The venerated process may get a makeover.
Like dough in the hands of a crazed pizza chef, merchant power generators have been tossed and turned in tumultuous markets over the past two years. Further uncertainties over market restructuring have pushed many merchants to the brink of despair-and beyond.
But on June 10, 2003, a glimmer of hope appeared at the Federal Energy Regulatory Commission (FERC), and it came from an unexpected source: Entergy Services Inc., the holding company for Entergy's regulated utilities.
Entergy's petition proposes to change the way the company sources its week-ahead power supplies so that its own plants would compete fairly against wholesale power merchants.
Entergy's petition barely showed up on the radar screens of industry watchers, but it represents a shot over the bow of the industry's established economic-dispatch processes.
Utilities have been dispatching their supply resources on an economic basis for decades. But they have typically included only their own plants or generation sources under contract. In most cases, economic dispatch processes have not considered merchant plants that might be able to supply power more economically.
If granted by FERC, Entergy's order could serve as a catalyst to reformulate the industry's venerated economic-dispatch protocols. And now might be just the right time for such a catalyst. Re-cent noises on Capitol Hill suggest that legislators and regulators will be receptive to the idea of expanding the definition of economic dispatch.
Creole Controversy
Entergy has been feeling the heat lately, and it has nothing to do with Loui-siana's steamy climate.
In the wake of a controversy over Entergy's power procurement practices, the Louisiana Public Service Commission (PSC) has been undertaking a study to examine the way Entergy plans and deploys supply resources. The PSC launched the examination after Entergy sought to conceal the results of its recent competitive bidding program, even after the utility selected its own affiliates as the winning bidders.
At about the same time, a study published by the Louisiana State University Center for Energy Studies as-serted that Entergy customers could save $825 million in 2003, and $926 million in 2006, if merchant plants began to displace Entergy's older units (see Figure 1).
Moreover, the study suggested that the status quo in Entergy's service territory deters merchant plant investments. "Incumbent utilities' investments in generation can provide a powerful economic incentive to operate their monopoly transmission systems to favor their own utility affiliated generation, and to discriminate against non-affiliated generators," the report said.
For its part, Entergy argues that it has bent over backward to bring merchant generation into the mix. (The company declined to comment for this story, citing the fact that its petition is still being processed.) Nevertheless, Entergy's petition proposes to establish a process under which third-party power supplies will compete against Entergy's own non-nuclear generation sources to supply the utility's native load on a week-ahead basis. Furthermore, Entergy would move weekly procurement decisions from its regulated wholesale merchant function to its transmission function, and would establish "independent oversight" of the process.
Entergy is advancing this proposal as an interim solution, rather than a complete answer to market structure questions. "The proposal in this petition is not a substitute for an RTO [regional transmission organization] and is not intended to replicate the SeTrans market proposal," Entergy's petition stated. "However, one benefit of the changes being proposed here is that they will serve as a first step toward such markets in the Entergy area."
Merchant players certainly welcome such steps, and they agree that their plants should be considered in utilities' economic dispatch processes. But they might greet Entergy's petition with a degree of caution.
"How much time will be spent on an interim proposal like Entergy's when your real goal is to get SeTrans running?" asks Julie Simon, vice president of policy at the Electric Power Supply Association in Washington, D.C. "If this becomes a red herring that forestalls SeTrans even more, it's not a good deal."
Glass Half Full
The merchant power industry is understandably frustrated by the continued state of uncertainty over market structure. "According to Order 2000 we were supposed to have RTOs by December 2001," Simon says. "Regulatory milestones have been missed that have had a huge impact on the industry's business model."
However, this same state of uncertainty-especially given the apparent demise of FERC's standard market design (SMD) efforts-is driving some merchant players to seek incremental improvements rather than all-or-nothing solutions.
"Whether the SMD moves forward or not, there are features that could be implemented in other ways that would give you 80 percent of the benefits of SMD," says Jolly Haydn, vice president of transmission operations for Calpine. "It may be easier for individual elements to gain traction than it is for the complete package."
Expanding the definition of economic dispatch is one such element, and indeed the idea is gaining traction in policy circles. In a March 5 House Energy subcommittee hearing, FERC Commissioner Nora Mead Brownell suggested that RTOs could be tasked with the economic dispatch function. "RTOs can perform economic dispatch over large geographic areas that will ensure the selection of least-cost generators," she said.
The House's omnibus energy bill includes an amendment by Rep. John Shimkus, R-Ill., ordering a study to analyze the benefits of including non-utility generation resources in economic dispatch procedures and to recommend a policy response. (Shimkus also had offered a more aggressive amendment that would have mandated regional economic dispatch, but he withdrew it during the bill's markup.)
At press time, the House energy bill faced an uncertain fate in the Senate. Nevertheless, proponents of expanded economic dispatch are encouraged by these policy trends.
"For it to be included in legislation shows that there's a much greater degree of interest in the subject than there was previously," says Larry Eisenstat, a partner with Dickstein, Shapiro, Morin & Oshinsky in Washington, D.C. "As people get to know the issue, they get more interested because they see it's a win-win. There's a way for utilities to be made whole, for ratepayers to get a better deal, and for the merchant sector to market some of its capacity."
Precisely how a redefined economic dispatch process will look, however, remains uncertain. Some proponents argue that utilities should actually earn a return on purchased power, to the degree it displaces aging units that would be retired in a truly competitive market.
"Utilities are rewarded for their asset base. They are incentivized to throw money at aging units when there are newer options out there that make more sense," Haydn says. "If we had a real market, we would start to see rational behavior where inefficient producers would either shape up or ship out. But utilities don't get a return on equity from a power purchase agreement."
Allowing utilities to earn a return on purchased power that replaces aging units could eliminate the incentive to continue using power from less efficient and dirtier plants. Furthermore, expanding the definition of economic dispatch could be part of a broader process of updating ratemaking procedures to bring them in step with today's market conditions, according to Michael Zimmer, international partner with Baker & McKenzie in Washington, D.C. An updated approach to ratemaking would consider not only costs and market conditions, but also fuel, environmental, and security issues.
"There are perverse incentives under the old regulatory paradigm," Zimmer says. "In some instances, utilities have not filed rate cases for three to 10 years. Their rates do not reflect market realities, and they have an incentive to stay out of the commission."
In any case, while issues involving ratemaking treatment and stranded assets might prove challenging, the simple logic of expanding economic dispatch processes is difficult to fault. Now, if the industry and its regulators can accept the notion of interim measures on the road to market reform, expanded economic dispatch seems like a bankable policy trend for the near term.
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