[BETA] Fortnightly

Can RTO market monitors really be independent?

The Federal Energy Regulatory Commission (FERC) initiatives on regional transmission organizations (RTOs) and standard market design give new prominence to the market monitoring institution (MMI), a novel regulatory tool never before contemplated in legislation. ¹

FERC is requiring that all RTO applications include an MMI staffed by employees or external experts chosen by the RTO's governors. The MMI will evaluate market rules, observe regional trading, and regularly report to FERC. Commentators on the commission's proposed RTO rule had highly diverse views on the organization, functions, and sanctioning powers of MMIs. In response FERC has stated that it would be receptive to differences in MMI proposals that are justified by differences in regional markets.

MMIs already exist in all functioning RTOs and similar regional transmission entities, except in Texas, where one is being installed. Although experience is accumulating, FERC has never investigated their performance. It has yet to attempt a balanced determination of what MMIs can and should do, or whether they should exist at all. No regulatory institution has ever achieved so much centrality with so little forethought, and thus far there is little reason for optimism.

All RTOs have faced contentious and ambiguous market issues, but no MMI has ever produced a split decision. Either MMIs employ decidedly nonrandom samples of economists, or their reports are compromises that lose value because they do not make opposing opinions explicit to FERC.

Some rationales for MMIs are questionable at the outset. To get closer to a region's markets, FERC can simply post employees there. If FERC wants to standardize markets, there is little reason to let the locals specify how they will be monitored, particularly when one region might otherwise learn from others. As for independence, there are good reasons to favor distant observers rather than local ones.

It has taken only half a decade to forget some important history. MMIs were not invented by regulators but were proposed and designed by parties with economic stakes in the monitors' findings. In the case of California, MMIs met the expectations of those parties. California and other regions have further provided us with a "natural experiment" on MMI independence. Three independent system operators (ISOs) and their MMIs reached quite different decisions on the economically efficient practice of "virtual bidding." Politics trumped economics, for reasons probably inherent in the organizations themselves.

The California Experience

Ideally, an MMI would originate in a structured regulatory rulemaking where representatives of all affected interests could provide their views. In reality, it arrived in a docket, and not as a response to concerns by potential victims of monopoly. California's three large corporate utilities introduced MMIs in their 1996 application for market-based rates in the Power Exchange and ISO. ² Their own studies showed that at times the region could not meet FERC's market power standards. (The main concern was predatory pricing that would facilitate stranded cost recovery under California's transition rules.) To save the bargain they proposed further generation divestitures, special contracts with must-run generators, and a market monitoring program whose details would come