The Political Tug-of-War Over Energy Pricing

In recent months, the spotlight has been on Pennsylvania Governor Josh Shapiro’s pushback against PJM's capacity market design. Faced with escalating capacity prices, Gov. Shapiro’s office filed a complaint with FERC, raising concerns about the financial burden on consumers. This action was not taken in isolation; it was soon joined by other blue-state governors who echoed similar demands for reform. The result? A compromise that adjusts the price ceiling and floor over the next few years, aiming to balance immediate affordability with long-term reliability.

This episode underscores a broader issue: the susceptibility of capacity markets to political pressures. While capacity markets were initially conceived as a solution to the "missing money" problem—where price caps prevent suppliers from recovering full costs—their effectiveness is now questioned. The reliability concerns associated with lower capacity prices are speculative, yet the immediacy of high energy prices during scarcity events remains a potent political force. Leaders from California to Texas have shown they will go to great lengths to avoid short-term reliability issues, even if it means higher costs.

Historical Context and Shifting Perspectives

In 2019, CAISO proposed raising the energy price cap from $1,000 to $2,000 per MWh in the Western Energy Imbalance Market. The idea faced opposition from consumer advocates and large energy purchasers who feared inflated costs. However, the summer of 2020 changed the narrative. Scorching heatwaves led to rolling blackouts in California, prompting a shift in public sentiment. Suddenly, the priority shifted from minimizing costs to ensuring uninterrupted power supply, no matter the expense.

This change in attitude reflects a broader trend. Historically, electricity systems have been governed with an emphasis on risk aversion, often leading to over-provision of capacity. The once-in-a-decade standard for system-wide power shortfalls became a benchmark, but when California experienced rolling blackouts after two decades, it sparked widespread concern. In most regions, such events are rare, yet the fear of potential outages drives policy decisions.

Customizing Reliability Standards: A New Frontier?

The question arises: why can’t states or utilities opt for different levels of planning risk? The current model mandates uniform reliability standards across connected entities, but this one-size-fits-all approach may not be optimal. If a state chooses to buy less capacity, it should be prepared to face the consequences—whether through higher outage risks or ex-post penalties. This concept isn’t new; it harks back to an era when independent balancing areas operated without centralized ISOs. Utilities were responsible for their own shortfalls, and NERC penalties ensured accountability.

Introducing performance incentives could enhance this framework. For instance, load-serving entities (LSEs) that secure capacity from unreliable sources or under-procure could face penalties if those resources fail during scarcity events. Such measures would encourage more prudent planning and reduce the reliance on inadequate capacity. An energy-only market, where LSEs pay high spot prices during scarcity, offers another perspective. Although it has its challenges, as seen in Texas post-winter storm Uri, it emphasizes real-time performance over theoretical planning.

Capacity Markets Under Scrutiny

One of the key criticisms of capacity markets is their forward-looking nature. They require predicting future needs months or years in advance, often leading to inefficiencies. Smart players exploit loopholes, resulting in an imbalance of resource types. Operators like PJM recognize the need for better incentives to ensure generators deliver promised capacity. Extending this performance-based approach to the demand side could further refine the market, penalizing poor planning and encouraging reliability.

Ultimately, the gap between the theory of capacity markets and their practical implementation reveals that they are not a silver bullet. As the industry continues to evolve within a highly politicized environment, finding the right balance between cost and reliability remains a critical challenge. The recent actions by Governor Shapiro and others highlight the need for adaptable solutions that can withstand both economic and political pressures.