Higher Power Costs in U.S. East as Regulations Squeeze Supplies

Costs to assure adequate electricity supplies on the biggest U.S. grid are poised to rebound from a three-year low as regulations limit supplies.

In a capacity auction being held this week, electricity suppliers will tell PJM Interconnection LLC, which manages the network stretching from Washington to Chicago, how much it would cost to make their plants available to meet peak demand on the hottest days. PJM will release results from the auction on May 23, covering the year starting June 2017.

Goldman Sachs Group Inc. sees prices rising as federal environmental regulations prompt more coal units to shut and recent Federal Energy Regulatory Commission rulings cap imports and demand-curtailing services that can participate in the auction. Capacity charges will increase to $75 to $100 a megawatt per day compared with last year’s auction, representing a gain of 26 percent to 68 percent, according to estimates from American Electric Power Co. (AEP), UBS AG and Standard & Poor’s.

“The regulatory changes and rule changes that have been approved by FERC favor higher prices,” said Paul Patterson, a New York-based analyst for Glenrock Associates LLC. “The rule changes appear to be designed to increase prices for incumbents, to improve their economics. What happens depends on how new entrants respond to market rules, and in the past they have showed when they weren’t expected.”

Boosting Revenue

Higher capacity prices would boost revenues and valuations at utilities and independent power producers from Public Service Enterprise Group Inc. (PEG) to Exelon Corp. (EXC) and NRG Energy Inc. (NRG) In 2013, capacity costs accounted for 18 percent of the $33.9 billion in market billings. The Valley Forge, Pennsylvania-based grid manager, which serves more than 61 million people in 13 states, selects the lowest-cost bids from nuclear, coal, wind and other power suppliers.

For this week’s auction, FERC approved two rule changes that limit supplies from neighboring grids and from so-called demand response providers, which cut usage during peak hours of the year. A surge in these sources pushed prices last year to a three-year low of $59.37 per megawatt per day. Reserve margins had swelled to a record 21.1 percent since the capacity market was started in 2007.

PJM will for the first time cap imports at 6.3 gigawatts, of which 4.8 gigawatts of supplies have received exemptions to participate in this week’s auction, according to Ray Dotter, a spokesman for the grid operator. That leaves 1.5 gigawatts of other import capacity that can be selected, he said. Last year, imports rose 90 percent to 7.5 gigawatts from the May 2012 auction.

Limit Cap

PJM is also imposing a cap on “limited demand response,” which refers to customers that can be asked to cut usage up to 10 occasions for up to six hours each from June through September, he said. Only 2.3 gigawatts of these services will be selected, compared with 9.9 gigawatts last year.

The rule change will shift away from cheaper sources available for a few hours in the summer to pricier services that can be used more frequently throughout the year, he said.

That will help lift PJM capacity prices to $76 to $100 a megawatt per day and to as high as $229 in northern New Jersey, Daniel Ford, a New York-based analyst with Barclays Plc, said in a note to clients. Julien Dumoulin-Smith, a New York-based analyst with UBS, said prices may climb to $80, though there is a chance prices may be little changed compared with last year’s results.

Demand Projections

Countering the possible price boost from rule changes are lower demand projections from PJM and NRG’s recent announcement to delay shutting two Maryland coal-fired plants, said Prajit Ghosh, senior analyst with North America power service with Wood Mackenzie Ltd. in Houston. His estimate for the capacity auction is $60, though prices could clear anywhere from $50 to $70, he said.

PJM cut its reliability requirement for this week’s auction to by 1.1 gigawatts, or 0.7 percent, to 165 gigawatts, according to its planning document. NRG Energy Corp. plans to delay mothballing 1.204 gigawatts of generation at its Chalk Point and Dickerson power plants in Maryland by a year to May 2018, according to a May 6 filing.

“If it comes in at $60, people will look at their assets closely in terms of shutting them down,” said Aneesh Prabhu, senior director for Standard & Poor’s Utilities and Project Finance division.

Plant Assessments

FirstEnergy Corp. has about 2,100 megawatts of less efficient coal-fired power plants located in the PJM market that the company may consider shuttering if capacity prices are too low, said Prabhu. The price drop in the May 2013 auction prompted the company to announce plans to close 4,780 megawatts, he said.

Exelon, the largest U.S. nuclear-plant owner, has been pushing for changes in the PJM capacity market because it is not compensating reactors for carbon-free generation and fixed fuel costs, Chief Executive Officer Christopher M. Crane said in an April 30 analyst call. Exelon said it will consider closing uneconomic units and is closely monitoring the 1,100-megawatt Clinton and the 1,800-megawatt Quad Cities plants in Illinois.

NRG, the nation’s largest competitive power producer, may consider shutting some plants it acquired through its acquisition of Edison Mission Energy, Prabhu said.

“These decisions will be influenced by prices set in capacity markets, but will perversely affect the pricing in future capacity auctions,” said Prabhu.

To contact the reporters on this story: Naureen S. Malik in New York at nmalik28@bloomberg.net; Jonathan N. Crawford in New York at jcrawford47@bloomberg.net

To contact the editors responsible for this story: Dan Stets at dstets@bloomberg.net Charlotte Porter, Richard Stubbe

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