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The High Cost of Restructuring

RTO markets aren’t living up to the promise of cheaper power.

Fortnightly Magazine - February 2008

administered markets to raise prices above current levels, thus providing an incentive for capacity investments. 1 Advocates for free markets believe targeted intervention is only likely to create more distortions that will require more interventions, ad infinitum .2 Ironically, the existing regulated solution may well provide such investment incentives at a lower delivered price to consumers than the administrated markets favored by Professor Hogan — even before a “missing money” upward intervention in administered markets.

However, benchmarks for measuring the performance of restructured markets are hard to find. FERC approved AB-1890 (California’s restructuring law) without providing the means to check later how well it worked. While today it would be fascinating to compare FERC Form 714 system lambdas with the results of the California ISO’s Ex-Post markets, FERC allowed the California Independent System Operator (CAISO) to stop reporting system lambdas on its commencement.

A literature survey reveals hundreds of papers about electricity restructuring; most authors have tried to tell the story with modeling and counterfactuals, but their conclusions suffer from the breadth of their assumptions and the complexity of their analyses. The small amount of impartial evidence available indicates administered markets are expensive. There are a few useful comparisons between real-time prices at RTOs and neighboring system lambdas as reported in the FERC Form 714 data. For example, the Los Angeles Department of Water and Power (LADWP) still reports system lambdas, and a cursory visual inspection shows they are lower than CAISO’s real-time prices.

This should be surprising. LADWP is surrounded by CAISO, is active in CAISO markets, and CAISO administers LADWP’s major interregional transmission lines. However, if the CAISO “market” was truly competitive and LADWP faced the disadvantages often associated with governments attempting to be competitive, then LADWP system lambdas might be higher than the corresponding CAISO real-time prices.

Price Proof

The real test of success is delivery of the product in the market — no more and no less. The Energy Information Administration’s “Electric Power Monthly” assembles electric price and quantity data and includes fossil-fuel costs and quantities for each state, facilitating state-by state comparisons. For example, in the ongoing debate concerning the administered market structure in Texas, Mark Jacobs, CEO of Reliant Energy, said in October that “other markets are still on an uphill climb.” 3 Yet Figure 2 shows Louisiana, with generation far more susceptible to natural gas prices increases than Texas, is now experiencing a lower rate of growth in electric prices.

While many analysts blame the differential on the use of natural gas in RTO markets, little effort has been expended to validate this conjecture. Because fuel costs are such an important component, a better measure is electric rates net of fossil fuel costs. The differential between administered markets and open markets shows a divergence. Higher fuel costs do not explain the discrepancy between Louisiana and Texas. Even with fossil fuel costs removed, Texas average prices have significantly diverged from Louisiana (see Figure 2) .

The two states’ experiences are mirrored in a comparison between Entergy’s system lambda and real-time prices in Texas. The same