In the PJM Interconnection, the concept of capacity costs plays a critical role in ensuring the reliability of the power grid. These costs, charged to consumers, represent the expenses incurred to ensure that sufficient electricity supply is available to meet peak demand, even during extreme conditions. Understanding what the PJM Capacity Auction is, what capacity costs are, why they exist, and how they differ from energy charges is essential for organizations seeking to manage their electricity expenses effectively.
Environ Energy is hosting an important educational webinar Thursday, December 12th at 2PM EST to discuss the impact of the record high PJM capacity price spike set to begin June 2025. This webinar aims to help organizations plan ahead and is free for anyone to attend and ask questions to our panel of energy experts. Learn what you can do to offset electricity prices that will cost significantly more for businesses in MD, PA, DE, NJ, IL, OH, MI and DC.
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What is The PJM Capacity Auction And What Are Capacity Costs?
PJM is the regional transmission organization that manages the electric grid across 13 states: Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia. It relies on a capacity market to maintain system reliability. Capacity costs are essentially payments made to power generators to ensure they are available to produce electricity when needed, particularly during periods of peak demand.
The capacity market operates through annual auctions where generators commit to being available during a defined delivery year, which runs from June to May. These costs are then allocated to electricity customers based on their contribution to the system’s peak demand, which happens during the hottest days of the summer. This ensures that adequate power generation capacity is in place to prevent blackouts and maintain grid stability during times of high usage, such as heatwaves or cold snaps.
Demand-Based (kW) Charges vs. Energy-Based (kWh) Charges
To understand capacity costs, it’s important to distinguish between demand-based (kW) charges and energy-based (kWh) charges, which are two fundamental components of electricity bills:
- Demand-Based Charges (kW):
Demand charges are based on the highest level of power (measured in kilowatts) a customer uses at one point in time. In PJM, capacity costs are tied to a customer’s Peak Load Contribution (PLC), which measures their demand during the system’s five highest demand hours in the prior year.
- Energy-Based Charges (kWh):
Energy charges, on the other hand, are based on the total amount of electricity a customer consumes over time, measured in kilowatt-hours. These charges cover the cost of producing and delivering the electricity used and are unrelated to the capacity required to meet peak demand.
The key distinction is that demand charges focus on the rate of energy use at specific moments, while energy charges accumulate based on overall consumption.
Why Do Capacity Costs Exist?
Capacity costs exist to ensure grid reliability. Electricity cannot be stored on a large scale economically (though battery storage is improving), and demand can spike unpredictably. PJM’s capacity market incentivizes power generators to invest in and maintain resources that can meet peak demand, even if those resources are idle for much of the year.
Without capacity markets, the grid could face shortages during periods of high demand, leading to rolling blackouts or other reliability issues. These costs ensure the grid is prepared for worst-case scenarios, which benefits all users.
Strategies to Reduce Capacity Costs
Since capacity costs are tied to demand during peak periods, reducing or shifting demand during these times can significantly lower costs. Here are some effective strategies:
- Peak Load Contribution (PLC) Management:
- What It Is: Customers are charged based on their contribution to the grid’s peak demand. PJM identifies the five highest demand hours of the year (known as “5CP hours”) to calculate a customer’s PLC for the following year.
- How to Manage: By reducing demand during these critical peak hours, customers can lower their PLC and reduce their capacity charges. Advanced tools like load forecasting, load shifting, and demand response programs can help identify and act on these peak periods. Importantly, to capture the financial benefit of these reductions, you must have an appropriate energy procurement agreement in place.
- Demand Response Programs:
Many utilities and energy service providers offer demand response programs, where customers are compensated for reducing load during peak periods. This not only lowers capacity charges but can also generate revenue.
- Energy Efficiency Investments:
Implementing energy-efficient technologies can reduce overall demand and peak usage. Examples include upgrading HVAC systems, installing LED lighting, and optimizing industrial processes.
- Load Shifting:
Organizations can shift energy-intensive activities to off-peak hours when grid demand is lower. This might involve running certain operations overnight or staggering production schedules.
- Battery Energy Storage Systems (BESS):
On-site battery systems can store energy during low-demand periods and discharge it during peaks, reducing reliance on the grid during critical hours.
- On-Site Generation:
Using on-site renewable energy or backup generators during peak periods can also reduce demand from the grid and, in turn, capacity costs.
- Real-Time Monitoring and Controls:
Advanced energy management systems provide real-time data on energy usage, allowing for precise control and immediate response during peak demand events.
The Bottom Line
Capacity costs in PJM are a necessary expense to maintain grid reliability, but they can be a significant component of an organization’s electricity bill. Understanding the PJM Capacity Auction and the difference between demand-based and energy-based charges is crucial for managing these costs effectively. By adopting strategies such as PLC management, demand response programs, energy efficiency upgrades, and load shifting, businesses can reduce their peak demand, lower their capacity costs, and improve their overall energy efficiency.
In an era of rising energy costs and increased emphasis on sustainability, proactive management of capacity costs is not just a financial imperative but also a step toward more responsible energy consumption.
Register Here for this free webinar, PJM Capacity Price Spike Explained, Thursday, December 12th at 2PM EST to discover the impact of the record high PJM capacity price spike set to begin June 2025 and learn what you can do to protect your business in the PJM Market: MD, PA, DE, NJ, IL, OH, and DC.