1200 G Street, N.W. Suite 600 Washington, DC 20005 To: DOE Drafting Team re: Secretary Perry’s April 14, 2017 Memorandum From: Craig Glazer, Vice President Federal Government Policy PJM Interconnection, LLC Re: Some Thoughts on Key Market and Operations Reforms: A Perspective from PJM Interconnection Date: June 9, 2017 As the DOE Drafting Team prepares its report in response to the April 14 request of Secretary Perry, PJM Interconnection wishes to share with the Drafting Team some key market and operations reforms that PJM believes would be responsive to the issues raised by the Secretary. The initiatives outlined below are ones which PJM is planning to undertake in consultation with stakeholders and states in the PJM region. However, given their national impact, these are issues which we believe need to be addressed at a national level in order to ensure both a resilient grid and resilient resource fleet to meet the public’s interest in ensuring reliable electricity supplies at just and reasonable prices. Although I am encapsulating these proposals in this Memorandum, each of these initiatives has been presented publicly, most recently through the filed testimony of PJM CEO Andrew Ott before the Federal Energy Regulatory Commission at its conference on state policy initiatives and in specific reports posted on the PJM website.1 Background for Market and Operations Reforms Over the past several years, the FERC has focused on a variety of issues associated with price formation in the energy market—with the stated goal of making prices more reflective of system conditions and appropriately valuing resources needed to meet changing conditions through the operating day. Although the Commission’s efforts have appropriately tackled some significant and difficult policy issues (such as amendments to the $1,000 nationwide offer cap) and deserve considerable praise as a result, a number of the energy price formation regulatory proposals have focused on very specific and, in some cases, very narrow issues.2 PJM has been supportive of FERC’s efforts but believes there is a larger price formation and related resilience issue that remains to be addressed which would have far greater implications for the future profile of the generation fleet. Specifically, as defined in this paper, PJM wishes to initiate dialogue on the following issues: Mr. Ott’s testimony is posted at http://pjm.com/~/media/documents/ferc/filings/2017/20170421-ad17-11-000.ashx. The PJM energy price formation initiative has further been defined in PJM’s recently issued response to the PJM Market Monitor’s State of the Market Report which can be found at: http://www.pjm.com/~/media/library/reports-notices/state-of-the-market/20170512pjms-response-to-the-2016-state-of-the-market-report.ashx. 1 For example, the Commission Staff has issued separate Notices of Proposed Rulemaking on extremely granular issues such as cost allocation associated with uplift (Docket No. RM 17-2-000) and a second associated with creating specific pricing rules for a limited class of resources deemed ‘Fast Start’ resources (RM 17-3-000). 2 202.393.7756 www.pjm.com    Pricing Reform: Defining locational marginal price (LMP) formation in a manner which recognizes the contribution of all resources, including large, inflexible units (often referred to as ‘baseload’ resources) in serving load in a given hour; System Resilience: Planning and operational reforms needed to ensure resilience in the face of black sky events and potential disruptions to the interstate natural gas pipeline system; and Impacts of Negative Offers: Addressing the pernicious effects of negative offers on discouraging the retention of critical fossil generation needed to address the variability of renewable generation Each of these issues is addressed below. INITIATIVE #1: Pricing Reform—Ensuring that LMP Reflects True Marginal Cost With Improved Incentives for Efficient Dispatch to Serve Load. Price formation has grown in importance as the supply curve in systems across the nation continues to flatten. Figure 1 displays this supply curve trend in the PJM region. Units formerly considered base and mid-merit are now being relied on to operate more flexibly as if they are peaking units yet at many times are ineligible to set LMP based on their operating parameters. Excess supply in light of reduced load levels has also contributed to this evolution. As a result, incremental movements in LMP seem less effective in incentivizing units to reduce output to follow dispatch. PJM has also observed that resources utilizing natural gas as their primary fuel tend to acquire gas on an inflexible basis given the economic advantage in so doing and the limited availability of flexible pipeline transportation products. The limited LMP variations at the margins, coupled with the natural gas procurement limitations referenced above, all combine to reduce economic incentives for resources to follow PJM dispatch signals. This phenomenon erodes one of the key drivers of moving to LMP pricing---namely to create economic incentives for units to follow RTO dispatch instructions designed to ensure efficient dispatch of the system and maintain system reliability. 2 Figure 1: Average PJM Aggregate Real-Time Generation Supply Curves in summer 2015 and 20163, 4 PJM is also observing diminishing energy market returns to supply resources, resulting in a shift to the capacity market for the greater proportion of units’ recovery of their total costs. Figure 2 shows that this trend has been more pronounced since 2014. The shift could lead to an unintended bias in the energy markets favoring lower capital cost resources. The concern is that this phenomenon is driven, not only by strict supply and demand fundamentals, but also, in part, by inadequate ability for the current energy pricing mechanisms to transparently value all resources. The trend is not new but its impact on energy prices is heightened given the flat supply curves and low demand which put financial stress on all units, but particularly large units with high capital costs. Figure 2: Share of Total Wholesale Electricity Costs 3 Monitoring Analytics, LLC, PJM State of the Market Report – 2016. Section 3 – Energy Market. 4 Real-time average hourly load was 88,601 MW in 2016, and 88,594 MW in 2015. 3 The goal of PJM’s price formation initiatives is to prompt discussion focused on ensuring that the marginal cost of serving load is more transparent and recognized in the LMP-based market clearing process. In turn, this should reduce uplift costs and improve price signals to support efficient investments. PJM Response to FERC Fast-Start Resources Notice of Proposed Rule Making (NOPR) As noted above, FERC Staff has recognized the issue in its recent ‘Fast Start’ Pricing Notice of Proposed Rulemaking (Docket No. RM 17-3-000 (December 15, 2016)) but, without explanation, limited its proposed remedy to ‘fast start’ resources which are principally natural gas-fired combustion turbine units. By so limiting the application of its proposed reform, the Commission Staff’s approach only addresses a subset of the larger issue with significant negative implications for larger units, such as coal and nuclear units, to the extent they are the marginal unit needed to serve load in a given hour. The FAST Start NOPR is very helpful in flagging the issue but its proposed remedy may mask the larger issue. In essence, PJM believes it is prudent for the regulator, with input from RTOs and stakeholders, to begin to address price formation on a scale that is larger than simply limiting the class of inflexible units eligible to set price to fast-start resources. Expanding Eligibility to Set Price Beyond Flexible and Fast Start Resources If the system needs the output of a unit to maintain power balance while managing transmission constraints, that fact should be made transparent through the energy prices. PJM believes that the eligibility of resources to set price should be expanded to all units whose output is needed to serve load or control transmission constraints. This is distinct from today, where only additional MWs above a unit’s economic minimum are considered “needed” for economic dispatch and therefore eligible to set price. This expansion of price-setting eligibility would include:   Inflexible units having the ability to set price whenever needed for 5 minute increments, and Evaluations of requirements for ramp rates, economic minimums, and emergency minimums. Allowing all units to set price would create a function in which price increases more consistently as load increases. This price-setting expansion would reduce uplift, and lead to more predictable and rational price signals. This concept is illustrated with an example in Figure 3. 4 Figure 3: Comparison of Price Setting Methods Reforming Reserve Pricing to Incent Development of Innovative Flexible Products Including Storage In order to maintain generation to load balance while inflexible units are being dispatched, this proposed pricing reform should be accompanied by development of reforms to the pricing of reserves (through either a load following product or other means) which would compensate those flexible resources which are forced to ramp down uneconomically to meet demand when a larger, inflexible resource must operate at a minimum output level. The load following product would thus provide enhanced opportunities for flexible resources, including new technologies such as energy storage resources, to be compensated for the value of their flexibility without their displacing the need for the dispatch of larger more inflexible units in the circumstances outlined above. PJM is also exploring reforms to reserve pricing in order to co-optimize and recognize the true cost of providing needed reserves. Valuing flexibility in electricity markets could potentially also drive innovation with respect to flexibility in the gas nomination cycle, and promote enhanced gas-electric coordination. These incentives would drive gasfired units to acquire (and pipelines to offer) more flexible products so that natural gas units could take advantage of the economic benefits associated with offering their flexibility to the market. INITIATIVE #2: Reforms to System Operations and Planning to Value Diversity & Resilience In PJM’s recent whitepaper, “PJM’s Evolving Resource Mix and System Reliability,” PJM highlighted the need to focus on grid resilience, especially as the electric system becomes more dependent natural gas generation and pipeline infrastructure. Part of enhancing resilience involves instituting operational reforms in which PJM would commit additional reserves or operate the system more conservatively. ’Resilience’ is distinguishable from ‘reliability’ as today’s NERC reliability standards, for example, do not necessarily require proactive actions such as conservative operations being utilized in response to potential but identifiable contingencies such as gas pipeline failures. 5 Addressing system resilience centers on at least three areas:    In the planning realm, the RTO planning process would include a driver designed to: o make critical facilities potentially less critical; and o would take into account potential disruptions of the gas pipeline infrastructure as a potential driver for reinforcement and expansion of the transmission grid so as to mitigate the impacts of such disruptions; In the operations realm, the system would be operated more conservatively under certain conditions with additional reserves procured in key locations in anticipation of potential interruptions of the gas pipeline system. Through its capacity performance requirements, PJM has created incentives and penalties designed to ensure that units maintain dual fuel resources or secure more reliable gas supplies during capacity emergencies. Conservative operations would go the next step and ensure that beyond any one generator, the system itself is being operated in a way as to maintain reliability in response to potential multiple interruptions of natural gas supply. These new operating procedures would need to be accompanied by changes in market rules to ensure transparency in market clearing prices; In the area of restoration planning, focused work would be undertaken with the natural gas pipeline community to ensure that restoration plans take into account the needs of the electric grid as well as the needs of the pipeline grid to serve critical customers. To date, restoration efforts have largely been ‘silo’d’ between the two industries with additional work needed to ensure additional communication and coordination efforts undertaken proactively to ensure effective restoration of critical electric and pipeline services. INITIATIVE #3: Addressing Impacts of Negative Offers PJM has been observing negative energy market offers from wind generation as a direct result of the federal wind production tax credit (PTC). This is problematic because the negative offers, encouraged by out-of-market payments, negatively impact all non-wind resources. While respecting the decisions of Congress to maintain but phase-out the wind PTC, PJM believes it appropriate for a regulatory initiative to address the impacts of negative offers on distorting price signals and eroding revenue streams needed to maintain critical fossil facilities used to ensure reliability given the intermittency of renewable resources. There are many ways this issue could be addressed. Nevertheless, the economic challenges facing the industry, as well as the operational challenges faced by units being unwilling to curtail in response to dispatch instructions during low load periods, argue for a broader discussion on ways to ensure grid reliability in the face of negative pricing. PJM intends to raise this issue with stakeholders and regulators in order to assist in the development of national and regional solutions that address reliability needs while recognizing the will of Congress in maintaining the tax credits subject to a phase-out. 6 Next Steps PJM is performing analysis and simulations to evaluate the price formation concepts described above, and intends to encourage proactive action taken by the FERC to begin to address needed reforms in each of the above areas. The above outline represents a draft encapsulating our initial thoughts which we will continue to refine in consultation with policymakers and stakeholders. Nevertheless, as noted above, these issues are not limited to the PJM footprint. As the FERC focuses on energy price formation and resilience issues, PJM posits that reforms in the above areas are worthy of national debate and discussion in order to further the important goal of ensuring a resilient resource mix and grid going forward. 7