[BETA] Fortnightly

IN A RECENT SPEECH TO A SOPHISTICATED WASHINGTON AUDIence of electric industry players, FERC Commissioner William Massey raised a difficult question: "Can ISOs become self-policing institutions, thereby allowing FERC to embrace light-handed regulation of transmission?"

In answering his own question, Massey confirmed a quasi-judicial role for independent system operators (em but only if they are "equipped with proper operational rules, including market monitoring plans that report market power abuses and contemplate enforcement mechanisms to assure compliance." %n1%n

Despite such optimism, it appears unlikely the FERC will easily shed significant regulatory functions by making ISOs its proconsuls in a restructured electric power industry.

The FERC has provoked a growing controversy by its provisional approval of market monitoring plans filed by the Western Power Exchange and ISO-New England (formerly NEPOOL). Industry critics have raised constitutional, due-process and pro-competitive objections. Some state regulators believe the indicated mitigation measures to be inadequate; others question the efficacy of having ISOs use "behavioral" as opposed to "structural" remedies for market power abuses.

This gathering debate implicates radically opposed views on the proper role for ISOs.

The FERC and most state regulators envision several regional ISOs, with broad powers to operate the grid, manage power exchanges and curb market abuses. To accomplish these tasks, ISOs would enjoy authority similar to that exercised by the FERC. With FERC-approved regional transmission tariffs as a platform, ISOs would adopt monitoring and mitigation plans to acquire detailed market information. If necessary, ISOs would intervene to prevent market power abuse through price caps and price floors. They also would employ sanctions to prevent strategic withholding of capacity and use of transmission constraints to exclude competitors.

Not all agree, however. To many regional transmission owners that have ceded operational control of the grid, this proposed intervention stretches the envelope of ISO power. Such owners typically view an ISO as little more than a neutral service provider and transmission tariff administrator.

The Proposals:

A Structural or Behavioral Remedy?

As conceived by antitrust theorists at the Department of Justice, ISOs are "structural institutional arrangements, short of divestiture, that¼ separate operation of the transmission grid and access to it from economic interests in generation." %n2%n

Once in place, according to this view, an ISO adequately addresses vertical market power by decoupling transmission and generation. The question then arises: What about horizontal market power?

In response to requests for market-based rates filed by ISO-NE, WEPEX and the Pennsylvania-New Jersey-Maryland Power Pool, the FERC has had to consider residual horizontal market power exercised by generators within a pool. Horizontal market power manifests itself in the behavior of market participants, particularly generators. To contain such power, ISOs must do more than operate the grid. They must also identify anomalous market behavior, devise acceptable mitigation procedures and be prepared to punish offenders.

In pursuit of these functions, industry critics assert, the WEPEX and ISO-NE market-power monitoring and mitigation proposals "represent a new and unstudied form of regulation, which entails extensive data collection and investigation, after-the-fact policing of seller behavior, and the imposition of sanctions." %n3%n

On the other hand, FERC claims comprehensive