Capacity Markets

A significant financial risk for AEP is the outcome of annual PJM Reliability Pricing Model capacity auctions. The auctions are conducted three years prior to the delivery year, and determine the prices AEP will be paid for its unregulated generating capacity. These auctions have been historically volatile, with prices ranging from $16/MW-day to $174/MW-day. The 2015 auction for the planning year beginning June 1, 2018 through May 31, 2019, cleared at $165/MW-day.

Capacity payments represent an important portion of an unregulated plant’s income. AEP Generation Resources may experience increased revenue and earnings volatility due to its exposure to PJM’s capacity market in addition to fuel and power prices.

The 2015 auction was the first base auction run under the new Capacity Performance (CP) rules. Approved by FERC in June 2015, the new CP rules were created largely in reaction to significant forced outages and fuel delivery challenges during the polar vortex of 2014.

FERC also allowed PJM to conduct supplemental auctions for 2016/17 and 2017/18. These supplemental auctions allowed units to re-offer for these delivery years if they could meet the higher availability requirements. The supplemental auctions cleared at $134/MW-day for 2016/17 and $151/MW-day for 2017/18, compared to the initial base auction prices of $59/MW-day and $120/MW-day.

The most significant change in the new rules involves the assessments to generators for non-performance. Beginning in 2016/17, if a unit fails to perform during a PJM emergency, it will be assessed approximately $1,900/MWh in 2016/17, increasing to approximately $3,500/MWh by 2018/19. This is significantly higher than under the previous rules, and the financial risk stemming from these higher rates were likely incorporated into the capacity offers for years beginning 2016/17.

Unregulated generation: AEP’s unregulated generation will realize the initial revenue increase from the higher auction prices.

Regulated generation - FRR requirements: The June 2015 FERC order gave a three-year exemption through 2018/19 for Fixed Resource Requirement (FRR) entities from the Capacity Performance requirements. The FRR alternative is the self-supply option, in which a utility that owns enough generation to cover its own load requirements is not required to participate in the PJM capacity auction. This is primarily applicable to regulated states only. AEP has chosen this option for its integrated utilities since the inception of the PJM capacity market in 2007. FRR entities will become exposed to the capacity performance requirements in 2019/2020.