This post was co-written by Senior Director, Project Finance Colin Murchie.

From New Jersey to Northeastern North Carolina, a growing number of generators in the PJM region are connecting to the wholesale side of the grid instead of behind the meter. For a sufficiently savvy solar developer, this can offer significant streamlining benefits compared to typical customer-sited development. By effectively decoupling site from load, more sites can be developed more quickly. However, wholesale generators also face a far more complex and dynamic revenue picture than a simple fixed-rate per MWh contract with a customer on-site. In particular, PJM’s multibillion-dollar capacity market has recently transitioned to a scheme with strong parallels to a mid-1990’s Chris Farley sketch. (Watch it, despite its cultural insensitivity, or the rest of this entry will make even less sense than it otherwise would.)

Capacity market basics

Through the “Reliability Pricing Model” or RPM, PJM region generators receive payment not only for energy produced (MWh), but also for having capacity (MW) available during peak or emergency events – during the hot summer afternoons when demand is highest, for example, or during the polar vortex.

In the past, some utility-scale solar has participated by bidding into the auctions at zero, and being credited with about 38% effective capacity (that is, a 1MW AC generator was treated as a 380kW generator). Actual performance would be measured during the five highest demand hours systemwide, almost invariably summer afternoons, and generators that hit their mark (i.e. a 1MW solar energy system that was producing at least 380kW during those hours) received payments.  Averaged across a year, these might add up to around $10/MWh – a meaningful amount – though one that many solar investors don’t take into account. In the less likely event of underproduction, penalties were minor; generators would just forfeit a portion of future payments. It all seemed like a lark set up by the hotel concierge.

The new plan: Capacity Performance

Then came the polar vortex. While nuclear and renewable generators reliably provided capacity to the market at typical historical levels, many fossil generators failed their obligations. The result was major instability in the power markets, and a push to reform facilitated by financially struggling nuclear generators who argued that they were not being compensated fairly for their reliability.

Accordingly, in early June, FERC approved an expensive new plan, the Capacity Performance Proposal. The decision was described as a “dream come true” for electricity generators. Although FERC Chairman Bay dissented with the approval, implementation is underway. PJM manual revisions, currently available in draft form here, should be finalized on July 23 despite continued stakeholder confusion and contention. PJM’s own analysis suggests that an extra $1.4-4 billion in capacity payments will flow to generators per year under the new structure with higher, but not commensurate, penalties for nonperformance. While market participants are scrambling in order to take part, most of the solar world is unaware of the significance.

The initial proposal to overhaul the capacity market was frankly grim for intermittent generation, to the point of essentially removing all compensation from renewable generators; their historically decent capacity performance (CP) would have been socialized among load-serving entities for free. Some intervenors (hat tip: Community Energy) got after PJM and pushed to make what was ultimately approved by FERC a much better solution.

Specifically, rather than simply being handed a 38% capacity factor and being measured against that yardstick, individual solar generators will pick their own exposure. Should they perform at that level, they’ll be paid the auction clearing price. Should they exceed it, they’ll be paid a share of any penalties from those who fall short.

“Nana ju, hiaku, hochi juhotchi.” – is the new RPM found money?

At first blush, it is possible for solar generators to obtain significant payments from the auction even without having a clear idea of how to do so. This is firstly because overall capacity market prices are anticipated to rise. Secondly, even across newly-expanded performance hours that include an explicit winter component alongside the typically-summer 5 CP, historic performance of solar as a capacity resource should be in the same neighborhood as it was previously. Preliminary analysis carried out by PJM at the behest of Community Energy indicates that solar, in fact, could do better under the new regime than the old. Solar generators can aggregate and even pair with other resources (e.g. wind) to strengthen their capacity, though the details of these coupled bids are still fuzzy and will likely be difficult for many solar facilities to arrange.

“Kagamoosha!” – Confusing and severe consequences for nonperformance

However, penalties for nonperformance will theoretically be stiffer for solar and could prove difficult to predict in advance. PJM’s view is that potential bidders need to be looking at a significant downside to make accurate decisions. Penalties are calculated at a rate equal to the annual net cost of new entry (Net CONE) divided by 30, with an annual stop-loss at 150% of Net CONE. (Further Net CONE explanation available here.) By contrast, the potential upside that flows to generators who underpromise and overdeliver could be low. By shifting to a pro-rata share of any penalties paid, in a market structure that makes paying penalties very undesirable, the system pushes for generators to develop their most accurate possible bid.

Kwakisurpineku?  Or Kwakisurpipiku?  Subtle differences lead to shocking outcomes

Overall, the market has become undoubtedly more complex – and it wasn’t simple in the first place. A simple error in a difficult-to-understand market structure could convert a big win into a serious shock. Potential wholesale bidders in the PJM market will have to develop a significantly more subtle capacity bidding strategy than many have today – or face the loss of what could be 20% or more of their revenue. The first real test will come in early August’s capacity auction for 2018/19 delivery, in which PJM intends to procure 80% of necessary capacity with the Capacity Performance obligations. By 2020/21, the transition is expected to be complete. Sol Systems anticipates that some owners of utility-scale solar assets may watch from the sidelines while the market shifts. However, developers and asset owners who are proactive enough to participate intelligently may end up winning big.

ABOUT SOL SYSTEMS

Sol Systems is a solar energy finance and investment firm. The company has facilitated financing for over 200MW of distributed generation solar projects on behalf of Fortune 100 corporations, insurance companies, utilities, banks, family offices, and individuals. Sol Systems provides secure, sustainable investment opportunities to investor clients, and sophisticated project financing solutions to developers. The company’s tailored financial services range from tax structured investments and project acquisition, to debt financing and SREC portfolio management. For more information, please visit www.solsystems.com.