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The Market Transition: Is FERC Pricing Policy on the Wrong Side of the Road?

Fortnightly Magazine - February 15 1995

In the United States, the Federal Energy Regulatory Commission (FERC) has undertaken the task of guiding the electric power industry from regulation to competition. But unless the FERC develops a plan to consider all facets of electric deregulation at the same time, we may end up driving on the wrong side of the road.

Last October the FERC issued its policy statement on electric transmission pricing. See, Inquiry Concern. Pricing Policy for Trans. Servs. Provided by Pub. Utils. Under the Federal Power Act; Policy Statement, Dkt. No. RM93-19-000, Oct. 26, 1994, FERC Stats. & Regs. (CCH) 31,005, 59 Fed.Reg. 55031 (Nov. 2, 1994). This document raises troublesome issues stemming from continued piecemeal deregulation. The time has come for the FERC to choose: Set transmission rates on embedded cost, or let utilities charge market rates. The FERC cannot legally continue forcing utilities to design transmission rates based upon either embedded cost or market, whichever is less.

Regulation vs. Market Pricing

Before considering the impact of the policy statement, let's look at the record of partial deregulation to date. The figure on the next page depicts the range of possible transactions for utilities buying or selling bulk power or transmission service at prices dictated by regulation (em prices that fall either above or below an unregulated market price.

QF Price Above Market. Let's first examine the effects of utilities buying bulk power above the market price (upper left quadrant), epitomized by New York's famous 6-cent rule. In that case, the New York Public Service Commission (NY PSC) required state utilities to purchase all energy offered them from qualifying facilities (QFs) at a minimum of 6 cents per kilowatt-hour (›/Kwh), a price far above market. Nonutility power suppliers flocked to New York. And with QFs collecting a regulated price above market, very little was heard from free-market proponents. The result? New York utilities were saddled with hundreds of millions of dollars of unneeded generation that forced prices higher and made them less competitive. (Note: The staff of the NY PSC now complains that this power is too expensive and should be disallowed for ratemaking purposes.)

QF Price Below Market. Now consider the case in which utilities buy QF power at prices below the all-in cost of new generation (lower left quadrant), as in Arizona where the Corporation Commission has set a low QF purchase price because of excess capacity. In states like Arizona, utility managers assigned to buy bulk power from independent power producers (IPPs) generally have less to do than the local Maytag repair person.

Generation Above Market. Now let's look at the sell side of the grid. Assume that the embedded cost (the regulated price) of utility generation exceeds the market price for the new generation, as governed by the all-in cost of new gas turbines (upper right quadrant). What happens? IPPs give stirring speeches on the power of the free market and the monopolistic attitude of utilities. Competitors demand that the market be allowed to operate.

Transmission Below Market. An interesting transformation occurs, however, when the subject changes to transmission pricing (lower