D.C. Circuit Upholds Use of Combustion Turbine as Reference Resource in PJM Capacity Market, Finds 10% Net CONE Adder Arbitrary and Capricious

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On July 9, 2021, the United States Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) denied in part and granted in part a petition for review of FERC’s orders accepting revisions to PJM Interconnection, L.L.C.’s (“PJM”) Forward Capacity Market (“FCM”). The Petition was filed by the Delaware Division of the Public Advocate, Maryland Office of the People’s Counsel, and the Office of the People’s Counsel for the District of Columbia (“Petitioners”). The Court upheld FERC’s use of a Combustion Turbine (“CT”) plant as the Reference Resource in approving the net Cost of New Entry (“net CONE”) calculation, and found that FERC’s approval of a 10 percent adder on Reference Resource’s assumed energy market offer was arbitrary and capricious. The Court remanded the case for proceedings consistent with its decision on the 10 percent adder.

Net CONE is an input to the administratively-set demand curve (the Variable Resource Requirement Curve or “VRR Curve”), which represents the prices that consumers should pay for varying quantities of capacity offered in PJM’s FCM. Net CONE measures how much revenue a hypothetical new generator—referred to as the “Reference Resource”—would need to earn in PJM’s FCM to recoup its construction costs. To calculate net CONE, PJM: 1) estimates the total cost to install and operate the Reference Resource, and 2) subtracts any revenues from PJM’s energy and ancillary services (“E&AS”) markets.

PJM reviews the VRR Curve every four years. For the 2018 review, PJM proposed to use a CT plant as the Reference Resource, notwithstanding its independent consultant’s recommendation to use a combined cycle turbine plant. PJM also proposed to update the E&AS revenue estimate by increasing the value of the Reference Resource’s offer by 10 percent. FERC accepted PJM’s proposal in an initial order issued in April 2019 (see April 24, 2019 edition of the WER) and upheld its acceptance in April 2020 (see April 23, 2020 edition of the WER).

The D.C. Circuit upheld FERC’s approval of the Reference Resource as a CT unit. First, the Court rejected the Petitioners’ arguments that FERC erred by declining to apply the same three-factor framework FERC previously used to examine ISO New England, Inc.’s (“ISO-NE”) choice of Reference Resource for its own VRR Curve. The Court found that the three-factor test had not been applied outside of the ISO-NE region and was therefore not an established framework. The Court also pointed out that FERC subsequently addressed the three factors in its rehearing order, concluding that PJM’s proposal was just and reasonable even applying the factors.

Second, the Court found that FERC articulated a satisfactory explanation for its decision to accept use of the CT plant as the Reference Resource and that substantial evidence supported FERC’s decision. The Court pointed to evidence showing that CTs are inexpensive, can be built quickly, and are more responsive to address rapid changes in demand. In addition, the Court stated that FERC appropriately found that CTs “have an important role to play and continue to be deployed in PJM’s region,” citing statistics showing that over 1,600 MW of CT plant capacity was built in the PJM region since its capacity market was adopted. While the Court acknowledged that using a CT plant as the Reference Resource was more slightly expensive than using a combined cycle plant, it held that FERC reasonably determined that the increase in costs associated with the CT plant would have greater reliability benefits in all conditions at an increased cost to consumers of less than 2 percent.

Finally, the Court held that FERC did not provide a satisfactory explanation for its approval of the 10 percent adder to the Reference Resource E&AS revenue estimate. The Court explained that PJM’s energy market rules permit generators to increase their offers into the energy market by 10 percent above their estimated costs to account for uncertainty in fuel costs. However, the Court rejected FERC’s decision to accept PJM’s proposal to include that same 10 percent adder in the E&AS revenue estimates assumed for the Reference Resource. The Court reasoned that FERC failed to assess whether and to what extent CT plants actually use the 10 percent adder in their energy market offers, characterizing FERC’s response to evidence tending to show that CT plants do not use the 10 percent adder as “little more than a hand wave.” Thus, the Court remanded the proceedings for reassessment of the 10 percent adder.

The D.C. Circuit’s opinion is available here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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