Capacity prices can make up anywhere from 10% to 50% of a customer’s electricity supply charge. The capacity aspect of the supply portion of a bill can cause some confusion for customers, so we will try and explain the concept here and further discuss the current state of the PJM capacity market, which is causing some angst in the market.
A very basic definition of electricity capacity for a consumer is as follows: It is the highest amount of energy a customer is expected to use or consume during any day, month, or year.
These numbers allow suppliers and electricity distribution companies to plan to have enough resources to cover peak loads. In straight economic terms, customers pay electricity generators a fee for ensuring that there is sufficient electricity generation available to supply their peak loads. The actual capacity obligation is measured differently according to the rules of each Regional Transmission Organization (RTO). In PJM (the RTO for part of 13 states and the District of Columbia, including Northern Illinois), a customer’s capacity obligations is termed PLC, which stands for Peak Load Contribution. Each customer in PJM is assigned a PLC number based on the customer’s peak demand during the highest five hours of total system demand during the period between June 1st-September 30th of each year. This is then the number used for the next capacity season, which runs from June 1st-May 31st . For example, a customer’s PLC was determined in the summer of 2018 for the capacity obligation period that will run from June 1st, 2019-May 31st, 2020. These numbers change from year to year and create a challenge for suppliers in providing fixed prices over long periods of time. Suppliers usually use some average of past PLC numbers and then build in a margin of upside error when determining the amount of capacity they will need to purchase on a customer’s behalf. Some customers choose to have capacity as a pass-through charge with all the other components of their bill being fixed. This makes sense for customers who receive a high PLC number (relative to their normal demand) and believe it will come down over time. Alternatively, if customers believe their usage is going to increase, they will probably be better off locking in their capacity.
It is important to highlight that the overall contribution of capacity as a percentage of price is determined by a customer’s load factor. Electricity load factor is defined as a measure of the utilization rate, or efficiency of electricity usage. It is the ratio of total energy (kWh) used in the billing period divided by the possible total energy used within the period if used at the peak demand (KW) during the entire period. For example, a company that provides refrigeration would tend to use electricity at a constant rate over time and would have a high load factor, while a recycler who uses large amounts of electricity for short periods of time would have a low load factor. Here at Alfa Energy, we use a model that can approximate the actual kWh cost of capacity for our customers and how that cost changes not only as the PLC changes but also the price of capacity changes.
This leads to the other part of the equation, and that is the actual cost of capacity. PJM has had a process of setting capacity prices three years forward by having an auction every April for the capacity period three years forward. This means that during this April there should be an auction for the capacity period of June 1, 2022-May 31st, 2023. This is not taking place since PJM has received permission from the Federal Energy Regulatory Commission (FERC) to postpone the capacity auction until August 2019. This has occurred because last year FERC (the federal regulator for PJM) told PJM that they could no longer operate their capacity auctions under their current rules. The intellectual foundation of FERC’s position is that under the former capacity market structure PJM was suppressing capacity prices since PJM was not accounting for the impact that state-subsidized resources, such as nuclear electricity generation in Illinois and all of the renewable electricity resources that receive state sponsored subsidies, have on the capacity price. Because of the subsidies, it is believed that these resources can accept a lower capacity price than perhaps an old coal or natural gas plant could.
PJM has developed an alternative plan, but FERC has yet to approve it. The new plan would effectively remove the subsidized resources from the market and allow such resources as coal and gas to bid their capacity separately (expected to raise the price of capacity). These auctions do not happen on their own as there is a lot of planning and execution that must happen. The delay to August could be acceptable, but until FERC approves a capacity plan for PJM, this uncertainty can cause suppliers to balk at pricing longer-term deals past June of 2022 because it is difficult to predict what that capacity price for a certain region may be.
Analyst – David Mousseau
Source – PJM and UTILITY DIVE