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Sixty billion dollars in benefits. Less than $6 billion in costs. In any business, those numbers mean just one thing: you've got a winner.
For the electric industry, these numbers demonstrate what many of us have been saying all along-regional transmission organizations (RTOs) are a winner.
Indeed, the numbers are so one-sided you might be tempted to think the study that produced them was jury-rigged by an interested party. Were the Electric Power Supply Association (EPSA) to commission such a study, for example, results of this magnitude likely would be dismissed out of hand by many as little more than thinly veiled advocacy. However, this study was commissioned by the Federal Energy Regulatory Commission (FERC) last fall, and conducted by an independent firm of high repute, ICF Consulting.
There are caveats and cautions sprinkled throughout the 91-page study, the first attempt to quantify the nationwide costs and benefits of FERC's current transmission policy initiatives. But the conclusions are straightforward. "Substantial net benefits should result from the commission's policy," ICF says in the study's executive summary. "Once policy changes are fully in place, the results suggest that $1 billion to $10 billion per year in economic gains could result." Equally important, ICF concludes that there is "relatively little downside risk to the commission's policy." In other words, we can argue about the magnitude of the savings if we want, but we cannot argue about the merits of FERC's RTO policy.
The ICF study takes a careful, step-by-step look at a host of policy changes now pending at FERC, or likely to arise in the near future, and finds benefits to all of them for virtually everyone. More importantly, what the study really shows, although never explicitly acknowledged by the authors, is that comprehensive reform offers the greatest potential benefits-a point the competitive power supply industry has been arguing for years.
To start with, the study looked at what ICF calls a "transmission-only case," which combines several discrete benefits expected from the formation of RTOs into one scenario. The improvements included in this scenario are: the reduction of barriers to transmission traffic between regions, the expansion of transmission capability, an increase in inter-regional capacity sharing, and slightly lower reserve margins requirements.
Taken together, ICF says, these improvements will cut costs nationwide by an estimated $405 million annually beginning in 2004, rising to almost $1.3 billion annually in 2020. ICF calculates the net present value of the total savings expected from 2002-2020 at some $6.2 billion.
"The benefits in this case," ICF added, "are significant even though [the] assumptions are conservative."
ICF's second scenario, what it calls the RTO policy case, incorporates all of these transmission-specific changes plus an anticipated improvement in the overall cost-effectiveness of the generator segment following the introduction of RTOs nationwide. This seemingly small addition, which assumes a more efficient allocation of new and existing generating resources-as well as a resulting increase in competitive pressures among all generators-results in a significant increase in the expected savings. ICF estimates that annual savings will top $5 billion by 2010, and top out at almost $7.5 billion in 2020. Overall, the net present value of the savings expected from this policy scenario is just under $41 billion.
The significant difference in savings anticipated from the transmission-only scenario and the broader RTO policy case is almost certain to prompt some to argue that we should not worry about the transmission changes and just focus on improving generator performance. We beg to differ. Such a course would be doomed to fail since, without the transmission improvements, particularly the lowering of inter-regional trade barriers, there will continue to be limited improvement in generator performance.
Finally, ICF looks at what it calls a demand response case, which includes the previously mentioned transmission and generator changes, plus an assumption that consumers will see and be able to respond to real prices. The savings really add up in this case, with ICF projecting annual cost reductions of more than $4 billion by 2006, rising to $7.5 billion in 2010 and topping out at almost $10.4 billion in 2020. All told, the savings would total some $60 billion.
In anybody's book, those are real savings. But what is even more impressive is ICF's caveat following the discussion of those savings.
"The demand response case is not designed as an upper bound ... to the possible savings under a successful RTO policy implementation," ICF said. "All of the assumptions used in the scenario are based on earlier related analysis, or other existing information. ... Hence, [emphasis added] in a more competitive electricity market."
A "more competitive electricity market"-that is exactly our aim.
Another crucial finding in ICF's study is that prices will go down, and go down substantially, virtually across the board. There are a couple of areas where prices are actually expected to go up, but according to ICF, these increases "are generally small (a few percent at most) and diminish over time." The study also does not factor in state regulatory actions that could ameliorate any adverse impacts in pricing.
The firm also noted that it had not studied the so-called secondary benefits of increased inter-regional trading. The only reason prices will go up anywhere, ICF pointed out, is because regions with low-cost power will be better able to export power to neighboring high-cost areas. As such, the low-cost exporting regions "should also experience gains from trade in the form of increased export revenue and supplier earnings."
And while these limited regional impacts should not be dismissed, it also is clear from a national policy perspective that we cannot afford not to pursue the adoption of RTOs across the country. The national benefits simply are too large to be ignored.
EPSA has never taken a position on the specific number of RTOs that should be formed, concentrating instead on the battle simply to get RTOs on to the front burner at FERC. Still, common sense tells us that fewer, larger RTOs would be more beneficial than lots of additional "seams," and the ICF study bears this out.
To bracket its RTO policy case, which assumed there would be five transmission entities, ICF looked at a scenario where there were just three (the western and eastern interconnections and Texas), and one where there were 10. What ICF found is that "the scope and configuration of RTOs does make a difference in the potential economic benefits of RTO policy. Larger RTOs could reduce more barriers to inter-regional trade, leading to greater efficiency gains."
That said, the differences are not significant, and EPSA is much more concerned about getting RTOs in place than the exact number that ultimately are established. In this, we wholeheartedly agree with ICF's take on the RTO numbers issue: "In the analysis carried out here, it is more important to have well-functioning competitive markets than it is to have one specific RTO configuration, although fewer and larger RTOs do lead to the greatest potential benefits."
Equally important, the benefits of a switch to RTOs will begin showing up almost immediately because the expected start-up costs associated with these transmission entities are relatively low. According to ICF, they could be as low as $1 billion, and almost certainly would not be more than $6 billion.
"For the purposes of this study," ICF wrote, "the major observation is that even if start-up costs are at the high end of the range, they are essentially one-time costs that are netted out against the ongoing economic benefits of RTOs. Even a $5 billion initial cost would be rewarded after several years with economic gains that appear to justify the initial expense."
Taken together, the pieces of ICF's study present a convincing whole: RTOs are a crucial component, perhaps the crucial component, of a truly competitive electric power industry. It is time for the industry to stop arguing about whether RTOs make sense and begin working together to get them up and running.
We are not just losing time, we are losing money. Let's get moving.
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