We Need Standard Market Design by Chris Trayhorn, Publisher of mThink Blue Book, April 1, 2003 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. Filed under: White Papers Tagged under: Utilities About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.