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

Fortnightly Magazine - February 15 1995

electric system and is almost impossible to reproduce. Yet, by default, the FERC has fashioned an allocation policy (or, I might say, nonpolicy) that assigns access to transmission on a first-come, first-served basis.

Consider a transmission line with an embedded-cost price of $7 and a replacement cost of $100. Assume that the first party to request use of the line will sell power to generate $20 in benefits. This type of transaction will occur under existing FERC policy. But should it? What if next week another party requests wheeling to arrange a power sale with a $100 benefit, but the line is no longer available. That transaction will not occur. Under the FERC's first-come, first-served policy, transmission lines are used to capture a gain of $13 for a private party, forgoing a higher public benefit.

Before the reader concludes that I only want to raise transmission rates, let me state that I would accept either a market price with invisible-hand allocation, or a regulated price with regulated allocation. But in denying purely market rates and then letting the "market" decide, the FERC effectively abdicates its responsibility to oversee the nation's largely irreplaceable transmission system. Now, the FERC's policy statement does acknowledge that nonconforming proposals must "produce greater overall consumer benefits than a conforming proposal." But optimum overall societal benefits arise when transmission is sold at its marginal cost for the period of the sale. Any sale above or below the correct marginal cost will produce fewer benefits. The FERC's own language, therefore, would seem to mandate market pricing.

And no regulatory system (em however complex, well conceived, or well accepted (em can possibly deal with the thousands of combinations and permutations that the free market handles with ease. In the United Kingdom, the National Grid receives more than one million pieces of information daily on competitive transactions and yet, last fiscal year, endured only

1,427 disputes. That number will surely drop significantly as the pool gains experience and sets precedents.

Lessons From Gas

One argument states that electricity is not like gas: What worked for gas will not work for electricity, ergo we cannot deregulate electricity.

Electricity is not like gas, but neither is it like tomatoes, cars, or single malt scotch, which all sport well-functioning commodity markets. An electricity market can work, but we must recognize the factors that make it unique. One major difference in the electric system is the lack of storage. Gas molecules can take two days to travel from producer to consumer. But gas from a storage field or line pack can be delivered instantly. (With single malt scotch, delivery takes about 10 to 25 years.) In the electric system, however, input must match output at all times.

This real-time constraint means we must hire operators and deploy equipment around the clock to perform switching, provide VARS, control frequency, institute load shedding, and execute the host of services known as "control area operations." The amounts associated with these services are not trivial. The National Grid was allowed to charge œ592 million (about US$954 million) for these services