The PJM Interconnection is responsible for operating the electric grid in 13 states throughout the mid-Atlantic and southeastern United States. In May, PJM held their 2014-15 electricity capacity auction; giving market analysts some indication of what electric prices will do in the future.

Capacity auctions are designed to ensure there is enough electricity supply in reserve to prevent brown-outs or blackouts during a sudden spike in electricity use. The method used to conduct the capacity auction is a fairly controversial system called Reliability Pricing Model or RPM. Suppliers compete against each other to offer additional electricity generation at the lowest price. The electricity offered by suppliers is often a mix of resources and can include plans to build a new plant, upgrades to an existing structure, or even transmission investments.

The auctions are designed not only to ensure reliability, but to send signals to suppliers about the need for new sources in the near future, avoiding the boom-bust cycle common in other markets. Since the RPM auctions began in 2007, PJM has obtained commitments for more than 28,000 megawatts (MW) of new resources, including demand side resources, new generation, upgraded generation (increases in the efficiency of existing generation) and plant re-activations.

May?s auction produced encouraging results with 4,900 MWs of new capacity resources clearing the auction- a new record for PJM. Overall, the auction resulted in a reserve margin of over 20 percent. This is good news; especially considering the number of challenges posed by widespread coal plant closures and continued government intervention from states that subsidize electricity suppliers.

PJM’s capacity auction represents the first market prices to take into account the EPA’s stream of restrictive coal regulations. The U.S. Energy Information Administration reported a shocking drop in coal consumption for electricity generation during the first quarter of 2012. Coal-fired power plants are now generating just 36 percent of U.S. electricity, versus 44.6 percent just one year ago.

Andy Ott from PJM stated: “Capacity prices were higher than last year because of retirements of existing coal-fired generation resulting largely from environmental regulations which go into effect in 2015”. The market-clearing price for new 2015 capacity, almost all natural gas, was $136 per MW. That’s eight times higher than the $16 per MW price for 2012. In the mid-Atlantic area of PJM, the new price is even higher–reaching $167 per MW. First Energy’s territory in northern Ohio was hardest hit by coal plant closures resulting is a shocking $357 per MW. Critics say the capacity auction did not give suppliers enough time to adjust to the new regulations.

One small consolation in the midst of the job losses and higher electricity rates caused by reduced coal generation is the small impact capacity charges have on the overall on wholesale prices. In 2011, the capacity charge accounted for only 15 percent of the total cost of wholesale electricity. The transition to plentiful natural gas from coal has a base fuel has helped total wholesale electricity prices continue their decline. The PJM region continues to experience historically low wholesale electricity prices–on average wholesale prices have dropped almost 50 percent since 2008.

Another challenge to robust market competition for capacity in the PJM region is government interference from states that purchase generation outside of the market. Subsidized plants in New Jersey, Virginia, and Maryland bid in the capacity auctions. The long-term obligations secured by state governments are often set above market rates–saddling consumers with higher prices. In addition, the intervention distorts price signals and increases regulatory risk, which leads to higher prices for all consumers.

The recent PJM capacity auction shows electric competition is continuing to ensure reliability at lower rates despite upward cost pressures due to interference from federal regulations and state governments.