FERC Proposal Would Cut Reactive Power Compensation, a Potential Hit to Independent Power Producer's Revenue Mix

In a time where capacity revenues are pricing lower and many generation owners find that their facilities are not being dispatched for energy on a consistent basis, reliable revenue streams are increasingly important. In addition to selling energy and capacity, many generation facilities collect fixed, monthly payments for the provision of “reactive power,” which are often set forth in a cost-of-service rate tariff filed with the Federal Energy Regulatory Commission (FERC) either by the transmission provider or the generation owner.

Although in many cases the compensation for reactive power represents a relatively small amount of revenue in comparison to a generator’s overall revenues for the sale of energy and capacity, these reactive power revenues can still play a critical role in maintaining a positive bottom line.

COMMENTARY

What is reactive power? It is an energy byproduct produced by generation facilities that allows grid operators to keep the electric grid stable. For example, reactive power service provides “voltage support” and has been recognized by FERC as a critical component toward maintaining a stable electric grid. A generator must either produce or absorb reactive power for the transmission system to maintain voltage levels necessary to reliably supply real power from generation to load.

Currently, six of the FERC-jurisdictional organized power markets compensate generation facilities for the provision of reactive power to the grid. Compensation ranges in both amount and form, but in all cases is set forth in either the applicable transmission market tariff on file with FERC or individual generator rate schedules approved by FERC.

In PJM Interconnection (which serves part or all of 13 states and the District of Columbia), a generator must file a reactive power tariff with FERC that sets forth a cost-based rate for the provision of reactive power. In recent years, the scrutiny over generators’ proposed rates has increased, and often these rates undergo settlement procedures that may last between one and two years, and most often result in a significant reduction to the proposed rate as part of settlement. These proceedings also often result in the requirement to make refunds of amounts collected by the generator above the rate reached in settlement.

On March 21, 2024, FERC issued its Compensation for Reactive Power Within the Standard Power Factor Range Notice of Proposed Rulemaking (NOPR) in FERC Docket No. RM22-2-000. If the NOPR is implemented as proposed, both the opportunity to receive compensation for reactive service and the amount paid for such service would be significantly reduced.

What does the NOPR propose? In short, the NOPR would disallow compensation for the reactive power within the standard power factor range of .95/.95 leading/lagging, also known as the “deadband.” Most reactive power service falls within the deadband, which would, in effect, eliminate reactive power compensation for most generation resources. A generator may, however, still be eligible for compensation for reactive service outside of the deadband under certain circumstances.

In particular, transmission providers would only be required to provide compensation for reactive power when the transmission provider asks the generation owner to operate its facility outside of the power factor range. The NOPR provides that within 90 days after transmission owners submit their revised tariffs implementing the changes, all compensation for reactive service within the deadband will be terminated prospectively.

The NOPR suggests that a generator is capable of providing reactive power service at no cost or de minimis costs, and that such costs are most likely recoverable in a generator’s energy and capacity payments. As a result, FERC indicates that generators may currently be overcompensated by receiving additional payments for the provision of reactive power service, resulting in potentially unjust and unreasonable rates.

FERC also remarks that generators are already required to provide reactive power within the standard power factor range as a condition of their interconnection agreement with the transmission provider. Because that obligation exists within most standard generator interconnection agreements, FERC contends that reliability should not be harmed if compensation for reactive power service within the deadband is eliminated.

FERC also rejects arguments that generators need reactive power service compensation for purposes of becoming financed. In short, FERC points to the fact that generation facilities are currently being developed and financed in markets that today do not compensate generation facilities for reactive power service provided to the grid. As a result, the elimination of compensation for reactive power service should not have a material impact on such investment decisions.

The NOPR is open for public comment by all interested parties. Initial comments on the NOPR are due on May 28, 2024, and reply comments are due on June 26, 2024. The NOPR seeks comments on, among other items: the proposal generally; how reliability may be impacted if transmission providers are prohibited from compensating generators for reactive power within the standard power factor range; the ability for generators to recover their costs in markets where reactive power compensation is currently being provided; how the NOPR may impact investment decisions to build new generation facilities; and whether or not some transition period would be needed to allow facilities to continue receiving reactive power payments for a limited time.

—Terence Healey is a partner focused on energy at Sidley. He represents clients on a variety of regulatory, enforcement, compliance and transactional matters involving the U.S. wholesale electricity and natural gas markets. He has extensive experience representing clients in regulatory and investigations proceedings before the Federal Energy Regulatory Commission, the North American Electric Reliability Corp., and multiple state energy regulatory agencies.