Econonomics of Energy and Environmental Policy

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Capacity Markets in PJM

The PJM capacity market evolved from a mechanism to support fair and efficient retail competition, to a core market design component implemented to provide adequate revenue to attract sufficient supply and demand side resources to meet PJM's administrative reliability criteria. The lessons learned in the evolution of the PJM capacity market illustrate issues that are shared across all wholesale power markets. An exogenously imposed administrative reliability requirement has generally been interpreted to require the ownership of, or contracts for, capacity in excess of expected peak loads by a reserve margin. In PJM, the reserve margin requirement resulted in a level of capacity greater than would have been the result of the operation of an "energy only" market without such a requirement. The result was lower energy prices for all units and a shortfall of net revenues compared to the annualized costs of building a new generating unit. The early wholesale power market designs, including PJM, replicated the efficient dispatch of a tight power pool, but did not address the sources of revenues to cover the costs of investment in new and existing generating capacity and thus did not address the endogenous sustainability of the market design consistent with administrative reliability criteria. The introduction and redesign of a capacity market has largely solved this "resource adequacy" problem. But the PJM capacity market design continues to be imperfect and the resolution of the remaining design issues is critical to the continued success of the PJM market as demand increases and generating units retire. Keywords: Capacity Market, PJM Interconnection, RPM, Minimum Offer Price Rule
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JEL Codes:L51: Economics of Regulation, D02: Institutions: Design, Formation, Operations, and Impact, L94: Electric Utilities

Keywords: Capacity Market, PJM Interconnection, RPM, Minimum Offer Price Rule

DOI: 10.5547/2160-5890.2.2.3

Published in Volume 2, Number 2 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.


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