PJM Capacity Prices: What They Are and What You Can Do About Them

Suppose you have a business in states like Pennsylvania, Ohio, New Jersey, or Maryland and have elected to purchase electricity supply from a licensed Electric Generation Supplier (EGS). In that case, your EGS may have referenced the terms “capacity,” capacity price, or capacity cost. Therefore, there is a good chance that “capacity” is referenced in your electricity supply agreement.

This post explains how the PJM capacity price translates into a capacity cost for a business that buys electricity from an EGS. Also, it includes example calculations and explores how companies can proactively manage capacity costs.

The Theory Behind PJM Generation-Related Capacity Prices

PJM, one of several U.S. regional transmission organizations, administers the reliable flow of electrons from generators to consumers. To ensure reliability, PJM makes sure there is enough generation supply to meet consumer demand.

Power plants cannot operate without revenues. They need these revenues to cover their costs. To secure commitments from power generators to provide electricity on demand, PJM allows power generators to get a revenue source in the form of a capacity payment.

The capacity payment is based on the annual capacity price and a generation load commitment.

PJM determines capacity prices via an auction process called the Base Residual Auction. All PJM-approved generators have potential access to the capacity payment (but not all will get one). The generators submit offers, with each representing a demand (Megawatt (MW)) value and a cost value. Each power generator is unique regarding the amount of load (MW) it can contribute and what “cost” is needed to operate that asset. However, some generators can commit more load than others and differ on their “cost” requirement.

How Does PJM Develop The Price?

Starting with the lowest-cost offer, PJM stacks generation load until the demand load goal is met. The cost of the last increment of generation-load that meets the demand load goal becomes the capacity price.

For example, PJM’s demand-load goal is 20,000 MW. Generator offers are as follows:

In this example, the final capacity price is $50/MW-day. The offers from Generators 1, 2, and 3 account for 20,000 MW of PJM’s load goal. As a result, Generators 1, 2, and 3 will receive a $50/MW-day capacity payment. Although Generator 4 can provide 10,000 MW of electricity, it will not receive a capacity payment. Therefore, their generation, priced at $60/MW-day, is not needed to meet PJM’s demand load goal.

PJM finalizes capacity prices in advance of a one-year term that starts June 1. Also, PJM establishes demand load goals for each “zone” within its footprint.

On June 2, 2021, PJM released the preliminary capacity auction results for June 2022 through May 2023 term. A snapshot of the results are as follows (by load-zone):

PJM Capacity Costs and Peak Load Contribution

“Capacity” is relevant to electricity supply deals because it is a cost obligation. The cost for capacity is a component of the total price for electricity supply provided and billed by an EGS. Therefore, higher capacity costs are associated with higher bills and vice versa.

Consumers fund the capacity payments, as they are relying on these generators to reliability produce electricity when needed. Furthermore, capacity costs can be a component of the supply price in fixed-price electricity deals. However, some businesses elect to have capacity costs itemized on suppliers’ invoices.

PJM invoices suppliers for their respective capacity cost obligations. In turn, suppliers collect capacity payments from their customers. Meanwhile, PJM pays these funds to the generators entitled to capacity payments.

In addition to the capacity price, consumer-paid capacity costs are a function of their Peak Load Contribution (PLC). Like the capacity price, PLCs are set for 12 months starting June 1. PLC’s are a demand-related (MW) value. The PLC is based on a customer’s demand coincident with the five peak hours experienced on the PJM network during the prior June through September period.

How Capacity Cost is Calculated Using the Peak Load Contribution

The annual capacity cost formula looks like this:

PLC x Forecast Pool Requirement (FPR) Factor x Final Zonal RPM Scaling Factor (ZSF) x Capacity Prce x # of days in year

For instance, a customer in the Duquesne Light Zone has a PLC of 1 MW and annual consumption of 5,000 megawatt-hours (MWh), or 5,000,000 kWh. The capacity rate is $50.09/MWh-day. The total yearly cost of generation-related capacity is $22,571, based on the following calculation:

PJM posts the capacity prices, forecast pool requirement, and zonal scaling factors on its website.

Why It Matters

Capacity costs represent about 15% of an Electric Generation Supplier’s price. Therefore, a 25% increase in capacity costs translates into a 5% increase in the supplier’s price, all other cost components equal.

Many electric generation suppliers have provisions in their agreements that allow for the “pass-through” of generation-related capacity cost increases. Consequently, consumers may have price risk tied to generation-related capacity cost increases billed as pass-throughs. Businesses that have a firm grasp on the relationship between capacity cost changes and price risk are a step up when it comes to top-notch electricity procurement. Valuing this risk is part of Foster LLC’s electricity buying services.

Businesses Can Reduce Their Capacity Cost Obligations by Lowering the Peak Load Contributions

Although businesses that take electricity distribution services from utilities within the PJM network are subject to the generation-related capacity cost construct, they can have some control over their capacity costs.

As referenced above, a component of capacity cost is the Peak Load Contribution. To mitigate capacity cost increases or secure future capacity cost reductions, many businesses take a proactive approach to reducing PLCs.

To do so, they arrange for notifications that PJM may experience a PLC demand-setting hour. Next, they reduce their electricity demand during that hour by slowing or shutting down parts of their manufacturing operations. For example, if they can lower their load by 0.25 MW during each of the 5 PLC-setting hours, their PLCs for the following June through May period will be about 0.25 MW lower.

The calculation below is based on the same parameters used in the example above. But, the consumer reacted to PLC demand-setting hour signals, reducing the PLC by 0.25 MW.

Therefore, by reducing the PLC by 0.25 MW, the customer lowered its annual generation-related obligation cost by $5,643, or $1.12/MWh of yearly consumption.

Additionally, businesses that proactively manage their PLCs in this fashion tend to have contracts whereby the EGS itemizes generation-related capacity costs. Most important, they can see, value, and reap the benefits of their PLC optimization strategy.

Wrapping Up PJM Capacity Costs

In conclusion, “capacity” is a reference to generation-related capacity costs. In the PJM network, electricity suppliers recoup the mandated recovery of capacity costs through their customers’ invoices. Capacity cost reset every June 1, based on annual changes to auction-based capacity prices and customer-specific peak load contributions (PLCs). Moreover, capacity costs can be built into suppliers’ fixed prices or suppliers can itemize them on their invoices. Finally, businesses that can proactively reduce their PLCs by responding to signals can reduce their capacity cost obligations.

Reap the rewards of lowering your electricity bill by reducing generation-related capacity costs. Let me help you make that happen. Reach out today!