An earlier version of this article was published in the This Week in Hyperscaling newsletter
When the National Energy Dominance Council and thirteen mid-Atlantic area governors signed a Statement of Principles in January, it was a rare moment of bipartisan agreement that their regional energy market — PJM Interconnection — needed a hard reset. But I keep coming back to one line that made me laugh out loud.
As background, the principles are high-level bullet points directing specific market reforms. One calls for an emergency auction to procure new generation resources just for data centers, along with demands to improve load forecasting and the interconnection queue (although these are things PJM was already working on). Another principle says the existing capacity market price cap should remain in place for the next two base auctions; let’s put a pin in that for now.
But the final bullet calls for PJM to “return to market fundamentals.” Sorry, what?
It sounds reassuring: a promise that the emergency intervention is temporary, that normal order will be restored, that the market will take it from here. But it also suggests that there was some kind of Camelot era where the markets functioned well and supply and demand were in harmonious balance.
Let’s hop in the wayback machine and see if we can find this magical economic dream-land, shall we?
Let’s start 100 years ago, with the birth of PJM. In 1927, the Pennsylvania-Jersey Interconnection was a “power pool” of three utilities that agreed to dispatch the cheapest power plant among them. It worked great, but it wasn’t a competitive market; it was basically a gentleman’s handshake, between vertically integrated utilities, with state regulators largely determining whether or not a new power plant (and guaranteed rate of return) was warranted.
Maybe we fast-forward to the birth of markets, then. In the mid-nineties restructuring era, the Federal Energy Regulatory Commission’s Order 888 turned the ole boys club into a community pool. Open access to transmission — a natural monopoly — went hand-in-hand with competition in the generation business. PJM shifted from a network of utilities to the model independent system operator. Algorithms sprung up where the handshakes used to be.
It also worked great — until the California energy crisis, that is. Without a coherent market structure, unbundling created uncertainty and confusion that allowed companies like Enron to exploit the nascent systems.
Partly as a reaction, in 2002, FERC attempted to establish “standard market design,” a uniform national framework for wholesale electricity markets, standardized and transparent enough that generators could make rational investment decisions and customers could understand what they were paying for.
It sounds fundamental, but it did not survive contact with politics. State regulators from more than 20 states objected immediately, seeing it as a federal overreach and an invitation for more manipulation. What emerged instead was the collection of regional constructs, each shaped by local politics and legacy utility structures, that exist today.
Ironically, PJM was still held up as the “model” market through all the national turmoil. So was this mid-aughties period the “fundamental” market zeitgeist we’re trying to recapture? Only if we ignore the hard reality that the fundamentals of supply and demand occasionally create circumstances that are politically untenable.
In a “pure” market, during a grid event like a polar vortex or a summer heatwave, the price of power should theoretically rise to whatever the most desperate buyer is willing to pay to keep the lights on. But after the California energy crisis, energy markets like PJM established price caps to guard against power brokers holding ratepayers hostage.
But, of course, this created what brilliant economists called the “missing money” problem. If you don’t let the prices rise to what the market commands during times of scarcity, generators we need on those peak days can’t recover their costs, and we don’t have enough power to cover the peak. This arbitrary cap is what necessitated the capacity market construct in the first place.
The capacity market, created by PJM in 2007, was intended to temporarily fill the revenue gap that the price cap created — emphasis on temporarily. Instead of letting the energy market operate under supply and demand fundamentals, this new administrative construct was supposed to simulate the investment signal that the energy market was prevented from producing.
But it remains in place despite having never really worked, and has been the source of constant changes and litigation. Even the PJM board acknowledges the capacity market is insufficient to incentivize new generation and had already embarked on a process of transitioning the capacity market to a prompt or seasonal construct before the White House’s January principles document dropped.
That’s why the new emergency backstop auction that they are calling for — alongside an insistence on price caps in the capacity market, and a vague reference to “market fundamentals” — is so deeply ironic. (We’re expecting the specifics of how that auction will unfold later today.)
What policymakers really want to return to isn’t a golden past market state, but rather a return to a time when they didn’t have to answer to voters outraged over their energy bills. There is no Camelot; there is only a century-long history of engineers, lawyers, and economists trying to figure out how to make money keeping the lights on.
Elizabeth Whitney is a managing principal at Meguire Whitney, a government relations firm. She has more than fifteen years of federal policy experience, focusing on energy policy, and writes the This Week in Hyperscaling newsletter. Her government relations practice centers on energy markets, environmental regulation, climate change, and nuclear power. The opinions represented in this contributed article are solely those of the author, and do not reflect the views of Latitude Media or any of its staff.
