Consumer advocates in the Northeast are learning a bitterly cold lesson about capacity markets this winter as frigid weather and high natural gas prices have caused over 40,000 megawatts of PJM’s installed capacity to fail. [PJM is the grid operator for the mid-Atlantic and the most developed capacity market in the country.]

In response to the outages, as well as the accompanying price spike, consumer advocates from 11 states wrote a letter to the Federal Energy Regulatory Commission (FERC) asking them to launch an investigation on why conditions had gotten so bad.

The group was worried that the high prices would have a “severe adverse impact[s] on major employers.” They were also worried that the conditions were not an aberration so much as a systematic flaw in how the PJM market was operating:

 "As we receive and digest more and more information about the recent weather operations in the PJM region, it is becoming apparent that the unprecedented energy and ancillary service prices that occurred in January were not reflective of smoothly operating market fundamentals, but were, instead, reflective of significant and systemic inefficiencies."

In addition, consumer advocates reminded FERC that PJM consumers pay “billions of dollars in capacity payments each year” to ensure a reliable supply of electricity. If PJM’s installed capacity could not be counted on when it was needed, then the additional subsidies were a wasted expense.

Notably, the letter touches upon several important points that the Texas Public Policy Foundation has uncovered in its research about the capacity market: namely, that they are expensive, inefficient, and impotent at improving an electric grid’s reliability.

Capacity markets theoretically work by giving electricity generators yearly subsidies in exchange for a promise that they will use the guaranteed revenue to invest in new capacity. Proponents of a capacity market claim that this additional investment will ensure reliability. [If imposed on Texas, experts predict that that a capacity market would cost Texas consumers $3.2 billion per year.]

Capacity markets, however, make the mistake of treating capacity and reliability as interchangeable goods, when they are in fact two separate characteristics of a grid’s generation. Yes, the electricity market needs an adequate supply of capacity, but the market also needs to be able to transmit and deliver that capacity if it’s going to dependably power consumers’ homes and businesses.

Capacity markets ignore this crucial distinction.

This omission has two very important implications. First, it means that no matter how much consumers invest in capacity payments, they will still be subject to reliability problems. Power lines may fall, natural gas may become scarce, and generating plants may fail to adequately winterize—as they did this past January in PJM.

Second, by ignoring the delivery side of generation, capacity markets create perverse incentives that hinder the market’s operational reliability. This is because capacity markets do not discriminate between efficient and inefficient generation, meaning that generators have no reason to phase out unreliable units since each unit receives the same amount of subsidies regardless of its age, cost, and reliability. The result is an older generation fleet, located in remote areas, that is more prone to failures.

Consumers are therefore paying billions of dollars for a regulatory system that makes plant outages and rolling blackouts more likely. Can it be any wonder why PJM faced 40,000 megawatts of lost capacity or why PJM consumers are angry at their inflated energy costs?

This winter has taught PJM consumers a bitter lesson about the empty promises of capacity markets. It should teach Texans the same. Capacity markets do not boost an electric grid’s reliability. There is no reason for Texans to assume the added $3.2 billion expense.