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Using Auctions to Jump-Start Competition and Short-Circuit Incumbent Market Power

Fortnightly Magazine - February 1 1999

the RMAs should be composed of a mix of retail customers; that is, there should not be a concentration of either highly "desirable" (say, large industrial or commercial customers) or "undesirable" customers (say, low-income consumers). It is also advisable, when possible, to keep the size and composition of customers in the RMAs comparable throughout the state. Maintaining some uniformity across RMAs would facilitate the submission of bids by suppliers and the evaluation by the PUC.

Utilities first will be given an opportunity to subdivide their service territories for the RMA boundaries. They should draw the boundary lines of these contiguous geographic areas with an eye toward transmission and distribution facilities. The creation of transmission and distribution bottlenecks would have to be avoided, to prevent any supplier being given an advantage. A logical dividing parameter may be to have the RMAs correspond with the distribution customers served by one or more distribution substations. Utilities could combine substations until the desired number of retail customers is reached. The PUC would be given authority to review the proposed boundaries and, provided the criteria for determining RMA boundaries have been met, will have final authority to approve the boundaries.

Before any potential supplier could submit a bid, it would need the PUC's designation as a "qualified bidder." This qualification would be based on a demonstration of sufficient financial resources and capacity commitment. It would serve as a minimal screening process to prevent participation by unqualified suppliers with inadequate financial resources and access to capacity.

Bidding: Sealed or Open?

A critical element in the RMA design is the selection of the winning bidders. There are two distinct possible designs: a sealed-bid auction run by the PUC or an automated auction that would be similar to the FCC's spectrum auctions.

In a sealed-bid auction, now part of the RMA proposal, the PUC would disclose in advance the bid evaluation criteria, which would explain price and non-price factors to be used to select winning bids. This procedure would be similar to the competitive bidding for new power supply that some states used for PURPA-qualifying facilities and new capacity needs. Price would be the most important single factor, but significant consideration should be given to non-price factors. These non-price factors primarily would be intended to ensure and maintain the state's system reliability. They would include an evaluation of the probability of supply, the financial viability of the supplier and specific performance guarantees. The evaluation criteria, procedures and selection of winning bidders should be disclosed to the public.

An advantage of the sealed-bid process is that the confidentiality of bidders' proposals can be maintained. This feature limits the chance of collusion among bidders and leads to the best price for consumers.

The downside is that suppliers may bid a very low price that causes financial hardship - that is, the "winners curse" may be more likely.fn4,fn5 While that is good for customers, it is important to maintain the reliability of the electricity system to ensure that suppliers are not withdrawing from the market because they cannot cover their costs.

Process: Multiple