The benefits and future challenges of regional transmission organizations.
If Compaq owned FedEx, would Dell be certain to get the same terms and conditions for overnight delivery as Compaq? Similarly, if a municipal utility wanted to contract with a supplier within the service territory of an incumbent utility that owned the transmission system and generation, how hard would it be to get transmission service to access the power?
With the passage of the Energy Policy Act of 1992, Congress endorsed the idea that competition among generation suppliers is in the public interest. A natural corollary to the notion of competition among suppliers requires that they not control the transportation of generation to a customer.
As a consequence of this understandable circumstance, the Federal Energy Regulatory Commission (FERC) decided to urge independent operation of the grid. Market administration to better facilitate trade was a natural evolution for this independent entity with no economic stake in market results.
Ten years after the initial Notice of Proposed Rulemaking that set in motion the establishment of RTOs, it is hard to dispute that the mature organized markets with independent management of the grid have achieved tangible benefits for all customers. It is important to remind ourselves of these accomplishments. At PJM we believe that the challenges ahead also need to be discussed. But let's start with the accomplishments.
What RTOs Achieved
: Perhaps one of the great accomplishments of RTOs has been the opening of the "black box" of transmission operation and generation dispatch. Until the advent of independent grid operators, no one outside the utility control room knew what was going on with regard to the transmission system and how dispatch of generation was affected. Independent generators, transmission- dependent utilities, even regulators were (pardon the pun) in the dark about how transmission was allocated. The transparency of both operation of the grid and administration of a market provided new confidence to transact electricity sales that did not exist under the old approach.
Importantly, in an RTO with locational prices, like PJM, the transparent operation of the grid and the market are interdependent, as prices bid into the market are linked with information about the state of the grid to produce prices for dispatch that reflect the needs of the system. In other words, RTOs such as PJM use the market to make grid resources more responsive to the grid's needs.
Prices experienced by customers in a competitive market should not be the measure of success of the market, as what constitutes a "high" price or a "low" price tends to be subjective. Nevertheless, on a fuel-adjusted basis, PJM markets produced prices that were more than 4 percent lower in 2004 than 2003, and 2003 was 9.5 percent lower on a fuel-adjusted basis over 2002. This performance seems to be in contrast to non-RTO areas. According to the Energy Information Agency of the Department of Energy, prices between 1995 and 2003 in regions with RTOs declined for all customer classes, while prices rose in the same time period in non-RTO areas.
: RTOs provide a platform on which transmission needs can be addressed on a regional basis and, if properly structured, provide the cost-allocation structure to allow for transmission expansion. The PJM Regional Transmission Expansion Planning process provides for PJM to determine transmission upgrades necessary to meet reliability needs and to "order" them to be built (subject to state siting authority). This approach has resulted in the authorization of more than $1 billion of transmission upgrades since 1997. PJM also has developed a process for making "economic" upgrades to the grid that opens participation in solutions to the grid to any participant, not just incumbent utilities. At PJM we recognize we must do more to provide for transmission expansion and economically driven upgrades to the grid, but does anyone believe that the old, single utility approach to transmission planning has a better chance of achieving regional results?
When discussing transmission expansion, congestion levels often come into the conversation. Some have alleged that congestion levels are increasing in RTOs. In fact, congestion in PJM steadily has averaged between 7 and 9 percent of total PJM market value since 2002.
Even this number does not tell the true story of congestion on our system. PJM provides instruments to hedge or protect against congestion costs in the form of financial transmission rights (FTRs). These hedges act as a revenue stream based on congestion to offset congestion expenses. The amount of congestion charges actually paid by load that is not offset by the FTRs is really only a bit above 1 percent of the total PJM market value. So, if this is the case, what is the "correct" level of congestion? Should we spend large amounts of money to eliminate all congestion or is it more economically efficient to manage to a level so that congestion does not grow beyond a certain threshold? Whatever the answer, being able to plan over a broad region certainly affords better tools to implement a solution once the threshold question is answered.
: It is often claimed by those in areas without organized markets that they too have markets. So they do. However, while transactions between utilities or other buyers and suppliers exist in all parts of the United States, without an independently organized market the transactions are limited, as many possible suppliers or buyers will not transact in that space given the inability to know if they will be dealt with fairly. The existence of a market that is independently administered leads to greater liquidity, which in turn leads to a better price.
EBay, a market with many buyers and sellers, illustrates the concept. Anyone wishing to contract in the eBay space has confidence that they are getting a fair price. But wait, this independent market helps even those who only use eBay as a reference price to know what the competitive price is-which is then used to transact elsewhere. So it is with organized markets: The independence leads to more confidence to conduct transactions, which leads to competitive results, which spurs more activity in other bilateral transactions. PJM's more than 350 members transacting at one time or another is a testament to the benefits of independent market administration.
: The electric grid can be thought of as conforming to a law of ecology: One action affects the rest of the whole. Because few would argue that each of the three interconnections in the United States works as one vast machine, it is curious that having a few large independent organizations operating over large regions is not more accepted. PJM has found that optimizing its large network of almost 160,000 MW of installed capacity has significant benefits. Prior to market operation, PJM had a required reserve margin of 18 percent. Because of the diversity of generation resources and load over such a broad area, the required reserve margin has been lowered to 15 percent. This reduction represents a significant savings to customers who have to pay for reserves, not to mention the benefits in terms of externalities, such as an environment where fewer reserves are needed to operate. Were the utilities in the PJM area to operate independently, none of these benefits could be realized.
: The size of a market is not an end in itself. However, size, when applied with the right market rules such as locational pricing, can be a powerful force for innovation and investment for the benefit of customers -innovation and investment not evident in single-utility systems. For example, PJM recently invested in an improved unit commitment program that resulted in an estimated savings to customers of $56 million annually. This application of technology was possible and justifiable only because PJM operates with locational prices over such a large area containing so many resources. The end result is increased efficiency that results in lower wholesale prices than otherwise would exist.
PJM Costs in Perspective
Some customers assert that RTO costs are out of control and bear little relation to benefits. In large part, PJM's costs reflects investments in information technology needed to implement services requested by our members. As services increased, so did PJM's bundled rate, at least until recently. As PJM grew, the rate any individual member paid began to decline because the costs were spread over more members. Figure 1 () puts the issue of costs into better perspective.
PJM's costs have grown at a slower pace than its: 1) load growth; 2) terabytes of data available; 3) total energy market transactions; or 4) total market billing. By almost any measure it is clear that PJM is doing amazing things with relatively small investments.
Through careful management, PJM is driving its bundled rate from a high of just under 50 cents/MWh in 2003 to 40 cents/MWh today, a 23 percent decline. Today, PJM's service cost to the average retail customer is no more than $3 on an annual bill of $833-less than one-third of 1 percent. Nevertheless, PJM is proposing to its members and FERC to hold a rate flat for several years to provide more cost certainty and even more accountability for cost and performance.
On the "To Do" List
Do these significant accomplishments mean that PJM and RTOs have solved all the problems in the wholesale electric market? Absolutely not. More remains to be done, most notably in the areas of enhancements to the grid, better tools to manage congestion risks, and better integration of demand response into the overall market.
PJM will be working with its members during the next year to develop longer-term FTRs. This will allow for those customers desiring long-term contracts to meet their load obligations and better manage congestion risks, while helping to spur even more bilateral activity. PJM intends to review its economic planning process to better allow broad investment in transmission expansion. It may be that the process can be used as the basis for forming "consortiums" that will seek to build out the transmission system to allow for the greater transfer of power over a broad area. Projects such as the recently announced Frontier project to move power from Wyoming to the California market could be facilitated by Eastern RTOs using their wealth of information. The first step may be to get transmission owners to cooperate in procurement going forward for transformers or other important transmission infrastructure items. PJM also will seek to establish thresholds to determine when transmission is robust but not "gold-plated." PJM already is working with its members to provide rules, procedures, and products to allow demand to respond to prices and act as the force it should in a competitive market. To this end, PJM recently has proposed to its members a "forward energy reserve" (FER) that will allow those serving retail load to better manage need in relation to demand.
These ideas represent only an illustration of some of the opportunities for improvement that are before PJM and its members. Other opportunities doubtless will be identified.
Most of what concerned policymakers in the mid to late 1990s has been realized. We have transparent markets. We have transparent operations. We have liquid markets. By any objective analysis, the costs PJM incurred on behalf of members to get to this point have been reasonable and are now becoming more predictable.
However, we understand the efforts to restructure the market should not end there. The electricity industry, arguably the most important part of the digital American economy, faces new challenges. RTOs such as PJM have not solved everything, but an organization that operates a large regional network is a far better platform for tackling the new challenges than any model we have had in the past. The industry, as one customer group noted, is doubtless at a crossroads. But rather than thinking about going backward, let's go forward and continue to innovate and improve. Let's not go back to 19th century business structures when we have 21st century needs.
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