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
December 11, 2008 11
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
December 11, 2008 12
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?
December 11, 2008 13
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!
December 11, 2008 14
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
December 11, 2008 15
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
December 11, 2008 16
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
December 11, 2008 17
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
December 11, 2008 18
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
December 11, 2008 19
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
December 11, 2008 20
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
December 11, 2008 21
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
December 11, 2008 22
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
December 11, 2008 23
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
December 11, 2008 24
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
December 11, 2008 25
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)
December 11, 2008 26
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?
Top Related