We Need Standard Market Design

No doubt in the future we will look back at this time as a turning point in
the history of America’s $225 billion electricity industry. The past decade’s
overly long transition to competition after a century of hands-on rate regulation
has been uneven and badly tainted by California’s painful market restructuring
missteps.

Competition in the electricity sector has been dealt a one-two punch, with
the stunning financial collapse of Enron Corporation coming close on the heels
of California’s electricity crisis. Wall Street has punished the entire energy
industry for the bad actions of a few. The public and even some policy-makers
have lost confidence in competitive markets as a driver of efficiencies that
lower costs for customers.

Given the vital importance of reliable, affordable electricity — the lifeblood
of our economy — we must not fail in completing the transition to competitive
markets. Competition will promote adequate investment in the electricity sector
to modernize the power grid, assure customers pay the lowest possible price
for electricity, and reduce manufacturing costs and protect jobs.

We must not let the problems of Enron and California allow us to lose sight
of other, highly successful market restructurings elsewhere in the nation and
internationally. Competitive energy market reforms have produced billions of
dollars in economic savings, and completing the transition to competition promises
to bring significant future economic stimulus and technological innovation.

An about-face to cost-of-service ratemaking is not a feasible option and flies
in the face of recognition that more than 100 years of regulation failed to
guarantee customers the lowest costs possible. And maintaining the transition
at mid-stream would promote market instability, higher prices, less reliability,
and costly litigation. The nation has no other choice but to finally complete
the transition to competition and make wholesale power markets work to the benefit
of customers.

The Proposed Rule

It is with this goal in mind that the Federal Energy Regulatory Commission
unanimously proposed new rules to standardize the structure and operation of
competitive wholesale power markets nationally. Our proposal for a Standard
Market Design represents the agency’s commitment to markets and marks our determination
that costly market dysfunctions such as California’s never happen again.

The rulemaking is a necessary step to restore public confidence in competitive
power markets by assuring adequate generation resources and establishing a
standard platform for the exchange of electricity and transmission services.

Its fundamental elements include active monitoring and mitigation to prevent
market abuses, well-organized spot power markets that complement a decentralized
contracts-based market for long-term power supplies, and price discovery and
market transparency.

The market standardization proposal will set the “rules of the road” and
spur sorely needed investment in electricity generation and transmission by
providing regulatory certainty and earnings opportunity.

History proves this approach works. The commission initiated a similar evolution
away from inefficient regulation to competition in the natural gas sector
more than a decade ago. Those competitive reforms lowered prices and provided
billions of dollars in customer savings. One estimate places the aggregate
customer savings from natural gas restructuring since 1984 at $600 billion,
or about $6,000 in savings for the average family.

The Department of Energy estimates that competitive reforms to date in the
electricity sector have produced $13 billion in annual economic savings. This
offers a key indicator of the potential savings from completing the competitive
transition.

In my home state of Texas, where the retail market opened to competition
in January 2002, customers within a matter of months were paying 10 percent
less for electricity than the previous year despite rising fuel costs. The
Texas restructuring effort also prompted a record upsurge in investment by
merchant power producers.

The Pennsylvania Public Utility Commission found that state’s Electric Choice
program produced more than $4 billion in electricity savings over five years.
In the PJM Interconnection, competition and the anticipation of competition
since 1996 has reduced the forced outage rate for generation by nearly 5 percent.
Competitive pressures have contributed to better operations and greater plant
utilization.

Similarly, on a national basis, wholesale market competitive pressures have
contributed to nuclear power plant operators establishing record capacity
utilization, confounding predictions that competition would spark early nuclear
plant closures.

Failure to complete the transition to competition puts these and many other
benefits at risk and will perpetuate problems that threaten our nation’s ability
to maintain economic growth.

 

Regional Transmission Organizations

 

High Costs of the Status Quo

For example, investment in new transmission has not kept pace with electricity
demand growth. In the past decade, transmission investment grew a mere 6 percent
as electricity demand surged 20 percent. With transmission representing only
between 5 and 10 percent of the delivered price of power, we should not let
such comparatively small costs become a barrier to overall customer savings
from lower-cost energy.

FERC staff found the top 10 transmission constraints cost customers more than
$1 billion during the summers of 2000 and 2001. Congestion-based pricing for
transmission helps assign a cost of these bottlenecks to those who cause the
congestion on the grid.

The White House National Energy Plan cited a need for 393,000 megawatts of
new generation by 2020, or the equivalent of 1,300 to 1,900 new power plants.
More than a third of generating plants are 35 years old or greater. They will
need to be repowered or otherwise rehabilitated to remain competitive. And the
industry will need to invest billions in coming years to meet new clean air
standards. We need a standard competitive framework that allows rational investment
decisions.

Clearly, there is no alternative to rolling up our sleeves and, learning from
experience, laying down rules that make markets work.

A leading example of the new market design FERC envisions can be found in the
effort to form an integrated wholesale power market in the Midwest and Mid-Atlantic
regions. That market integration is conservatively projected to save customers
in 26 states $7 billion over the next decade.

Making Markets Work

The Standard Market Design is the third chapter in FERC’s electricity restructuring
saga. The first came in 1996, when the commission issued Order No. 888 to open
up transmission lines to competing power providers on a nondiscriminatory basis.

But FERC soon realized that more must be done to truly ensure effective competition
in electricity. In December 1999, the commission issued Order No. 2000, directing
utilities to turn operation of their transmission lines over to independent
management by regional transmission organizations (RTOs).

In addition to eliminating the residual ability of utilities to use their control
of transmission lines for commercial benefit, RTOs promise to bring efficiencies
to the current state of operations of the nation’s interconnected power grid.
With seamless trading across regional markets and between regional markets,
transmission customers will avoid so-called “pancaked” rates in which fees are
paid to each individual transmission-system owner.

The RTOs now well on their way to being implemented in various regions of the
country are integral elements of the commission’s Standard Market Design. RTOs
will enhance competitive access and power-grid reliability. These independent
transmission providers will administer competitive spot markets for wholesale
power and help the commission police against potential anticompetitive actions
by market participants. Truly independent governance of RTOs is a bedrock principle
of Order No. 2000 and the proposed Standard Market Design.

The third and final chapter, FERC’s Standard Market Design proposal, builds
on the wealth of experience the commission has accumulated in its nearly decade-long
experience with competitive wholesale power markets. The proposal marks an end
to a period of state- and regional-level experimentation with competitive wholesale
electricity markets. FERC’s stan-dardization incorporates a “best practices”
framework based on the experience gained from years of experimentation, while
providing necessary flexibility to account for regional differences.

Wholesale Electricity Markets

Under the Standard Market Design proposal, an independent entity will administer
spot markets for wholesale power, ancillary services, and transmission congestion
rights; a real-time balancing market to maintain reliable operations of the
power grid; and a separate day-ahead market. These will complement bilateral
contracts for long- and short-term energy purchases.

The voluntary centralized spot-power market is a “security-constrained, bid-based”
system. “Security-constrained” assures that energy transactions will not jeopardize
grid reliability, while “bid-based” describes the proposed auction for imbalance
energy. Power will be bought and sold through a power auction in which buyers
and sellers bid the price at which they will buy or sell power in any hour.
The market-clearing price will be revealed to all supply-and-demand-reduction
sources to encourage efficient short- and long-run operations and provide market
transparency.

The commission’s proposal also provides a mechanism to curb potential runaway
market volatility, much like the so-called “circuit-breaker” tool used by the
New York Stock Exchange. This proposed mitigation measure would bar power providers
from bidding to supply power at prices higher than $1,000 per megawatt-hour.
Such a $1,000 volatility check is already in place in the Northeast states and
Texas.

But the vast majority of power transactions will still be made under bilateral
contracts negotiated between buyers and sellers. Energy delivered under these
contracts will have to secure transportation between generator and customer,
which can be assured by obtaining rights to transact between those points. Firm
transmission rights, or FTRs, are tradable financial rights for transmission
between two points on the grid over a particular period of time, and lock in
a fixed price for the transmission, making the FTR holder indifferent to the
cost of congestion over that pathway.

Transmission Service

The proposal creates a new, universal form of transmission service to replace
the two types of open-access transmission tariffs provided for under Order No.
888. The new form of a network transmission service tariff combines elements
of the existing network and point-to-point services available under Order No.
888, and allows all wholesale power sellers to use the grid much as transmission-owning
utilities do.

An important change in the proposed new transmission service is the commission’s
call for all transmission uses to be scheduled under the network tariff. Thus,
transmission service in support of both wholesale and retail transactions will
fall under a common tariff for the first time. The commission’s assertion of
jurisdiction over all interstate uses of transmission acts on an invitation
from the Supreme Court in its decision upholding Order No. 888.

This change will prevent transmission providers from reserving more capacity
than needed to serve native load retail customers as a means of blunting competitive
entry at wholesale. Remedying undue discrimination in interstate commerce requires
that the commission assert its authority over bundled transmission.

The commission proposes to eliminate point-to-point transmission service as
a standalone service. This addresses a key concern that utilities, after denying
point-to-point service to a competing power provider, use the information provided
by the transmission customer to sell power to their competitor’s intended customer.
Under the Standard Market Design proposal, all transmission users will be able
to schedule power deliveries using multiple receipt and delivery points, providing
the same operational flexibility enjoyed by transmission owners.

A primary difference between the existing form of network service and the new
proposed tariff is the feature creating a market for firm transmission rights
to lock in a fixed price for transmission across power-grid bottlenecks.

By allowing transmission customers to lock in transfer rights across congested
transmission pathways with FTRs, and by promoting a secondary market for those
firm transmission rights, the commission lets the market assign a value to the
congestion, which signals investment needed to relieve the bottleneck.

The proposed market design also incorporates locational marginal pricing (LMP),
a form of congestion pricing, which allows more efficient management of the
transmission grid. LMP provides price signals indicating where investment in
generation and transmission is needed to improve grid operations. LMP has proven
to be the most reliable and efficient market design, and it minimizes opportunities
for market manipulation.

The proposal further provides an incentive for power grid enhancement by allowing
the companies that invest in new transmission to retain the fixed rights to
the added power-transfer capacity. By providing predictable rules and clear
rewards for investment, the commission expects the proposal to speed the necessary
expansion of the nation’s highly interconnected electricity grid.

This congestion pricing and management approach should dramatically reduce,
or even eliminate, the need for curtailment of transactions as a means of preserving
power-grid stability. Recent commission staff studies found the use of transmission
loading relief, or TLR, procedures increased markedly in the Midwest and Southeast
in recent years, suggesting that transmission owners are exercising the option
for more than grid reliability purposes.

Demand Reduction

To promote long overdue investment and avoid over-reliance on the spot market
auction, the commission establishes a mechanism to ensure sufficient resources
will be on the system when needed in the future. This approach will help avoid
undue price volatility in the spot markets.

A watershed feature in the proposal encourages the use of demand reduction
to meet the resource adequacy requirement. Reducing electricity usage shaves
the peaks in high-demand periods when prices typically spike, and thus dampens
high prices and moderates price volatility. The commission proposes that demand
reduction be bid into the spot market in addition to power supply. Demand-reduction
mechanisms can include electing for service interruption or taking steps to
lessen electricity use.

By making certain segments of the market receptive to price signals, the commission
aims to address a key inefficiency in electricity markets: “inelasticity.” Most
electricity customers today buy their power at a fixed price that does not vary.
Whether prices in wholesale markets are high during periods of peak demand or
low during slack demand, the price remains the same. Economists have consistently
urged that customers be exposed to price signals that would curb demand for
electricity during periods of peak demand when prices tend to spike as a means
of providing “elasticity” in the market.

Decisions about demand-reduction programs would be left to state and regional
transmission planners. Most of those customers opting for exposure to potentially
volatile real-time pricing are expected to be sophisticated industrial entities
initially, although similar opportunities are expected for average household
and commercial customers over time.

But FERC can’t complete this needed transition from regulation to competition
alone.

State and federal regulators must work together so customers, whether or not
they live in states with retail competition, reap the benefits of a national
marketplace for wholesale electricity. Through a coordinated approach to power
markets, adequate and reliable supplies of electric energy at just and reasonable
prices can be assured while respecting the unique characteristics of regional
power markets.

Without this cooperation, we risk continued under-investment in generation
and transmission, divergent rules that promote discriminatory business practices,
and lost economic gains for customers across the nation.

We have an opportunity now to make markets work in the interest of customers.
Our nation will succeed in this important endeavor.