Energy & Infrastructure Alert
October.11.2017
On September 29, 2017, the Secretary of Energy submitted to the Federal Energy Regulatory Commission a notice of proposed rulemaking to support electric grid resiliency. The notice states that changes to wholesale market pricing rules are necessary to avoid premature retirements of coal and nuclear generation facilities. The notice further states that these generation resources contribute to grid resiliency because they use fuels that can be stored on-site unlike natural gas-fired resources, which rely on pipeline supplies, or renewable resources, which rely on intermittent resources such as wind and solar. Accordingly, the notice directs FERC to issue a final rule requiring regional transmission organizations (RTOs) and independent system operators (ISOs) to implement market rules that “accurately” compensate grid-resilient resources for the benefits that they provide.
The Secretary’s proposal includes revisions to FERC’s regulations that would require each ISO and RTO to establish a wholesale tariff rate for the purchase of electric energy from an “eligible reliability and resiliency resource” and the recovery of costs and a return on equity to ensure that these resources are “fully compensated for the benefits and services that it provides to grid operations….” In addition, the Secretary proposes to define “eligible grid reliability and resiliency resources” as any electric generation resource that: (i) is located within an ISO or RTO; (ii) is able to provide essential energy and ancillary reliability services; (iii) has a 90-day fuel supply on site; (iv) complies with all applicable federal, state and local environmental laws, rules and regulations; and (v) is not subject to cost of service rate regulation by any state or local regulatory authority. In practice, coal and nuclear facilities would benefit most from the rule if implemented as proposed.
The Secretary gives FERC 60 days from publication of the notice in the federal register to issue a final rule adopting these proposals. The final rule would become effective within 30 days of its publication in the federal register. RTOs and ISOs would have 15 days from the effective date of the final rule to prepare and submit revisions to their wholesale market tariffs to comply with the rule, or to file a statement explaining why their existing tariffs comply with the rule. As discussed further below, it remains unclear if and how FERC and the RTOs and ISOs will comply with the deadlines set forth in the Secretary’s notice.
Expedited Rulemaking Procedures
The Secretary’s authority to initiate a FERC rulemaking derives from the 1977 statute that established FERC as an independent executive agency to replace the former Federal Power Commission. Section 403 of the Department of Energy Organization Act states that the Secretary is “authorized to propose rules, regulations, and statements of policy of general applicability with respect to any function within the jurisdiction of the Commission….” When the Secretary proposes a rule that affects the rates, terms, and conditions of wholesale sales of electricity or transmission, FERC has discretion under the statute to initiate a rulemaking proceeding, which begins with the issuance of a notice of proposed rulemaking, is followed by public comments, and concludes with a final rule issued by FERC, which is subject to rehearing and appeal procedures. The Commission must act “in an expeditious manner in accordance with such reasonable time limits as may be set by the Secretary.”
Although the Secretary’s authority to initiate a FERC rulemaking is clear, it is less clear if FERC can or will respond with a final rule within 60 days. FERC rulemaking proceedings affecting wholesale market design often require many months, if not years, to resolve. Moreover, at FERC’s monthly open meeting in September, acting FERC chairman, Neil Chatterjee, stated that he does not want to address any major issues until the final two FERC vacancies are filled. On September 19, 2017, the U.S. Senate Energy and Natural Resource Committee confirmed the appointments of Kevin McIntyre and Richard Glick to FERC, but it is not clear when the full Senate will vote on their appointments.
Under the Organization Act, FERC is compelled to act on the Secretary’s proposal in “accordance with such reasonable time limits as may be set by the Secretary.” The Secretary states that FERC can respond within the deadline because FERC has already developed an extensive record on price formation within the ISO and RTO markets. In June 2014, FERC initiated a proceeding to evaluate issues regarding price formation in the energy and ancillary markets operates by RTOs and ISOs. After months of comments and reply comments, FERC issued a notice of proposed rulemaking in September 2015, inviting additional rounds of public comments that resulted in a final rule that was issued in June 2016. However, the proceeding did not address the price reforms suggested by the Secretary, and the Secretary’s proposals will no doubt generate significant new comments from the industry.
The timeline established in the Secretary’s notice presents further challenges to the ISOs and RTOs that must comply with FERC’s final rule. The notice directs FERC to make its final rule effective within 30 days of its publication in the final register, and RTOs and ISOs are required to submit compliance filings within 15 days of the effective date of the final rule. However, ISOs and RTOs will need to engage their stakeholders, including vertically integrated utilities and independent power producers, to evaluate the need for and develop revisions to their wholesale market tariffs to comply with FERC’s final rule. Like a FERC rulemaking, ISO and RTO stakeholder proceedings typically require many months to resolve.
On October 2, 2017, eleven industry groups, including the American Council on Renewable Energy, the Electric Power Supply Association, the Interstate Natural Gas Association of America, and the National Rural Electric Cooperative Association, filed a joint motion stating that the Secretary’s notice “does not establish a reasonable and adequate time for the submission of comments.” The joint motion urges FERC to provide at least 90 days for initial public comments, as well as affording an opportunity for reply comments. In addition, the joint motion suggests that FERC convene a technical conference prior to the comment deadline to provide interested parties an opportunity to better understand key aspects of the proposed regulations, and facilitate the submission of meaningful comments. Finally, the joint motion recommends that FERC extend the timelines for FERC to complete the final rule and for RTOs and ISOs to prepare and submit compliance filings.
In spite of the joint motion, and Commissioner Chatterjee’s comments at FERC’s open meeting in September, FERC issued a notice on October 2, 2017, setting deadlines for initial and reply comments of October 23, 2017, and November 7, 2017, respectively. Two days later, FERC issued a series of questions for commenters to address in their submissions to FERC. FERC’s questions address the need for reform, the proposed eligibility requirements, the 90-day on-site fuel requirement, implementation, and potential effects on wholesale markets. On October 5, 2017, several other parties, including the National Associations of State Utility Consumer Advocates, filed motions requesting FERC to extend its comment deadlines. Considering the breadth of reforms proposed by the Secretary, their potential implications on wholesale market operations, and FERC’s lingering questions on the need for reform and implementation, it remains uncertain if FERC can develop a sufficient record and produce a final rule by the 60-day deadline adopting the Secretary’s proposals. In addition, there is no assurance that RTOs and ISOs would be able to prepare and submit compliance filings within 15 days of publication of the final rule in the federal register.
Whatever the outcome of the FERC proceeding, the final rule likely will be subject to multiple requests for rehearing and appeal. When DOE invoked its authority under Section 403 to initiate FERC rulemakings in 1979 and 1985, the respective final rules were subject to multiple requests for rehearing that took years to resolve. In addition, any final action by FERC can be appealed to a United States circuit court of appeals, where the court must evaluate whether FERC’s action or inaction was arbitrary or capricious. Moreover, if a new administration takes control in 2020, these reforms, if adopted, could be reversed. Accordingly, it is difficult to see how owners and investors in coal and nuclear generation will, in the short term, significantly change their planning with respect to generation development and retirement.
Need for Reform
The Secretary’s proposal relies on statements collected from a variety of sources, including from DOE, FERC and the North American Electric Reliability Corporation (NERC). Taken together, these statements may underscore the need for reform, but they also should be viewed in their original context, and it is not clear that all of the reforms proposed by the Secretary are fully supported by existing data. In rendering a final rule in this proceeding, FERC will need to review the entire record, including public comments, to determine if the proposed reforms are necessary.
In August 2017, DOE staff released a report on electricity markets and grid reliability. The staff report highlights dramatic changes in wholesale electric market supply, including the increased use of natural gas-fired and renewable resources in the generation mix, which have led to significant retirements of coal and nuclear generation. According to the staff report, between 2002 and 2016, approximately 59,000 MW of coal-fired generation, and approximately 4,666 MW of nuclear generation, were retired. The DOE staff report states that there is an “urgent need for clear definitions of reliability- and resilience-enhancing attributes” and “FERC should expedite its efforts with states, RTOs/ISOs, and other stakeholders to improve energy price formation in centrally-organized wholesale electricity markets.” However, in spite of its warnings, the staff report concludes that wholesale markets “are currently functioning as designed – to ensure reliability and minimize the short-term costs of wholesale electricity.” In addition, instead of the reforms proposed in this proceeding, the staff report calls for a continued regional and national review of wholesale markets to ensure continued grid reliability and resilience. If FERC adopts the Secretary’s proposals, it will need to explain why the reforms are necessary now in light of findings by DOE staff, among others, that wholesale markets are functioning properly to ensure reliability.
The DOE staff report and the Secretary’s notice both point to the polar vortex event of 2014 to demonstrate the need for electric grid resilience. The Secretary’s notice states that the vortex created record-high winter peak electric demand, and that PJM – the FERC-approved RTO for the Mid-Atlantic region – struggled to meet demand for electricity because a significant amount of generation was not available to run. As was widely reported, many natural gas-fired plants were forced off-line due to natural gas production and delivery problems during the vortex. In his notice to FERC, the Secretary credits a number of coal and nuclear plants that were scheduled for retirement with sparing sixty-five million people within the PJM footprint from electric service outages during the vortex. However, the notice does not acknowledge NERC’s Polar Vortex Review, dated September 2014, which states that coal plants accounted for 26 percent of the outages during the vortex.
The Secretary’s notice states that wholesale electric markets are not adequately compensating fuel-secure resources, such as coal and nuclear resources, for the benefits that they provide to grid resiliency. As support, the Secretary cites DOE’s January 2017 Quadrennial Energy Report stating that wholesale market rules may require adjustment to enable better valuation of resources that contribute to grid resiliency. In addition, the Secretary points to a study by the international consulting firm, IHS Markit, stating that “some wholesale market price formation rules do not fully compensate generating resources for providing the desired power system supply resiliency.” However, the IHS Markit study relied on a base case where there was no meaningful contribution from coal and nuclear resources. Accordingly, the study did not evaluate the status quo scenario in which coal and nuclear plants continue to supply power without additional compensation for resiliency.
Although the Secretary cites multiple FERC proceedings addressing price formation and the reliability, the notice does not address existing market mechanisms that compensate coal and nuclear facilities for their costs. For example, in several RTOs, owners of generation facilities must provide advance notice to the RTO of any plant retirements. In response, the RTOs must study the potential effects of the retirement on the reliability of the electric grid and, if those effects are significant, the RTO will enter into a reliability must run or similar contract with the resource owner to compensate the owner for the costs of the plant’s continued operation. In addition, eligibility and performance requirements in forward capacity markets have, in some cases, been designed to favor thermal generation, including coal and nuclear generation, but have remained resource neutral. For example, in order to participate in the PJM capacity market, a resource must be capable of sustained, predictable operation demonstrating that the resource will be available to provide energy and reserves throughout a delivery year. Beginning next year, entities with commitments in the PJM capacity market will be subject to performance penalties if they do not provide energy that they committed in the capacity auction.
The proposed rule provides little support for the requirement that reliability and resiliency resources have 90-days of fuel available on site. The Secretary’s notice points to a May 2017 letter from NERC stating that “coal-fired and nuclear generation have the added benefits of high availability rate, low forced outages, and secured on-site fuel.” However, the Secretary does not cite any rule, standard, or industry practice that supports recommending a 90-day on-site supply of fuel. In addition, in its Polar Vortex Review, NERC identifies a three-day period where cold temperatures resulted in a reliability need for dispatch of additional resources. FERC has requested comment on the need for a 90-day on-site supply of fuel, and whether it would contribute to electric grid resiliency.
Cost-Based Compensation
Under the Secretary’s proposal, RTOs and ISOs would be required to develop wholesale market policies that provide “fuel-secure generation” resources (i.e., coal and nuclear resources) full recovery of their costs. The Secretary does not make any specific proposals with respect to mechanics, but proposes to direct RTOs and ISOs to establish just and reasonable rate tariffs for the recovery of costs and a fair rate of return. Assuming that FERC issues a final rule adopting DOE’s proposal, RTOs and ISOs will be tasked with determining how to adjust their wholesale market structures to provide “fuel-secure generation” resources full recovery of their costs while also balancing mandates under the Federal Power Act to establish just and reasonable rates, terms, and conditions of wholesale electric sales that are not unduly discriminatory or preferential.
In response to the proposal, RTOs and ISOs with capacity markets, such as PJM, might propose revisions to their capacity market rules to provide additional compensation for fuel-secure resources. RTOs and ISOs that lack capacity markets might propose adding them. Alternatively, they could propose revisions that provide fuel-secure resources full recovery of their costs in the day-ahead and real-time markets. Whatever the mechanism, compliance with the proposed rule will require significant changes in how RTOs and ISOs operate wholesale markets.
Currently, RTOs and ISOs run competitive, price-based auctions to procure sufficient energy and capacity to satisfy load and operating reserve requirements. One of the reasons there have been significant retirements of coal and nuclear facilities in the past two decades is the growing number of generation resources that are bid into the market at a lower price than the retired facilities. If RTOs and ISOs are forced to fully compensate fuel-secure resources for their costs, then they will need to modify how their competitive auction structures to give resources like coal and nuclear resources an opportunity to set a higher auction clearing price and be dispatched to generate wholesale electricity. This could result in higher wholesale electric prices, which would lead to higher prices to ratepayers. In addition, if vertically integrated utility members of an RTO are subject to increased wholesale energy costs, they might petition FERC to withdraw from the RTO, causing further disruption within the wholesale markets.
Conclusion
Even if FERC adequately supports the need for reform in its final rule, it will need to explain how reforms that in effect favor particular resource types are not unduly discriminatory or preferential. In addition, FERC will need to explain why potential increases in ratepayer costs are justified to ensure grid resiliency. In turn, the RTOs and ISOs will need to take a hard look at their wholesale market rules to determine what, if any, revisions are needed to comply with FERC’s final rule. It is difficult to imagine that RTOs and ISOs will be able to engage their stakeholders to prepare and submit tariff revisions and compliance filings within the timeframe proposed by the Secretary.
At this time, it is unclear how FERC will respond. Two former FERC chairmen, who were appointed by President Obama, have criticize the Secretary’s proposal, as has a Republican former FERC commissioner. Current FERC commissioner Cheryl LaFleur is expected to oppose the proposal. FERC commissioner Robert Powelson, who was nominated by President Trump, responded to the Secretary’s proposal by saying that FERC “will not destroy the markets.” Accordingly, there is a chance that FERC will, after collecting public comments, decide not to issue a final rule implementing the Secretary’s proposal. However, the Secretary has made his policy agenda clear and, while FERC is an independent agency, it is more likely that the proposal will result in market reforms that are fuel neutral and require a demonstration of a reliability need before FERC grants cost-based recovery to facilities that contribute to grid resiliency.
A copy of the Secretary’s notice of proposed rulemaking can be found by clicking here.
A copy of FERC’s notice providing questions for comment on the Secretary’s proposal can be found by clicking here.
By Adam Wenner and A. Cory Lankford