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International Law News

International Law News, Spring 2024

Intensifying Storms and Intensifying Risks: Merchant Generators Underestimate the Increasing Risk of Grids’ Capacity Regimes

Anthony P Alden, Elijah Turner, and Andrew Shifren


  • A substantial portion of the U.S. grid uses a system of bonuses and penalties to incentivize the build-out of reserve energy capacity. 
  • Electricity generators in New England and much of the Ohio Valley region have the option to be paid bonuses in exchange for a promise to commit to generate power during emergency power shortages. 
  • But generators underestimate the risk of catastrophic storms, increasingly likely due to climate change, that result in penalties which can hurt or even bankrupt their businesses. 
  • This article analyzes the misperception of risk and poses potential solutions.
Intensifying Storms and Intensifying Risks: Merchant Generators Underestimate the Increasing Risk of Grids’ Capacity Regimes
Brian Jarman via Getty Images

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In December 2022, Winter Storm Elliot slammed the United States with a wave of Siberian air so cold that it broke records across the country. In Cincinnati, Ohio, temperatures dropped 52 degrees Fahrenheit in twelve hours. In Cheyenne, Wyoming, temperatures fell from 43 to three degrees in just 30 minutes. And in Elk Park, Montana, the recorded temperature of -50 Fahrenheit was as low as sensors could detect. Known as a Category 4 “Crippling” winter storm, Elliot pushed the U.S. power system to its limit. On December 23, 2022, nearly 1.5 million electricity customers lost power. As of December 24, 400,000 electricity customers across New England’s six states still could not turn on the lights.

Two organizations that manage interstate electricity grids, PJM Interconnection (PJM) and New England-Independent System Operator (ISO-NE), prepare for emergency events like Winter Storm Elliot with a unique system of payments and penalties for electricity generators. Generators receive payments from the grid in exchange for committing to provide a certain amount of power during emergency periods. Generators that exceed their commitment receive bonus payments, paid by the generators that produced less.

But this system had never before been tested by a storm like Elliot. Months after generators throughout PJM’s territory failed to meet their supply obligations, they were hit with colossal eight- and nine-figure penalties that were inconceivable before the Storm. In total, PJM fined underperforming power generators $1.8 billion. In New England, the overall figure was smaller, but still catastrophic for individual generators, totaling $39 million in penalties.

Companies that participate in these pay-for-performance programs must reassess the risks in the face of climate change. Record-breaking, unpredictable weather events like Winter Storm Elliot are becoming more common, and generators need to scrutinize any business model with exposure to crippling penalties for non-performance out of their control. Winter Storm Elliot demonstrates that power producers in PJM and ISO-NE have not accurately forecast the colossal liability they may face under these capacity payment regimes. Companies can take certain steps to manage the risk, but climate change may require a complete reassessment of participation in these programs.


There are seven Regional Transmission Organizations/Independent System Operators (RTOs/ISOs) in the United States, which coordinate, plan, and control multi-state energy systems. These organizations serve as marketplaces for wholesale power. While they play key roles in short term energy transactions, coordinating auctions in both spot and day-ahead electricity markets, some RTOs/ISOs also incentivize longer-term planning of the energy system.

This long-term planning is driven by capacity markets. Unlike energy markets, which facilitate the sale of energy on the grid, capacity markets facilitate sale of the potential to generate electricity when needed in the future. RTOs/ISOs that run capacity markets pay electricity generators for generation capacity, instead of electricity. In other words, generators are paid in exchange for a contractual commitment to supply power in the future.

What happens when a generator cannot uphold its commitment during an emergency?

Two ISOs, PJM and ISO-NE, pay power generators bonuses for providing extra power during high-demand periods, and penalize those who fail to generate when they are needed. During emergencies, these RTOs/ISOs put generators on notice that the exact amount of electricity they produce is being recorded. PJM calls each hour of this evaluation a Performance Assessment Hour (PAH). The incentive system is designed so that generators performing during an emergency period of low energy supply and high demand receive bonus payments from the ISO for every PAH in which they generated more power than they committed. Bonuses are paid out of the penalties levied against generators that supplied less than their promised electricity during each PAH.

During Winter Storm Elliot, steep temperature drops caused mechanical and electrical failures at gas wells, pipelines, and plants. Gas-fired generation accounted for 63 percent of outages in the Eastern Connection. While the record temperatures constrained gas supply, they also caused a dramatic increase in demand for heating. The combination led to skyrocketing energy prices and penalties, with catastrophic consequences for some generators.

Elliot Exploded Past Assumptions

A 2017 whitepaper by Charles River Associates entitled, “Navigating PJM’s Changing Capacity Market,” analyzed the bonus-and-penalty scheme that PJM was then beginning to incorporate into its capacity market. The paper stated, “The parameters defined by PJM make it highly unlikely any [generator] will lose all of its capacity revenues.” It continued that even in a scenario where a generator had relatively conservative capacity revenues, “it would take more than 10 [Performance Assessment Hours] without performance for a resource to owe more in penalties than it collects in revenues. This is a greater number of PAH than are expected for most years, particularly as system performance improves.”

In 2022, analyses still underestimated the risk that severe storms pose to capacity market participants. A March 2022 consulting memorandum commissioned by PJM entitled, “Deriving the Optimal No-Look Offer Cap Considering Only Performance Penalties,” calculated the breakpoint at which the reward of accepting capacity payments began to outweigh the risk of non-performance penalties. The calculation was based on data from 2011 through 2021, with the author concluding that “the average number of performance assessment hours has been just over 7 hours.” But this average obscures the risk that many years of single-digit PAHs could precede a year that exceeded 20 PAHs where a generator could not produce power.

Whatever system performance improvements the 2017 paper anticipated did not materialize during Storm Elliot. PJM instituted more than 23 PAHs in just two days during the Storm (December 23 and 24), more than three times the average number of PAHs from 2011 through 2021. While both PJM and ISO-NE cap penalties per year, both caps on annual penalties were insufficient to protect small merchant generators.

To illustrate the potential risk that generators can face for non-performance during high-demand events, consider the case of the Cogentrix Energy companies Lincoln Power (owners of the Elgin and Rocky Road plants in Illinois) and Nautilus Power (a power marketer). During Winter Storm Elliott, both of these plants underperformed, and both now face business-altering consequences due to PJM penalties. Lincoln Power is restructuring under Chapter 11 bankruptcy, after it was assessed a $38.9 million penalty for violating its obligations to produce power. Nautilus, also facing millions in penalties, has petitioned the Federal Energy Regulatory Commission (FERC) for relief. Given these risks, power generators would be wise to consider all actions they can take to minimize the risk of non-performance under a PJM or ISO-NE capacity market regime.

Generators Can Hedge Risk Their Risk

Extreme weather events that increase demand for or decrease the supply of power capacity on the grid are forecast to grow over the coming years. Even generators that meet their capacity obligations may feel the ripple effects of these penalties, because lenders associate the possibility of capacity performance penalties with increased credit risk, driving up the cost of capital. Additionally, reliable performance during past demand events does not ensure reliable performance during future events. The rapid drop in temperature during Winter Storm Elliot snarled gas pipelines in PJM, but the next extreme weather event could pose a different set of risks to generators.

So, what can generators do to mitigate these risks?

Preventive investment. Given that generators’ costs of capital could increase due to added penalty risk, they should weatherize assets, while lenders still have an appetite for cheaper loans. Generators operating in PJM and ISO-NE should treat this as both a risk and an opportunity. Failure to meet capacity obligations can pose grave consequences, but well-prepared generators that meet or exceed their obligations could receive more frequent windfalls from performance bonuses.

Severe weather protocols. Generators should implement protocols for severe weather events to ensure that all personnel understand their responsibilities when things go wrong. Identifying pressure points in plant operations and instructing staff and leadership on how to navigate issues can prevent avoidable errors that compound problems caused by high demand and severe weather. For gas-powered generators, one such pressure point is the gas scheduling process in which generators provide estimates of the next day’s gas requirements to gas marketers, who then coordinate with pipelines. This process requires clarity in timing, as a misstatement of the window during which the generator will need gas could lead to fuel deficiencies and trigger capacity non-performance penalties. Generators would be wise to implement redundancies in the gas nomination process to ensure that correct orders are executed during high stakes capacity performance events.

Fuel supply contracts. Gas generators should reevaluate their fuel supply contracts, as well. Data from Winter Storm Elliott suggests that about one third of underperforming gas-powered generators in PJM utilized interruptible gas contracts, meaning their fuel was the first to be cut when demand for gas spiked, along with demand for power. While pricier in the short term, firm gas supply contracts could pay off later, because they reduce the possibility that a generator will not be able to acquire fuel in an emergency.

PJM/ISO-NE participation. Generators and their parent companies may want to reevaluate the proportion of assets in their portfolios that are subject to PJM and ISO-NE penalties. PJM and ISO-NE include generators in Delaware, Illinois, Indiana, Kentucky, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia, Washington D.C., Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. Generators could consider new acquisitions and developments in regions that do not employ capacity performance penalties. Generators may also wish to “rebalance” their portfolio by shedding assets in PJM and ISO-NE regions. With the right counsel and the right strategy, generators can manage their assets in ways that allow them to not only endure but thrive in extreme weather events.