Ten ways to fix the mess in electric restructuring.
Crisis in California! Double-digit increases in Maine's default service rate! Wholesale prices up to $6,000 per megawatt-hour! Independent system operators struggling to get the market to work! In the background, we hear strains of that old Gershwin tune: "Let's call the whole thing off."
Electric restructuring is struggling. Many would write it off as a failure. But we cannot turn back. Mergers are a fact. Power plants have been sold. To be sure, some regions have done little as of yet, but they will be forced to do so eventually. We need to step back, learn the lessons from the first phase of restructuring, and make it work.
Here are the most important lessons we've learned since passage of the Energy Policy Act eight years ago.
1. Accept the High Price. Too frequently, politicians insist that restructuring should produce savings right away. But that's not our economic system. Instead, it should be enough to ask only that competition will dictate the price of electricity, just like for any other product. That price, whatever it is, will certainly prove more efficient than any "just and reasonable rate" that regulators may devise.
As California has shown, you cannot expect restructuring to work miracles when demand outstrips supply. Instead, trust competition to send a price signal that will encourage power producers to build more generation—the kind of signal that, if sent earlier, could have made a real difference by now.
Also, accept the fact that competition at first will encourage consumption, leaving no incentive for conservation other than price. After all, higher prices are the best way to trim demand when supplies are limited. We should live with the system we have created, instead of complaining when it works.
In Maine, no amount of competition could stave off the effects of rising oil prices. When crude goes from $12 a barrel to $35, the price of power must surely follow. Yet some politicians make lower electric rates a condition for restructuring. In so doing, they succeed only in delaying the inevitable. Instead, they should take their satisfaction in knowing that customers no longer would suffer the risk of bad investments by generators. Imposing that risk on suppliers should mark a major step forward.
Of course, it is only proper for federal and state regulators to have concerns about the transmission grid and its reliability. They want the industry to build new transmission, but fail to acknowledge the heavy burden imposed by environmental rules. The ultimate regulators of the electric market are state siting authorities. They should change the rules to make it easier to build, or else let the prices rise to reflect the difficulty of siting and the resulting scarcity of transmission, and stop complaining.
2. But Phase It In. Don't expect to do it all right away. In treating electricity like the telephone, regulators have tried to open the power market to all customers simultaneously, but that strategy has only led to chaos and mass disappointment. It has frightened away some other states from 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 an imperfect operation.
5. Force the Grid Owners Out of Generation. Though this principle is broadly accepted, some players continue to fight a rearguard action to remain in both generation and transmission.
Regulations for open-access transmission originated at the Federal Energy Regulatory Commission. The FERC wanted to prevent utilities from dominating both generation and the delivery of power. Obviously, a company that controls transmission can and does use that control to benefit its own generating resources.
Now, several large utilities are proposing to create regional transmission organizations (RTOs) that they will own and control at the same time that they supply power across the grid. RTOs are an excellent and timely initiative by FERC, but they would be almost useless if the commission were to allow rebundling.
The purpose of the entire restructuring exercise is to increase customer choice; the purpose of controlling both generation and transmission is to limit customer choice. Not only does control permit dominance, it allows the bundled entity to subsidize generation costs in a way that is not possible for other market players.
6. Protect and Educate Consumers. Let's face it: The states have done a poor job of educating consumers and protecting them from the scams and abuses—such as bait-and-switch and false claims—that tend to crop up in emerging markets.
Consumers would be less likely to be disappointed if legislators and regulators would just do a better job of explaining the changes. Far too often, state regulators or legislators promise that prices will fall right away. Such predictions are often premature or just plain wrong.
And all those licensing requirements that govern the suppliers will not be enough to protect consumers from harm. Suppliers want to keep their offers confidential for competitive reasons, which is understandable, but the virtually complete cover they get allows them to mislead customers with impunity. To believe that larger customers are knowledgeable enough about this new market to protect themselves is a false assumption.
The states should institute and enforce real trade rules and be much more vigilant about actual complaints of market power. The state attorneys general and the utility regulators have been slow to step up to this challenge. Without such protection, customers are signing contracts they barely understand, based on assurances that suppliers cannot keep.
7. Cut the Social Mandates. State governments traditionally have forced utilities to clutter their bills with charges to pay for low-income programs and energy conservation schemes.
This manipulation of what is supposed to be an open market, in which electricity prices and terms are to be set to compete with other resources, serves only to falsify. At a time when we are struggling to get the rules right, government undermines the market.
Of course, it has never been equitable to impose mandated costs and conditions on electric power when they are not imposed on other resources such as oil. But with legislative action to allow retail competition, states seem to have seized the opportunity to add even more requirements, apparently believing that competition will be so robust that the market will bear some added costs and complexity. We now find that such mandates are burdens some potential competitors cannot live with.
8. Give Consumers A Fallback Option. As the telecommunications experience teaches, many people are indifferent to potential price savings because they do not want to deal with another choice. They need a default provider.
Furthermore, the default provider can serve as a benchmark for the market. Either state authorities or wires companies that are fully unbundled can obtain the default power supply through a competitive process. The price will reflect a bulk purchase for a class of customers, and should not be changed artificially by regulators either to encourage competition or insulate customers from the market. If suppliers want to compete, they will know the price they have to beat.
Though a default or standard offer supply may not be required indefinitely, states should end it only if and when customers are fully involved in the competitive market.
9. Use Metering, Not Load Profiling. Using load profiling to simulate customer demand and consumption is a poor substitute for the real thing. Load profiling provides a strong incentive for sellers to subsidize generation and transmission costs, one against the other. It moves us away from the goal of having customers pay prices that reflect their true cost of service.
Because of the arbitrary load determinations in effect in some places today, customers without demand meters are getting better deals than the larger customers with high load factors that already have demand meters. There simply is no load factor or load shape risk to the supplier with profiling, though some customers evidently are subsidizing others. Such cross-subsidies also exist when transmission and distribution costs are allocated according to load profiles.
Of course, it will take time for all customers to be provided with new meters. By requiring they have such meters before entering the competitive market, phasing is promoted.
Perhaps best of all, actual metering reduces complexity and the need for regulatory involvement in making arbitrary and inaccurate determinations about load profiles. Though complete metering comes at a cost, competition is here to stay and this one-time cost has long-term benefits.
10. Create a North American Market. Transmission lines do not stop at borders. The most efficient use of resources, reducing the need for new transmission and generation, would ignore borders.
Despite all the claims about the North American Free Trade Agreement and complaints about the reciprocity requirement in FERC's Order 888, cross-border trade has not increased significantly. Both suppliers and markets would benefit from a more open exchange.
Both the Congress and the Clinton administration have focused on reliability, but the agencies that can do something about it, the FERC and the North American Electric Reliability Council (NERC), in fact have not done enough to elicit a truly North American-wide response. It is time to end turf battles and provide NERC or a new agency with the tools to do the job without being beholden to any players. Real reliability in North America requires a real North American market.
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