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Missed Opportunity: What's Right and Wrong in the FERC Staff Report on the Midwest Price Spikes

Fortnightly Magazine - November 15 1998

48 hours, the owners of a combustion turbine could pay off the costs of the investment in just two days, earning profits from all future sales for the next 30 years. %n3%n A more reasonable equilibrium price is below the current "into Cinergy" futures prices (prices for the futures contract at the Cinergy trading hub).

The FERC staff correctly notes that there were no blackouts in the Midwest, but it under-emphasized the fact that there were voltage reductions (em one step away from blackouts. Even more important, the past summer was not as unusual as the report concludes it was. %n4%n The Midwest has insufficient capacity and could have a similar generation shortage in 1999. This problem could even continue for the next few summers.

Had it realized how bad the situation really is, the FERC staff might have drawn the correct conclusions about the urgency of additional action. The region is sufficiently close to having future blackouts next summer (em so close that regulators and others should make it a primary concern to remove all impediments to deregulation and take proper steps to manage generation reliability during the transition to full deregulation. If we continue to move forward half-regulated and half-unregulated (i.e., with the wholesale market deregulated and the retail market regulated), then one of two transition strategies is required. Planning reserve margins sufficient to protect end users should be put in place and enforced with clear penalties, %n5%n as in NEPOOL. In the alternative, policy makers should rely on the market alone to set reserves. If the market route is chosen, the public should be warned of the potential for rolling generation shortage-caused blackouts, especially in major urban areas, and especially during the transition.

Capacity: The Specter of Shortage

The origins of this capacity shortage must be understood rather than minimized as in the FERC staff report.

First, the report notes that Midwest utilities have underestimated load growth over the last two years. However, the report fails to note that the industry has repeatedly and systematically underestimated load growth in the affected areas, those being MAIN, ECAR, SPP, SERC-TVA, and SERC-Southern. Note that these five areas were the only areas with super-high prices. (See Figure 1.) That fact emerges by comparing long-term forecasts of electricity demand growth with actual figures recorded over several recent years. It is not uncommon for actual demand to grow by two to four percent, but for utility forecasts to call for growth at only one to two percent. (See Tables 1 and 2.) Over the long run, these differences are huge; they are outside the range of forecast error (remember, these are 10-year averages). For example, a discrepancy of one percent a year for the identified five regions means an annual under-forecast of twelve 250 megawatt-sized plants and a 10-year under-forecast of over 120 individual plants sized at 250 MW.

The reason for this systematic problem is well known to insiders, though there are no depositions that one can identify to support this view. It is not simply that long-term average demand growth is difficult