Low-Energy Fridays: Everything You Wanted to Know About PJM’s Capacity Auction But Were Afraid to Ask (Part 1)

The big news in the energy world this week was the release of PJM’s annual capacity auction results for the 2028/2029 delivery year. We had planned to devote this week’s Low-Energy Fridays to the auction and what it means for the future of organized wholesale markets; however, in developing our analysis, it became clear that we must first address certain prefatory questions like “What is an annual capacity auction?” and “What is a PJM?”

Today’s newsletter will provide that necessary background foundation, but you’ll have to come back next week to find out what it all means. So let’s start at the beginning: The universe was formed approximately 14 billion …

Actually, let’s skip forward a bit. For most of the 20th century, electric utilities largely existed as self-contained bubbles. A utility would build generation and then use that generation to provide power to its own customers. Over time, people began to recognize some significant drawbacks to this setup. Having each utility build only (and all of) its own power supply meant that a large amount of unused capacity would be sitting around most of the time, and it also meant that customers could get stuck paying high energy prices even when cheaper sources existed elsewhere.

So about 30 years ago, the Federal Energy Regulatory Commission (FERC) developed rules for the creation of new organizations to facilitate the development of wholesale electric markets over broader regions spanning multiple states. While some of these organizations are called Independent System Operators (ISOs) and others Regional Transmission Organizations (RTOs), they all allow multiple utilities to form a broader market for wholesale electricity, which reduces overall costs while increasing reliability.

Membership in these organizations by utilities is voluntary, and non-utility power producers (e.g., independent power producers) can also participate. ISOs and RTOs are meant to be independent of all utilities and large enough that they aren’t beholden to or easily manipulated by any single utility. Currently, around two-thirds of the country is part of an RTO or ISO. The PJM Interconnection, which held this week’s auction, is an RTO that spans various Mid-Atlantic and Midwestern states from Illinois to New Jersey, in addition to part of North Carolina. (In case you were wondering, “PJM” is an acronym for the organization’s previous name, the Pennsylvania-New Jersey-Maryland Interconnection. As it grew, the name was changed to PJM Interconnection, LLC in the late ‘90s.)

Wholesale electricity prices in RTOs and ISOs are set by capacity auction. Generation owners (whether a utility or some other power producer) submit bids for how much power they can produce at what price, and the lowest bids are accepted up to however much power is needed to meet demand.

While most of the action happens in the “real-time market,” which buys power to meet demand on an almost minute-by-minute basis, the majority of RTOs and ISOs also operate a separate “capacity market” to ensure there will be enough generation to maintain electric reliability for some point in the future. In PJM, that future point is three years. As with the real-time market, capacity markets are conducted via auction—though less often (typically once a year) and with generation owners pledging readiness to provide a given amount of power if and when called upon by the RTO or ISO. If a generator wins an auction and subsequently is unable to perform as promised, it is banished to the Phantom Zone—er, I mean, it must bear a significant financial penalty.  

Not everyone is a fan of the RTO/ISO system. In particular, utilities in states that are not currently part of an RTO or ISO but are considering joining one are eager to pour cold water on the idea. So we have statements, both loud and quiet, suggesting that the RTO experiment may have run its course and that we should return to vertical integration of utilities.

That brings us to this year’s auction. Like the last two, this one cleared at the cap of $325 per MW-day as proposed by Pennsylvania Gov. Josh Shapiro, accepted by PJM, and approved by FERC. If the market were left to its own structure, the value would likely range from $171 to $597 per megawatt-day depending on the region. You could conclude from these values that 1) PJM is sending a signal to the generating community that they need new generation and 2) that out-of-market forces are constraining the value of that generation.

But to get our full analysis, you’ll have to wait until next week.