Energy firms take note: Maryland officials are launching a major new initiative to support the construction of new natural gas generating capacity, and the governor's office seems poised to expand the initiative to include renewable energy.

News of the initiative came when the Maryland Public Service Commission (PSC) ordered each of the state's electric distribution companies (EDCs) to issue a Request for Proposals (RFP) for developers to build up to 1,500 MW in natural gas-fired generation in the state. The proposal is significant because it could lead to an increase in stable, cost-effective energy for Maryland consumers.

Maryland Governor Martin O'Malley, in a recent letter to the PSC, reaffirmed and sought to expand the RFP to include renewable energy. However, the PSC's action could face legal and regulatory challenges similar to those confronted by similar initiatives, most notably New Jersey's long-term capacity agreement pilot program (LCAPP). Potential Maryland bidders should carefully review the requirements of the RFP and weigh the legal and regulatory challenges faced by similar programs, such as LCAPP, before proceeding with a bid.

On September 29, 2011, the PSC issued a "Notice of Approval of Request for Proposals for New Generation to be issued by Maryland Electric Distribution Companies" (Notice) ordering Maryland's EDCs to issue an RFP for capacity and energy. In response to the Notice, the EDCs (i.e., Baltimore Gas and Electric Company, Delmarva Power and Light Company, The Potomac Edison Company, and Potomac Electric Power Company) jointly issued the RFP on October 7, 2011. A pre-offer conference was held on October 21, 2011, and eligibility documents from potential bidders were due on October 28, 2011.

The PSC warned that Maryland faces a threat of insufficient new capacity because (among other reasons) PJM's capacity market construct – referred to as the Reliability Pricing Model (RPM) – has failed to attract significant new generation to Maryland since its inception in 2007. Under the RFP, selected bidders will contribute to the capacity market through the PJM Base Residual Auction (BRA), but will not be paid for any year in which their capacity fails to clear the BRA.

Selected bidders also are required to enter into a Contract-for-Differences (CfD) with the applicable EDC. Under the CfD (a form of which is attached to the RFP), winning bidders are paid based on the difference between its bid prices for energy and capacity (as reflected in the CfD) and the PJM's corresponding prices for energy and capacity, as adjusted for certain conditions and factors reflected in the CfD (e.g., dispatch and price clearing under the BRA). In essence, the CFD assures that the winning bidder will always be paid the greater of (1) the PJM price or (2) the bidders winning bid price. In short, the RFP contemplates a long-term contract for capacity and energy that will likely support capacity prices at a higher level (at least initially) than prevailing prices in the PJM capacity markets.

This approach is similar to the LCAPP program that is currently the subject of litigation at FERC and in the U.S. District Court in New Jersey. Opponents of LCAPP (and, potentially, of the Maryland RFP) argue that such incentives are the buy-side equivalent of withholding capacity from the market – a practice that FERC held to be unlawful market manipulation in orders regarding the California market crisis of 2001).

At FERC, the challenges to LCAPP have so far resulted in significant amendments to PJM's Minimum Offer Pricing Rule (MOPR). For example, FERC approved amendments allowing PJM to "mitigate" (i.e., revise upwards) capacity offers submitted to PJM which are deemed to be uneconomic and are not encompassed within the limited exceptions for such bids contained in the amended MOPR. These amendments overturn a longstanding policy (previously sanctioned by FERC) of allowing states and state entities to attract construction of new in-state generation through economic incentives, even where such incentives could be viewed as subsidies. Thus, although some may argue that FERC-approved amendments to the MOPR will reduce future uneconomic bids, the specific types of state economic incentives subject to mitigation remain unclear.

Likewise, it remains to be seen whether the LCAPP proceedings in federal court will end the proposed subsidies for new electric generation in New Jersey and, by extension, whether other forms of state economic incentives (including those contemplated in the RFP) are unlawful or subject to mitigation under the amended MOPR. Thus, the long term viability of a project seeking a contract under the RFP – and the availability of financing for such a project – should not be taken for granted, and project sponsors should consider recent legal and regulatory developments in assessing the risks of proceeding with investments under the RFP.

Finally, in a letter dated October 20, 2011, Maryland Governor Martin O'Malley urged the PSC to expand the scope of the RFP. In essence, the Governor proposed that the RFP "eliminate … natural gas exclusivity" by allowing bids from projects using renewable energy resources, that it require an "apples to apples" price comparison among competing resources (including renewables), and that it allow bids for utility-owned generation. Renewable and natural gas resources are complimentary, the letter said, because natural gas provides a hedge against intermittency in renewable resources and renewable resources provide a hedge against potential future increases in the price of gas. In sum, O'Malley asserted that "limiting the RFP … to natural-gas fired facilities is not in the public's best interest," and that the RFP should be broadened, or a new should RFP be issued with an expanded scope.