Ancillary services are used within an RTO to support the transmission of energy from generation sources to areas of load and to maintain reliable operation of the energy grid. Ancillary services in PJM include:

In addition to the two markets described above, Black Start Service enables transmission providers and owners to designate certain generators as “Black Start Units,” which are used to restore power to the transmission system following a system-wide blackout. An agreement for ancillary services should be evaluated to determine if it qualifies as a derivative under ASC 815. In general, ancillary services contracts in PJM do not meet the definition of a derivative because they fail the net settlement criterion. Figure 4-10 highlights the derivative evaluation for a typical ancillary services contract; however, each contract should be evaluated based on its individual facts and circumstances.

Figure 4-10
Does a PJM ancillary services agreement meet the definition of a derivative?

In general, we would not expect a contract for PJM ancillary services to be accounted for as a derivative because it fails the net settlement criterion.

Factors to consider in assessing whether PJM ancillary services contracts meet the net settlement criterion are further discussed in the following paragraphs. See UP 3.2.3 for further information on overall application of the net settlement criterion.

When evaluating whether the net settlement criterion is met, a reporting entity should first consider whether the contract explicitly or implicitly provides for net settlement of the entire contract. Contracts for ancillary services typically require physical delivery (i.e., a notional amount of power to provide for system stability) and do not permit explicit net settlement. In PJM, bilateral contracts for regulation and synchronized reserve service typically require physical transfer and may not be changed once reported and confirmed. If changes are necessary, the original bilateral contracts would need to be deleted and a new contract created. However, the type of contract and its terms should be carefully reviewed to determine that there are no implicit net settlement terms or liquidating damage provisions that may imply that the contract could be net settled.

In this form of net settlement, one of the parties is required to deliver an asset, but there is an established market mechanism that facilitates net settlement outside the contract. ASC 815-10-15-110 through 15-116 provide guidance on indicators to consider in assessing whether an established market mechanism exists. A key aspect of a market mechanism is that one of the parties to the agreement can be fully relieved of its rights and obligations under the contract. Ancillary services information is posted to PJM eMKT, a market participant interface. We understand there may be some activity in this market; however, it does not appear that there is sufficient liquidity that provides the ability of parties to be relieved of their rights and obligations. The key factor in this evaluation is that there are no quoted market prices and no buyers standing ready to transact via eMKT.

Whether there is an active spot market for the particular product being sold under the contract is the key factor in assessing whether an asset is readily convertible to cash. Current market conditions should always be considered in this analysis. To be deemed an active spot market, a market must have transactions with sufficient frequency and volume to provide pricing information on an ongoing basis. In addition, quoted prices from that market will be readily available on an ongoing basis. See UP 3.2.3.3 for further information on the determination of whether a market is active. Based on the current structure of the markets, we are not aware of any active spot markets for PJM ancillary services.

We are not aware of a market mechanism or active spot market for PJM ancillary services contracts, and thus we believe that derivative accounting is generally not applicable to these contracts. Instead, the contracts are accounted for as executory contracts or a legal obligation. However, a reporting entity should evaluate all current facts and circumstances in concluding on the appropriate accounting for a specific PJM ancillary services contract. In addition, a reporting entity should monitor its conclusion periodically because markets may evolve, potentially rendering this type of contract a derivative. Finally, a reporting entity should evaluate the contract to determine if there are any embedded derivatives that require separation.

Reporting entities may also consider conditionally designating PJM ancillary services contracts under the normal purchases and normal sales scope exception if physical delivery is probable throughout the life of the contract and the other criteria for application of this exception are met (ASC 815-10-15-22 through 15-51 as applicable). If a conditionally designated normal purchases and normal sales contract meets the definition of a derivative at a later date, it would be accounted for as a normal purchases and normal sales contract from the time the contract becomes a derivative. Absent such a designation, the reporting entity would be required to record the contract at its fair value at the time it becomes a derivative. See UP 3.3.1 for further information on the normal purchases and normal sales scope exception.