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Power Markets Disconnected? How to Reconcile Retail with Wholesale

Fortnightly Magazine - September 15 1999

Shopping credits, capacity rules and other mistakes from California and PJM.

With retail electric markets opening rapidly, why are so many getting off to a slow start? Why do suppliers abandon some markets and consumers decline to participate in others? The answer may lie in a series of disconnections between wholesale trading patterns and retail opportunities.

Utilities, marketers, suppliers and electric customers have joined with state public utility commissions to invest thousands of hours and millions of dollars to set up these new markets in a way that will help consumers and regional economies. Their goals are laudable. Yet they have paid little, if any, attention to the intricate interfaces between the retail and wholesale markets for electricity. This omission has slowed or crippled development of even potentially robust retail markets.

One need not look far to find causes for these disconnections. In large part they stem from conflicts between state and federal rules at the PUCs and the Federal Energy Regulatory Commission. In general, there appears to be a lack of appreciation for how wholesale rules can affect the success of retail competition. Meanwhile, regulators get distracted by seemingly more pressing issues, such as stranded costs, reliability and customer protection. And within some regional markets, organized by an independent system operator, or ISO, it appears that some members really would prefer to slow down competition.

Overall, we can identify five disconnections between wholesale and retail electric markets, suggesting the need for five corresponding solutions:

1. Boost Shopping Credits. Consumers won't see savings and suppliers won't see profits unless shopping credits exceed the bundled cost of generation, fully loaded for such items as line losses, capacity charges, risk management and costs for customer acquisition and handling. Include stranded-cost true-up for customers taking standard offer.

2. Tailor Credits to Load Patterns. Add demand component to mirror wholesale capacity costs, ensure no bias between customers with high and low load factors. Consider a seasonal or time-differentiated shopping credit.

3. Eliminate Capacity Obligations. Power pool requirements for installed capacity are outdated. They serve no purpose under retail competition.

4. End Locational Marginal Pricing. Separate prices at each bus or node add too much fine tuning and discriminate against suppliers in allocating fixed transmission rights (FTRs). The regulated regime worked fine without LMP; so can retail competition. But if LMP is retained, then allocate FTRs by load, not supplier.

5. Let Disco Arrange Transmission. Give suppliers the option of purchasing transmission or relying on the regulated wires utility to provide such service, to avoid an unfair shift of risk to competitive suppliers.

Regardless of the reason, these disconnections must be bridged. If retail electric competition is to flourish, then retailers, wholesalers and regulators alike must identify and solve these market disconnections. The job may mean more work up front, but should yield commensurate benefits to all involved. Consider, for example, the problems that have occurred in two market regions, California and PJM Interconnection.

Learning from California

The first year of retail competition in California revealed several disconnections between wholesale market rules set by the independent system