What Energy Prices Are Telling Us About Electric Reliability

The current energy market is unlike any we have ever seen. The fundamentals have changed drastically and we have yet to reach a point of stasis. Paradigm shifts are happening everywhere: where and how we extract natural gas to how we generate, use and store electricity. The tension between the old and new paradigms often drive opposing views among market participants. This is especially true around the topic of electric reliability which is squarely in the heart of the discussion.

Pricing pressure is squeezing out inefficient coal-fired power plants and most recently nuclear plants as well. In order to keep these generation plants financially viable, some asset owners are turning to regulators and politicians for subsidies. Back and forth go the argument over one simple question: Do we have enough power generation to satisfy future demand? Many asset owners say no. But, what does market data say?

Experts model the supply and demand of electricity. Most of these experts work for energy trading companies, independent power plant developers and utilities. The information from these models is used to help create a market view or opinion that influences current and future pricing by traders. Can we use this market pricing to inform us about reliability?

The ability for supply to meet demand will show up in two elements in the Ohio energy markets: as prices for energy and capacity. Energy in the future is priced based upon where traders believe the market will clear each hour during that future period. Capacity pricing is set by an auction administered by PJM Interconnection, the regional transmission grid operator, based on the price the power plant owners are willing to sell their capacity to meet the demand. Looking at the data for both these markets should give us an indication of the market view for reliability.

Wholesale energy in 2020 is 6% cheaper than electricity delivered in 2018. This would indicate that the traders believe there will be an excess and/or cheaper supply of electricity available in 2020 than next year. It also tells us that they believe demand is not going to increase enough to pressure this supply. Not only does 2020 electricity cost less than in 2018, but the trend of the prices for both years has been downward since May and is now sitting at historic lows. Both the downward trending direction and the fact that future years are less costly than next year indicates a market belief that there is an excess of low cost electricity supply. Such excess is positive for reliability.

The other price indicator is capacity. Capacity prices are cleared in an auction held by PJM three years in advance of the required delivery. PJM models predict the future demand along with a required reserve margin. The capacity offers by the power plant owners are accepted in ascending order until the demand plus the reserve requirements are satisfied.

PJM is required to have approximately a 16% reserve margin. In the last three auctions, the reserve margins resulting from the auctions were from 25% to 50% more than what is required. This over supply of capacity has put downward pressure on the clearing prices. Capacity delivered in 2021 will be 49% lower in price than capacity today. This is another indication of an excess of supply (with no real contribution from demand increases).

While markets are not infallible, one cannot argue that this market has a strong and distinct view of the future supply and demand fundamentals. Both the energy and capacity markets are indicating, through pricing, that we are over supplied with cheap power even with the uncertainty of the nuclear fleet and further coal retirements. This data cuts through much of the rhetoric in the reliability discussion with its view that electricity reliability will be strong for the foreseeable future.