Perspective

Proper authority and market monitoring and mitigation could make the system work.

 

In the last few years we have watched appalled as the western U.S. electricity markets collapsed, taking with them the solvency and viability of several very large participants, including the California Power Exchange (PX).

In August, we watched in disbelief as blackouts spread almost instantaneously through New York, Canada, and the Midwest, leaving millions stranded without electricity for hours and days. There is a common thread. Today the Federal Energy Regulatory Commission (FERC) lacks clear statutory authority under the Federal Power Act (FPA) to do the tasks most policy-makers expect it to do: (1) regulate markets (though it has authority to regulate prices);

(2) ensure the reliability of the electric transmission system; and (3) ensure the adequacy of the nation's supply of generation. Moreover, the combination of the physical development of the system on a multi-state regional basis, and constitutional limitations, make it impracticable to assume states can effectively provide that authority.

Technology and economics have moved the industry far beyond the point where the state/federal division of 1935 can work. When there is less-than-robust demand response and unequal bargaining power between buyers and sellers, market behavior rules are required, but regulators need to have the right authority to craft effective rules. That authority does not currently exist for FERC in the Federal Power Act (FPA), and the issue of federal pre-emption makes it impracticable to assume states can effectively provide that authority.

The FPA is also ill-suited to being the legal cornerstone for reliability of the industry. Without clearer authority, FERC will have to continue its "carrot and stick" approach-coaxing transmission owning utilities to join regional transmission organizations (RTOs) and fashioning contractual, rather than statutory, obligations to maintain resource adequacy and transmission system reliability. The process has not worked well. Without changes that give regulators the right tools, the next power crisis could be right around the corner.

To get the tools (and the rules) right in a market economy, products and markets can be regulated either by price (on a cost-of-service basis for essential services) or by regulation of behavior of market participants. The consequences of the several forms of regulation are different, as are the methods used to regulate. ¹ In price-regulated markets, all sellers selling above a certain price point may have to pay refunds to all buyers who bought from them, regardless of whether the seller did anything wrong, or even if it sold below its own cost. But price-regulated sellers often benefit from limited liability for other damages if selling under an approved tariff. ²

Surely a lesson from the California crisis is that in deregulated markets, the rules need to focus on behavior-ensuring (by incentive or fiat) competitive behavior. This approach is not particularly well-suited for an agency with a price-regulated market statute, but, fortunately, models for behavior regulation exist. The Commodity Exchange Act, ³ and the Securities Exchange Act of 1934, ⁴ authorize the operation of organized markets under the supervision of federal agencies and clearly forbid certain manipulative actions