New Jersey Gov. Chris Christie has signed into law controversial legislation creating a long-term capacity agreement pilot program (LCAPP) to encourage the development of 2,000 MW of new electric generation facilities in the State.1

The key issues raised by the LCAPP include the following:

  • Resolution of legal challenges to certain LCAPP provisions under the "federalism" principles of the U.S. Constitution
  • Future regulatory and market risks associated with long-term contracts under LCAPP
  • The uncertain impact of LCAPP subsidies on market capacity prices, including whether FERC modifies its rules as a result of market rule changes proposed in response to the legislation

Detailed rules and guidelines for the program remain to be drafted and issued by the New Jersey Board of Public Utilities (NJBPU), which must complete proceedings within 60 days of the legislation’s effective date (i.e., before the end of March 2011).

The legislation, which establishes minimum capacity prices for payments to "eligible generators," has triggered substantial controversy. Since its passage, complaints have been filed in U.S. District Court and before the Federal Energy Regulatory Commission challenging the validity of the law based on constitutional considerations and seeking to modify the capacity market rules.2

Most observers agree that the LCAPP's long-term "floor" price for eligible new generation capacity, which will be reflected in "standard offer capacity agreements" (SOCAs), will encourage the development and construction of new generation projects. However, concerns have been raised about the possible long-term impact of capacity pricing incentives on ratepayers, and about their effect on the long-term competitiveness of renewable energy projects and preexisting generation facilities. Moreover, companies providing energy efficiency and demand response services have argued that projects built under the LCAPP will benefit from an unfair competitive advantage over their projects that offer lower-cost alternatives to building new generation assets.

The LCAPP provides that New Jersey's four investor-owned electric public utilities will enter into SOCAs pursuant to an auction system in which "eligible generators" will submit bids on three key contract terms: price, quantity, and contract term.3 Each utility will evaluate bids based on their key terms and on their environmental, economic, and community benefits, and is authorized to engage an agent or consultant to perform these evaluations. Projects with a high likelihood of completion and those likely to enter commercial operation by 2015 will, all else being equal, receive a higher rating.

After evaluating the bids, each electric public utility will forward its recommended short list of projects to the NJBPU for approval. The NJBPU will then either approve, modify, or reject the utility's list and state the terms of the SOCAs for each eligible generator. The utility will enter into SOCAs with NJBPU-approved projects. The cost to the utility of SOCAs signed in this manner will be eligible to be "passed through" to utility ratepayers.

Throughout the term of the SOCA, eligible generators must participate in and submit an offer price that clears the PJM4 Interconnection LLC capacity market’s annual base residual auction.5 This provision makes it likely that eligible generators will submit "zero" price offers to ensure that they clear the market. Participating eligible generators are guaranteed to receive the Standard Offer Contract Price (SOCP) for capacity from the purchasing utilities. If the SOCP is less than the market clearing price in the PJM capacity market, the eligible generator must pay the difference between the clearing price and the SOCP to the utility; if the SOCP is greater than the market clearing price in the capacity market, the utility must pay the eligible generator the difference between the market clearing price and the SOCP. This arrangement is intended to prevent windfalls, while ensuring stable long-term revenues, to eligible generators pursuant to the SOCA. Some existing market participants have, however, cited this pricing structure in challenges to the validity of the law and have raised concerns about possible distortions to the market signals in the capacity and energy markets.

"Eligible generators" are defined to include baseload or near-baseload6 units that qualify as a PJM "capacity resource." Only generators that commence construction after the date of LCAPP enactment are eligible to bid on an SOCA. In addition to other generation facilities, cogeneration and other on-site generation structures are eligible to bid under the LCAPP program.