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FERC's Market Design: The End of a 'Noble Dream'

How state opposition cowed the feds and turned a powerful rule into just a set of talking points.
Fortnightly Magazine - February 15 2003

mitigation in either the day-ahead (DAM) or real-time markets whenever and wherever an interface constraint creates a local load pocket that requires generation to be dispatched out of merit order. Once triggered, the plan will mitigate bids for must-run plants operating within the load pocket, usually by reducing the nodal clearing price to a level equal to the generator's estimated incremental cost, plus 10 percent. The Maryland People's Counsel praises the PJM method and urges FERC to incorporate it in the SMD for load-pocket relief. (PJM also allows other alternative mitigation options for load pockets: either a simple price negotiation, or a reduction in the clearing price to the level of the average of LMPs at the same generator bus for hours that featured a merit-order dispatch.)

One might think PJM would serve as an exemplary model for FERC's SMD. Especially here, where the SMD lays down a heavy hand to keep prices low. But it seems that FERC can't win for losing, because even in this case, state regulators in PJM's home state of Pennsylvania actually would prefer a different rule-one that would adopt less of a regulatory approach and more of a competitive or market solution.

Of course, the Pennsylvania PUC acknowledges that some have proposed to improve the PJM rules by substituting some sort of guaranteed generator payment reflecting variable and fixed costs plus a rate of return. But again, the PUC sees such solutions as so much "formula tweaking, headed in the wrong direction towards more RTO rate setting, rather than less."

For its part, the Pennsylvania PUC would prefer some sort of "proxy competitive price," derived either from historic unconstrained hours in the region on different days, or proxy LMP prices for the hour in unconstrained regions outside the load pocket (or perhaps even the historical average successful LMP bids by the generator itself, during unconstrained hours, which would have the effect of making the unit its own price proxy).

The point, says the PUC, is to avoid an "irrationally generous" mitigation scheme that destroys any incentive for efficient plant operation by setting an administratively mitigated price that still exceeds the plant's incremental cost by a substantial margin.

Otherwise, the PUC says, such plants could still operate, despite mitigation, as "the only big fish in the local pond, sure of a risk-free market for power, and fiercely contesting any new entrants."

Funding Transmission Expansion

Politics makes for strange bedfellows. As an example, consider that many of the states that oppose FERC's SMD plan most ardently-Georgia, Arkansas, Kentucky, North Carolina-are themselves some of the biggest boosters of perhaps the most progressive element of the plan: participant-funded transmission (PFT), which calls on merchant generators to pay for grid expansion in place of rolled-in pricing. Indeed, these states typically will defend PFT as an essential adjunct to an LMP congestion pricing system, so as not to distort price signals. Kentucky has even passed a state legislative resolution endorsing PFT.

"Participant funding leaves decisions over 'economic' grid upgrades to free market forces," says the Arkansas commission. "This allows for full and