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Order 888, Between the Lines

Fortnightly Magazine - July 1 1996

utilities will probably always be blamed, but they may not be responsible if the ISO faults.

What we have here is a problem of accountability and legal responsibilities. The Order prescribes that the ISO's rules "should promote efficient trading," that it "should have appropriate incentives for efficient management and administration," and that "its pricing policies should promote the efficient use of investment in generation, transmission, and consumption." These prescriptions are easier to invoke than to realize in practice. How does one create incentives for an efficient trade-off between reducing transmission outage times (em at the cost of double or triple shifts and using a larger crane (em and reducing the cost of running a unit out of merit?

The Order requires utilities to file the traditional fictional tariffs for firm and nonfirm point-to-point and firm network services, but the FERC avoids giving advice on the principles to use in pricing transmission, "continuing," it notes, "to allow pricing flexibility." Concurrently with the Order, the FERC published a NOPR on "Capacity Reservation Open Access Transmission Tariffs," which will hopefully bring some semblance of economic rationality into the debate on transmission pricing.

Franchise and Market Power

So far so good, but it is important to appreciate that the Order only goes a limited way directly to creating a truly competitive electricity market.

The "market" the Order is developing is founded largely on trading between vertically integrated utilities whose retail load is protected by franchise, takes most of their generation, and recovers costs that are prudently incurred regardless of their level. These utilities compete at the margin at low prices that do not reflect levels that would prevail if the whole load were put on the market. For example, the embedded cost of generation in the Midwest averages about 4.5 cents per kilowatt-hour (¢/Kwh); prices in Illinois Power's 50-megawatt retail access trial are rumored to be about 1.8¢/Kwh. Effectively, the companies (with power marketers as intermediaries) sell to munis and co-ops with no generation of their own, and intertrade to reduce their costs slightly by optimizing among themselves.

Because the major part of the nation's power is protected by retail franchise, Order 888 does not invoke the radical effect of Order 636, which threw open all of the wholesale gas market. Gas producers can hurt each other in the wholesale gas market; in contrast, the electric wholesale market cannot hurt any of the integrated undertakings. Thus the Order remains satisfied with functional unbundling; it fails to require divestiture and proffers no advice on market structure, such as a PoolCo versus bilateral trading. It includes energy balancing as an ancillary service, but envisions that inadvertent interchanges should be physically balanced over a month rather than settled continuously at market prices, which is how they would be priced in a real market to reflect periods of high and low prices.

Significantly, the Order does not address the issue of market power, which is not really a problem in the current wholesale market because much of the trading between investor-owned utilities is discretionary. They do not have to trade