower version of buyer-side market power as the “ability of Capacity Market Sellers with a Load Interest to suppress RPM Auction clearing prices for the overall benefit of their (and/or affiliates) portfolio of generation and load.”[103]  And while this new, narrowed definition has gained some currency in others’ arguments,[104] even the most charitable among us can be forgiven for taking the somewhat cynical view that PJM is merely attempting to define its way out of a problem.

Thankfully, when sitting in review of PJM’s proposal, the court’s analysis will not be constrained by PJM’s definition.  Whether or not PJM denominates a particular species of market power as “actual” market power, the case law is clear that no tariff can be found to satisfy the just and reasonable standard absent guardrails mitigating the effects of price-suppressive market behavior.  The mitigation of price-suppressive state subsidies in the wholesale markets is absolutely necessary—it takes only one unit’s offer to suppress capacity prices and those prices will be suppressed for all participants.  PJM’s narrow application of the MOPR to only a subset of those entities that can (and do) exercise buyer-side market power will undermine the capacity market and result in unlawful rates.

Reliability and Resource Adequacy Are Necessary Considerations in Assessing the Justness and Reasonableness of PJM’s Proposal

When it comes to capacity markets, rate design has profound practical implications: if we get the rates wrong, the electric system will be unreliable.  One purpose of the capacity markets is to ensure resource adequacy.  It does so by sending the price signals required to procure the correct quantity of the correct type of generation such that there is sufficient generation, with the correct attributes, to meet system demand and ensure system stability.  The Focused MOPR will permit unmitigated state subsidies to suppress prices thereby distorting the market’s price signals.  The result will be that the market will fail to send the price signals necessary both to induce new, required generation to enter the market and to retain needed, existing generation.  Rates that fail to advance or, as in the case of the Focused MOPR, actually obstruct, the capacity market’s purpose of ensuring resource adequacy are not just and reasonable.

Because state subsidies are directed toward intermittent resources, the generators that will suffer their price-suppressive effects will be the marginal coal and gas units whose offers must reflect their fuel costs.[105]  They will fail to clear the market as subsidized units undercut their offers and will thereby be denied the capacity payments required to remain solvent.  The attributes provided by these dispatchable generators are required for system stability—they cannot simply be replaced by additional intermittent generation.  While some downplay these reliability concerns, I note that the instant proposal comes on the heels of PJM’s Effective Load Carrying Capability (ELCC) submission which assigns varying capacity values to intermittent resources, in recognition of their reduced reliability value.[106]  When the inevitable price suppression caused by unmitigated state subsidies results in the premature retirement of too many conventional, dispatchable resources (like gas and coal-fired generators), reliability will be compromised.[107]

I am hardly alone in these concerns; they are shared widely among those charged with the responsibility of ensuring the stable operation of the electric system in our markets.  As we recently learned from the head of the North American Electric Reliability Corporation and his colleagues, gas-fired generation is necessary to maintain system reliability and, in fact, more gas-fired resources will be needed to meet demand:

The North American bulk-power system (BPS) is undergoing major transformation, driven by a rapidly changing generation resource mix.  Traditional baseload generation plants are retiring, while significant amounts of new natural gas and variable energy generating resources are being developed.  During this transition, natural gas-fired generation is becoming more critical to provide both ‘bulk energy’ and ‘balancing energy’ to support the integration of variable energy resources.[108]

PJM recently recognized the reliability challenges that attend increasing proportions of intermittent generation and the potential need for rates that take into account the attributes required for system stability:

Given the ongoing evolution of the markets, we believe that we and our stakeholders should evaluate the need for procurement of additional reliability attributes, such as ramping, flexibility and inertia that may be required for a system with increased intermittent and distributed energy resources.  Resource adequacy in the future should no longer be measured based solely on the characteristics of the peak day; it must evolve to include the ability to serve load in all hours of the year.[109]

ISO New England agrees: “the capacity market must evolve to ensure ‘energy adequacy’—resources that can provide on-call electrical energy for extended periods when energy is unavailable from intermittent generation and generation with ‘just in time’ fuel sources.” [110]

Resource adequacy for the entire region depends upon PJM’s capacity market.  As Ohio Public Utility Commissioner Dan Conway explained earlier this year, Ohio relies on PJM’s market mechanisms to ensure resource adequacy and reliability:

First, some background.  Ohio restructured its retail generation service markets in 2000.  We have retail competition; our vertically integrated electric utilities were required to separate from their generation assets; and Ohio has a default standard service option, procured through a competitive wholesale auction and provided by the utilities for customers who don’t shop.

Our transmission owners were required to become members of and transfer control of their facilities to a FERC-approved RTO, which they did, and that is PJM.

Ohio restructured, and joined PJM, based on the expectation that PJM would provide a reliable transmission grid, and the wholesale bulk power markets that PJM oversees would provide adequate supplies of power—at all times.  And, we rely upon the competitive model for those bulk power markets to deliver reasonable prices.[111]

The bottom line is this: the Focused MOPR will allow state subsidies to suppress capacity prices, depriving needed dispatchable generation of the revenue required to remain in service.  PJM will be unable to discharge its responsibility to ensure resource adequacy as those generators leave the market—reliability will suffer as a result.  This cannot be just and reasonable.

The Commission’s “Order” Should be Remanded upon Petition for Review

Because of a 2-2 vote, the Commission did not form a majority and consequently “fail[ed] to issue an order accepting or denying” PJM’s proposed tariff revisions.[112]  Under FPA section 205(g)(1)(A), that failure is “considered to be an order issued by the Commission accepting the change for purposes of section 825l(a).”[113]  The designation of our failure to issue an order to be, itself, an order, will present a handful of novel but foreseeable issues on appeal,[114] all of which counsel the reviewing court to vacate and remand the matter back to the Commission for an opportunity to issue a merits order in the first instance.

The acceptance of the Focused MOPR appears, on its face, to work multiple violations of the APA.  Courts review final Commission orders under the APA’s arbitrary and capricious standard.[115]  Commission orders will be upheld if the agency “articulate[s] a satisfactory explanation for its action including a ‘rational connection between the facts found and the choice made.’”[116]  The Commission’s factual findings will be upheld if supported by “substantial evidence.”[117]  When an order is seemingly inconsistent with past precedent and practice, courts require thorough reasoning.[118]  “The Commission can depart from a prior policy or line of precedent, but it must acknowledge that it is doing so and provide a reasoned explanation.”[119]

Here, the acceptance of PJM’s Focused MOPR has effectively reversed years of Commission precedent without any explanation.  The Commission has a long history of orders explaining how and why it has required or accepted numerous market-power mitigation provisions.[120]  One such order was that which imposed the Expanded MOPR.[121]  To jettison an established market-power mitigation regime which was itself the result of extensive findings and reasoning by the Commission without a word of explanation cannot satisfy the basic requirements of the APA.[122]  This is in addition to the other obvious violation of the APA—the acceptance of PJM’s proposal without any response to protestors’ arguments.[123]

Rate structures are not permanent, and rates, even those imposed as replacement rates under FPA section 206, can change.  My colleagues remind us that “[a] utility may file to update its tariff at any time by proposing what it believes to be a just and reasonable rate even if it differs from past filings, as ‘[a] rate order is not res judicata.  Every rate order made may be superseded by another.’”[124]  True enough.  But that is not the point.  The problem with this “order” is that, the Commission, having made a series of unambiguous determinations in the earlier section 206 proceeding (and absent a change in circumstances), will face a substantial challenge when trying to explain its abrupt 180-degree turn.[125]  PJM’s proposal was accepted without the opportunity to offer the explanation needed to justify this reversal.  The same goes for what appears to be the tacit repudiation of years’ worth of Commission precedent regarding our obligations to mitigate the exercise of market power.

Some contend that the Fair RATES Act entitles a court to affirm the acceptance of the proposal absent an order that offers the Commission’s reasoned explanation for its choices.  Chenery holds otherwise.[126]  Courts sit in review of an agency’s reasoning.  And while FPA section 205(g) provides an avenue for rehearing and judicial review, it does not, by its plain terms, purport to extinguish the Commission’s obligations under the APA.  It would be surprising indeed if Congress were to have intended, in what amounts to a minor amendment to a single administrative agency’s organic statute, to undermine bedrock principles of administrative law like Chenery.  One would expect that if Congress had intended to do so, it would have included language to that effect.[127]

Commissioners’ written statements[128] are not, individually or collectively, an “institutional decision,” [129] nor can they be cobbled together to form a “majority vote.”[130]  The Commission speaks through its orders, not the opinions of individual Commissioners.  Our statements have no legal significance.[131]  Neither does the Secretary’s notice: it is merely an acknowledgement of the Commission’s failure to act within the statutorily-prescribed time period and it serves to inform litigants that their rehearing rights have been perfected.  Because it contains no findings of fact, no choices made, no legal analysis, and no reasoned explanations, the notice cannot serve as a stand-in for an order.

Remand, at a minimum, appears to be the necessary remedy on appeal.  Given that this “order” necessarily contains no reasoning, a court might well be reluctant to reach a decision on the merits[132] and decide to remand the matter back to the Commission with instructions to issue an order on the merits.  It might also consider vacating the order, a power which the courts should employ when sitting in review of manifestly deficient issuances, such as the one at hand.[133]

Conclusion

PJM’s proposal eliminating all mitigation of the price-suppressive effects of state subsidies is irredeemably inconsistent with FPA section 205’s requirement that proposed rates must be just and reasonable.  For this reason, I voted to reject.