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Perspective

Ten ways to fix the mess in electric restructuring.
Fortnightly Magazine - November 1 2000

opening their markets.

Instead, a phase-in plan might start with customers who can self-generate. For that group, consider incentive rates coupled with a price cap. That would give the utility a foretaste of what restructuring will do, but allow the company to earn whatever a more efficient operation can yield.

The next step would be to open competition to larger customers. More sophisticated purchasers can better handle market risk, and test the market mechanism before it is more widely used. In any case, it is doubtful that many residential customers can do better in small, aggregated groups than they can by taking a default service provided to the entire rate class.

Many states understood this lesson from the outset, but still went ahead and opened the gates for all.

3. And Make It Simple. The state regulators, legislatures, and power exchanges have set up exceedingly complex rules for the operation of the electricity market. So have the independent system operators (ISOs) in the case of transmission access. Suppliers, in particular, must disclose volumes of information, including the air emissions of generators in their portfolios. They may be required to have a certain percentage of supposedly renewable resources in those portfolios. Yet this complexity exerts a chilling effect on competition. Would-be competitors become reluctant to get tangled in the web. They stay away in droves. Customers lose choices; they find the market dominated by a handful of the most well-financed players.

Why such complexity? To some degree it stems from attempts to make do with pre-existing tariffs. This compromise in turn requires interminable tinkering. It produces a cumbersome and unintelligible contraption, of the sort once known as a "Rube Goldberg device." The ISOs, to be sure, will learn from experience, but rule makers should start with a blank sheet of paper.

4. Try Bilateral Deals, Not Just the PX. A power exchange, or PX, is not a bad idea; we simply have not figured out yet how to make it work. Suppliers can hold generation off the market in hopes of setting high market clearing prices when they finally allow their resources to become available. Customers suffer from astronomical prices. ISOs and market managers try to fix the mess after the fact, but more often than not, they cannot reverse the damage.

The solution of the day calls for price caps—hardly a great notion. Any cap on the market-clearing price also restricts generation supply. Price caps look more like a political expedient than a true solution.

Instead, try bilateral deals, with buyers and sellers trading one on one. Bilateral arrangements provide for more certainty and should result in greater stability by charging marketers with responsibility for making explicit any price risks imposed on customers.

Power exchanges should not be banned, but they need not have an official status. If suppliers find it useful to create exchanges to help them in developing supply packages, they should be able to establish them. But existing exchanges are not functioning well enough to set the price properly, even for bilateral transactions. That is too much authority for