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There ought to be a better way for electric utilities to set prices for ancillary services - so that customers pay rates that fairly reflect the needs they impose on the bulk power system. However, while federal officials seem to agree with this point, so far they have done little to turn the idea to action.
Last spring, in its notice of proposed rulemaking on regional transmission organizations (RTOs), the Federal Energy Regulatory Commission appeared to encourage innovative pricing for ancillary services. At that time it wrote, "The Commission believes that, whenever it is economically feasible, it is important for the RTO to provide accurate price signals that reflect the costs of supplying ancillary services to particular customers."[Fn.1]
Several years earlier, in Order 888, the FERC had warned against the simple solution of charging for ancillary services through transmission rates: "Because customers that take similar amounts of transmission service may require different amounts of some ancillary services, bundling these services with basic transmission service would result in some customers having to take and pay for more or less of an ancillary service than they use. For these reasons, the Commission concludes that the six required ancillary services should not be bundled with transmission service."[Fn.2]
Nevertheless, in spite of the FERC's fine words, almost all utilities today charge for ancillary services on the basis of customer demand (in megawatts) or energy (in megawatt-hours). Likewise, the existing and proposed independent system operators use billing determinants that have little or nothing to do with the services being provided.
By contrast, we believe that in competitive electricity markets the prices set for each ancillary service should track two ideas: (1) charge the costs to those that cause the costs to be incurred; (2) collect the costs to reflect the factors that contribute to these costs.
As an example of the first point, operating reserves are required to protect bulk-power systems from potential adverse effects associated with major forced outages at a power plant or transmission facility. For a plant outage, the costs of operating reserves should be assigned to generators, and should reflect the frequency and severity of forced outages. Although these costs ultimately are paid by retail electricity consumers, charging them to generators encourages generation owners to maintain equipment to reduce the frequency of forced outages.
As an example of the second point, the amount of generating capacity assigned to the regulation service is a function of the short-term volatility of system load. Therefore, the charges for regulation should be related to the volatility of each load, not to its average demand.
In this article we discuss the economic efficiency and equity benefits of assessing charges on the basis of customer-specific costs (rather than the traditional billing determinants, megawatt-hour or megawatt). We focus on two key real-power ancillary services - regulation and load following. We determine the extent to which individual customers and subgroups of customers contribute to the system's generation requirements for these two services, in particular