PJM Interconnection LLC’s (Aa3 stable) capacity auction that began on August 10 is expected to be credit positive for the merchant power industry but will see new power plants competing against the old, Moody's Investors Service says in “PJM Capacity Auction Pits New Plants Against Old, with Higher Prices Likely”.
“We expect that this auction will pit existing coal and nuclear plants, which suffer from weak margins in the energy market, but have a new ability to bid high in the capacity market, against new gas-fired power plants, which can afford to bid low in the capacity market given their stronger margins in the energy market,” says Moody’s Vice President — Senior Credit Officer Swami Venkataraman.
PJM has made substantial changes this year to the market rules and auction mechanics in an effort to improve electricity reliability, which Moody’s expects to result in higher capacity prices.
The centerpiece of the reforms is PJM’s capacity performance standard that requires higher levels of operational reliability from power plants and come with stringent penalties for failing to deliver. PJM is also offering to pay more for capacity than last year, as indicated by its new demand curve for the auction.
Moody’s says this year’s auction is expected to see the entry of substantial amounts of new gas-fired generation in PJM, driven by low gas prices in the Marcellus shale region that geographically lies in the heart of PJM. “We estimate that new gas-fired capacity will exceed the 6 GW seen last year and run scenarios where it could reach 10 GW,” says Venkataraman
Changes to price caps allow power plants to bid much higher than they were permitted to in the past, allowing them to incorporate the risk of penalties. How companies adjust their bids in response to the capacity performance standards while also incorporating the risk posed by the entry of substantial new gas-fired capacity will be a critical driver of capacity prices, the report said.
“Our analysis indicates pricing in the range of $185/MW-day as the mid-point among the more likely scenarios,” says Venkataraman. “However, pricing is extremely sensitive to small swings in capacity cleared and some of our scenarios indicate lows close to $100/MW-day,” he says.
Even with higher prices, the fate of many baseload plants will likely remain uncertain. “The shape of the PJM demand curve dictates that a significantly higher price is possible only at the expense of clearing fewer megawatts than last year,” says Venkataraman.
“Many baseload plants will thus continue to receive zero capacity revenue, leaving their viability open to question,” he says.
The interim auctions, which effectively redo the auctions of the last two years, could be credit positive for companies like Exelon and FirstEnergy with uncleared capacity in the last two auctions, the report said.