A critical element of effective energy risk management is an understanding of all of the cost components behind a retail electric bill and what causes these components to move. Recently, capacity costs, which are determined by PJM’s Reliability Pricing Model, or RPM, have followed a bell shaped curve across multiple utilities in the Eastern Mid-Atlantic Region, including the Public Service Electric & Gas (PSEG) area in New Jersey.[1]
The following graph shows capacity costs on a $/MWH basis for PSEG from June 2012-May 2015 time frame, which covers three (June 1 –May 31) delivery years.
As can be clearly seen, capacity prices for all 3 typical load factors—low (35%), medium (55%) and high (75%)—increased for the 2013/2014 delivery year but then tapered off for the 2014-2015 Delivery year. The questions we should be asking are:
- What caused the jump in 2013/2014 delivery year Capacity Costs?
- Will the trend be towards lower prices as seen in the 2014/2015 delivery year or will prices jump back up; and
- Most importantly, as a prudent energy risk management strategy, what is the right approach to managing the risk of capacity costs going forward?
Increased Energy Capacity Costs for 2013/2014
With increased demand response participation in the RPM Auction (the increase in PSEG was roughly 600 MW more in 2013/2014 versus 2012/2013), the expectation would be that capacity costs would have decreased as more “resources” were available to meet demand. However, 2 factors mitigated the impact of increased demand response participation in the PSEG area. First, transmission upgrades scheduled during the 2013/14 limited the ability to “import” capacity from other areas of PJM into the Eastern Zone, lowering the supply curve. Second, approved changes to the Cost of New Entry (CONE) component of RPM model resulted in higher cost. CONE, which is used to set prices on the demand curve, increased 23% year over year , shifting the demand curve right.
What pattern will capacity costs follow beyond 2014/2015 delivery year?
While peering in to the future is inherently uncertain, preliminary 2015/2016 capacity prices in the PSEG region of PJM show an increase of 20% compared to the previous delivery year. In other regions we see increases between 5% - 20%.
How to manage energy capacity costs going forward
In 2011, capacity payments accounted for approximately 15% of retail electricity prices. The table below shows present and future years’ capacity payments as a percent of retail electricity prices using the same Load Factor percentages as above:
|
Percent of Retail Electricity Prices | |||
|
Delivery Year |
35% LF |
55% LF |
75% LF |
|
2012/2013 |
21% |
13% |
10% |
|
2013/2014 |
31% |
20% |
14% |
|
2014/2015 |
23% |
15% |
11% |
The table shows that for low and medium load factor profiles, capacity payments have become a material cost component. Recognizing that some retail energy contracts allow end users to shift risks, the prudent thing to do is to evaluate a pass-through option strategy vs. the option of bundling capacity as a $/MWh component for better risk management. Contact your Acclaim representative to further discuss mechanics and contract language needed for the latter strategy.
CONTACT ALBERTO RIOS, DIRECTOR ENERGY RISK MANAGEMENT ON HOW TO EFFECTIVELY MANAGE YOUR ENERGY RISK!
arios@acclaimenergy.com (832) 294-2506
[1] While prices in the Eastern Region of PJM exhibit this bell shaped curve, prices in the Western Region of PJM, including Ohio are showing a steadier increase. This increase is being driven in large part by EPA regulations which have resulted in the retirement of 3,000 MW of capacity as well as increasing costs as coal plants are required to install emissions control technology to comply.
Disclaimer:This information has been provided to you for informational purposes only. Unless specifically stated otherwise, no infornmation contained herein constitutes an offer or solicitation by or on behalf of ACCLAIM Energy Advisors (ACCLAIM) to enter into any risk management product arrangement. The risk of loss in trading commodities can be substantial. You should therefore carefully consider the associated risks of trading of any securities. Information presented is time sensitive and subject to change at anytime without notice. Information contained within is compiled from sources believed to be reliable and the information provided herein is based upon a number of estimates and assumptions that are subject to significant business, economic, regulatory and competitive uncertainties. ACCLAIM makes no representation, warranty or guarantee as to, and shall not be responsible for, the accuracy or completeness of this information. ACCLAIM is not acting as an agent and is not liable to any recipient or third party for the use of or reliance on the information contained herein. This information may not be reproduced, distributed or published by any recipient for any purpose.
