Electric Market Restructuring in the 21th Century trading old for … O'Neill... · Electric Market...

Electric Market Restructuring in the 21th Century

trading old for new shibboleths

Richard O’NeillChief Economic Advisor

Federal Energy Regulation Commission

Regulation, Industry Structure, and Market Power Conference

Gold Coast, Australia1 August 2003

December 11, 2008 2

Transitioning from Transitioning from planning and planning and

dispatch to auction dispatch to auction and market power and market power mitigation modelsmitigation models

December 11, 2008 3

CulturalCultural ShibbolethsShibbolethsIt takes a decades to change a cultural paradigmOld timers are hard to convince but they often have good insightsDon’t let the model dictate the answer

Hammer looking for a nailAssume Nash (no collusion) behavior when there is collusion

Jargon traps you in the old systemUse cost-based approach language in a auction based model

Small rules matter; all are not written Mafia and the insurance

Culture matterscompetition between gov’t corps (New Zealand )Utility execs become non-utility execsCrown corp. becomes private corp.; buy corp jet and raise salary

Analogies often are often self-serving

December 11, 2008 4

Fool me once shame on youfool me twice shame on me

Old culture: government control of commanding heights (Lenin)Sunk-cost-based pricing becomes costly

Transition paradigm: Thatcher-Reagan-Hayek Laissez faire (almost) for commanding heightsWeak institutions lead to outlaw culture and abuse

New paradigm: where is the Tipping Pointmarket-based regulation for commanding heightsKeep prices in competitive range; Ignore sunk costs Deal with externalties; transition to less regulation

December 11, 2008 5

All markets are regulatedthe policy question is how?

☯Contracts and Property rights : common law☯eminent domain

☯Institutional rules: SEC, CFTC, …☯Antitrust (monopoly): collusion☯Does Nash behavior violate antitrust law? no

☯Utility regulation: just and reasonable prices☯Punishments for illegal behavior ☯Restrictions on behavior☯disgorgement of profits☯compensation of harm☯Fines and jail time

December 11, 2008 6

Twenty-first century LudditesOld testament: vertical integration with cost-of-service regulation is efficientTechnology innovation

Scale economies in generation have declined Information technology has lowered scope economies

New testament: market structure amenable to more competitionRequires shift in regulatory authority from

Cost-based to market-based regulationState to federal

Luddities stand in the way

December 11, 2008 7

Market-based v. cost-based regulation: it’s all about incentives

Imperfect regulation v. imperfect marketsHayek/Lerner debate: which is more efficient$200 billion in stranded cost Cost-benefit test is softTipping point for market-based regulation? Market structure determines the tipping pointMarket structure is dynamicDepends on concentration, supply and demand therefore the mitigation tools are dynamicDynamic mitigation has dynamic guard rails

December 11, 2008 8

Cost-based v. market-based regulation

approach Cost-based Market-based

Fixed costs Allocated to customers

Recovered in the market

Variable costs

Allocated to customers

Used in bid caps

market design

Discounting Negotiated rates

Market clearing auctions

Market power mitigation

Recourse rate (rate cap)

Bid cap

December 11, 2008 9

Market structure dictates efficient regulation

☯Concentration☯Supply functions depend weather, e.g.,

precipitation☯Demand functions depend on weather,

heat and cold☯Market mechanisms☯Contract structure☯credit

December 11, 2008 10

The 20th century utility regulation in a nutshell

FPA (1935) and NGA (1938): ‘just’ ratesMust give the opportunity to recover prudently (efficiently) incurred costsUntil late 1980s, cost-based regulationMarkets grow geographicallyScale economies declineFranchised monopolies/fiefdoms Late 1980s, tipping point switch to market-based regulationjurisdictional turf: states v. feds


Analogies usually failAnalogies usually fail..electricity is electricity is notnot air traffic, natural gas or telephoneair traffic, natural gas or telephone

telephone: hush-a-phone and spectrumair traffic controller:

no Kirchhoff lawsa reservation changes seats available

on all other flights natural gas: no valve; no storage lead to a socialization of the market

subsidize real-time marketsubsidize congestionsubsidize trading


The Enron phenomenonWall Street encourages Enron clonesInstead of a measured transition in California, we jumped to reasonably unfettered markets designed by Enron and its aspiring clones with intense lobbing and without any transition mechanism.Result: Rube Goldberg market rulesMemo to Cal. strategiesEnron online: Enron told the Comm it was a bad idea?


gencosTransco/Gridco/IsosLSEs/discos

RTO

iou

system operatorsecurity coordinatortariff administrator

Market operator for commoditycapacity tx rights

What did we do before we went back to the drawing board?

ENRON creates ether money; ENRON creates ether money; wall street believes!wall street believes!


Pre-day-ahead markets for transmission rights: CRT/TCC/TRCs/FGRsfor generation capacity/resevres (ICAP) market power mitigation via options contracts

day-ahead market for reliability(valium substitute)simultaneous nodal market-clearing auctions for energy, ancillary services and congestionallow multi-part biddinghigher of market or bid cost recovery allow self scheduling allow price limit bids on ancillary and congestion

Real-time balancing myopic marketmarkets are nodal-based LMP with fish protection


Role of Transmission in Electric Markets Traditional approach: Integrated Resource Planning

Plan systemBuild assetsAdd costs to rate baseRoll-in the costs

Order 888Rolled in v. incremental‘And’ v. ‘Or’ the ‘but for’ for cheap expansion

SMD and Merchant transmission


Merchant expansionMerchant expansionPublic good: Eminent domain and environment Test: contestability or no withholdingOperation under control of RTO/ISO:

open breaker optionsystem is no worse off

TX property rights without withholdingFTR and Flowgate rightsChoice seems to be DC subnetworks


Transmission rate design and Transmission rate design and revenue requirementrevenue requirement

Transco/Gridco does revenue requirementCost-based: traditional v. PBR

Incentive compatibleBenchmarking (EU): percent availability

RTO does rate design Total revenue requirements via access chargeTX rights auctions for forward rightsCongestion fees

system expansion must go thru planning processtransmission property rights via RTO auction


TX rights auctionsTX rights auctionsJoint TX and generation auctions

San Fran nomogramHedging phase shifter settings

Point(s) to Point(s): FTR/TCC/FCR/CRT“perfect” hedge except lossesIf constraint set is nonlinear, no options contracts

Flowgate rights: elements or combinations Option v. obligation contractsApproximations

Linear: PTP decomposable Nonlinear: PTP not decomposable; no PTP option


ELECTRIC WHOLESALE MARKET PLATFORMFERC White Paper Issued April 29, 2003

Why Issue A White Paper? Let the industry, states, and others know Commission views about the scope and direction of a final ruleExplain changes in the proposal based on the

comments and our outreachAddress legitimate concerns while moving

forward to better wholesale markets


The Commission Rule That Would

Establish a wholesale market platform with good market design and market power mitigationRequire public utilities to join an RTO or ISOAllow regional flexibility in policies & timelinesEstablish regional state committees to provide

state input on FERC issuesNot require an element of the wholesale market

platform if its costs outweighs its benefitsNot set retail rates, irrigation, flood control, …Bottom up approach


Wholesale Market Platform GoalsWholesale Market Platform Goals

improved wholesale competitionReasonable transparent prices Prevent market manipulation Prevent transmission owners from favoring their own wholesale power salesEncourage needed investment Improve reliabilityRecognize the regional character Provide for federal and state cooperation


MARKET PLATFORM ELEMENTSMARKET PLATFORM ELEMENTS

Market Power Mitigation and MonitoringRegional Independent Grid OperatorRegional Transmission Planning ProcessFair Transmission Cost AllocationSpot MarketsEfficient Grid Congestion ManagementFirm Transmission RightsFacilitate Resource Adequacy Approaches


Market design and mitigation Surrogates for demand side

Sellers exercise market powerDemand curve for reserves

Entry conditionsPropertyEnvironment Interconnection

MitigationEx-ante structural analysis creates guard railsReat-time mitigation enforces guard railsEx-post penalties for physical withholding


REGIONAL STATE COMMITTEESwould have strong roles in deciding:

Transmission cost allocationExisting costs: e.g., License plate v. postage stampCosts across RTOs: e.g., export fees v. no feesNew costs: e.g., rolled-in v. participant funding

Transmission planningresource adequacy (generation, tx & demand) Firm transmission rights allocation and assurance Market monitoringTransition process: e.g., time line and budget


Should we subsidize competition?

☯The purpose of market design is efficient and fair markets☯Market power in electricity markets is

dynamic (function of the weather)☯Generators start in life as

inframarginal and often migrate to marginal (old oil and coal)


Mother ship brings home the prodigal children

beam me up Scotty Utilities buy power and assets from affiliates under questionable circumstancesCinergy utility buys plants from affiliatesAmeren utility buys plants from affiliatesEntergy and Southern buy power from affiliates under competitive RFP ‘auction’Was the competition fair? Makes affiliate generation less riskyWhere are the customer benefitsWill others enter in the future?

Electric Market Restructuring in the 21th Century trading old for … O'Neill... · Electric Market...

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