The ISO takes on critics of its new market design.
Electricity market design is a complex, even arcane, subject-which is why any discussion of the makings of a new market structure should focus on substance, rather than sound bite material. The California Independent System Operator Corp. (California ISO) was disappointed to read what appeared to be a narrow view of the state of market redesign in the August 2002 article "A Vision for Transmission: How the RTOs Stand on Market Design." It told a one-sided story. The article let readers down by neglecting to assess the validity of critical comments selected for quotation by the authors. As a result, the article left readers with a distorted impression of our comprehensive Market Design 2002 (MD02) proposal filed with the Federal Energy Regulatory Commission (FERC) in May and approved to a large extent by the FERC order of July 17.
Many of the allegations in the article focused on price mitigation tools. Those measures, we believe, are necessary with the approaching expiration of the existing FERC-established West-wide price mitigation. Until the benefits of the long-term market redesign-accurate and consistent price signals that result in needed infrastructure investment-are realized, the mitigation tools are essential. It is important to note the level and magnitude of the price mitigation measures will moderate as the market becomes more stable and competitive. Thus, the article completely fails to distinguish where we are from where we are going.
Big Three Fallacies
One fallacy promulgated by the article is that MD02 is not very different from the ISO's original design. It appeared the authors quoted comments filed with FERC on our MD02, but did not include the ISO's response to FERC regarding those very comments. Case in point, one comment included in the article was that "MD02 … offers only incremental change … rather than a fundamental rethinking of what has been proven to be a fatally flawed system." Nothing could be further from the truth. The executive summary of the Comprehensive Design Proposal, which the ISO filed with FERC on May 1, describes several key design elements that depart dramatically from California's original design, including:
- Integrated day-ahead and hour-ahead spot markets that optimally clear energy trades, procure ancillary services, commit supply resources, and manage congestion. The original design placed day-ahead and hour-ahead energy trading and unit commitment completely outside the ISO, requiring sequential ancillary services procurement after energy trading was completed by the Power Exchange and other scheduling coordinators (SCs). MD02 overhauls the original design by eliminating the often criticized "market separation rule" that prevented the ISO from executing energy trades (i.e., moves from a completely "decentralized" approach to a more "centralized" energy and ancillary services marketplace). This approach is completely consistent with FERC's recently released Notice of Proposed Rulemaking (NOPR) regarding a standardized wholesale market design (SMD NOPR).
- Locational Marginal Pricing (LMP or nodal) in the forward and real-time markets based on an accurate model of the grid. The original design used a three-zone model that ignored "intra-zonal" constraints and allowed SCs to establish schedules that could not be delivered in real time, leading to inaccurate congestion pricing, congestion gaming, and real-time operating challenges. Under MD02, transmission capacity will be allocated and priced consistently across all ISO market time frames. The resulting prices will reflect the value of energy at each node, will correctly charge grid users for their impact on congestion, and will send accurate locational price signals for demand response and new generator siting. In conjunction with LMP, the ISO's proposal completely overhauls the design of firm transmission rights (FTRs) to a design that is fully compatible with nodal pricing. Once again, the ISO's LMP pricing and associated FTR proposals are perfectly aligned with FERC's SMD NOPR.
- An available capacity (ACAP) obligation on load serving entities. When the restructured market began in California, no entity had the responsibility to make sure that adequate supply resources would be available to meet load requirements. What was known in the pre-restructuring world as the "obligation to serve" was softened to an obligation to procure energy in the spot markets of the Power Exchange, with the belief that these markets would provide adequate supplies at reasonable prices. This huge exposure to spot markets turned out to be a fatal flaw. With ACAP, the ISO directly addresses this flaw by sending strong incentives for forward contracting and minimal reliance on spot markets. Recognizing the need for such measures to ensure reliable grid operation and long-term resource adequacy, FERC proposes a similar mechanism in the SMD NOPR.
A second major fallacy of the article is that MD02 differs dramatically from the successful market designs of the northeast. The authors quote a comment from the Independent Energy Producers Association, "Given the relative success of markets such as PJM and NYISO … IEP is wary of proposals that California blaze new and untested trails." In truth, the ISO's MD02 team carefully studied the eastern market designs, which are the basis for FERC's SMD NOPR, and followed them quite closely in developing MD02. MD02 embodies most, if not all, the key features of these other ISOs and of the SMD, including:
- Integrated forward optimization of energy, ancillary services, unit commitment and congestion management, as described above;
- Residual unit commitment (RUC), which enables the ISO to issue unit commitment instructions when there is a significant gap between the supply scheduled in the day-ahead market and the ISO's forecast load for the next day;
- LMP or nodal pricing in all ISO markets, as described above;
- Capacity obligations on load-serving entities, as described above (admittedly the ISO's ACAP proposal has some distinguishing features when compared to eastern models, but this aspect of market design is not fully resolved anywhere, and the eastern ISOs are still working among themselves to arrive at the optimal model for capacity obligations);
- Point-to-point FTRs, which go hand-in-hand with LMP;
- Allocation of FTRs to native loads, to mitigate their risk of high congestion costs; and
- Market power mitigation provisions that are approved for other ISOs, including damage control bid cap, local market power mitigation, and automated mitigation procedures (AMP).
All of the items above-which constitute the core of the MD02 design-are consistent with the designs of other successful ISOs and with the SMD.
A third fallacy is that MD02 abandons markets in favor of central control. The authors quote Williams Energy: "… the politically motivated ISO is seeking a full return to heavy-handed command and control regulation …" Patently false, unless Williams would assert that the eastern ISOs and the SMD are also "heavy-handed command and control regulation." Of course, in contrast to the ISO's original design, MD02 provides stronger incentives for behavior that supports reliable grid operation and stable markets, and better tools for the ISO to take corrective action when needed. Such measures are necessary to correct the "fatally flawed system" pointed out in another critical comment quoted above.
Budget and the GMC
The California ISO also takes great exception to many of the assertions in the article regarding the ISO's budget and grid management charge (GMC), which funds the budget. Nowhere in the article was it mentioned that actual ISO spending has declined. For 2002, the combined anticipated operations and management and capital budgets total $199.5 million, down from $209.5 million in 2001. While this does not include all items that comprise the ISO's revenue requirement, it does show that for the areas of spending over which the ISO has principal control, spending is down dramatically. Indeed, contrary to the alleged rancor reported by the article over the 2002 GMC case, the ISO recently has reached a settlement in principle with all parties in the GMC case. Constructive criticism of the GMC is expected and is appreciated by the ISO, and that is why the proposed budget is released for public comment before it goes to the FERC for review.
Regarding the headcount at the California ISO, also absent in the article was any mention of the breadth of responsibilities placed upon the ISO. In sharp contrast to the eastern ISOs and the historical central pools from which they evolved, the ISO has been asked since inception to develop, implement and evolve complex market and operational protocols that did not previously exist. Moreover, as noted below, with the onset of the 2000-2001 electricity crisis, the ISO has been forced to address, and be the primary source of information regarding, numerous federal and state investigations into the conduct of the market and market participants. Despite this onslaught of increased activity, the ISO has focused on reducing expenses. For example, over the past year the ISO has engaged in an aggressive contractor conversion effort. This has resulted in reduced employee expenditures-savings that come from transitioning the contractors, who performed much of the initial work at the ISO, to full-time permanent employees. At least half of the ISO's headcount growth from 2000 to 2002 has been related to these contractor conversions, which save an estimated $10,000 per position.
The complaint that the ISO is collecting too much revenue via the GMC is fundamentally incorrect. The ISO is a not-for-profit entity and has no incentive to overstate its revenue requirement. Any over collections do not go to shareholders-they are applied as a credit toward the following year's rates. In fact, what the ISO has been encountering this past year is under collection. For example, permitting and encouraging self-provision of ancillary services, combined with the reduced reliance on the spot energy market, has resulted in reduced volumes to support the costs associated with one of the three major GMC service categories. To this end, we will be revisiting the ISO's rate structure later this year and expect to have a revised rate structure in place for 2004.
While volumes may decline, the ISO is being asked to deliver more services and be more of an information clearinghouse than ever contemplated. Extraordinary costs related to litigation and crisis response add up to at least 11 percent of ISO spending in 2001 and 2002. These include the costs associated with arguing the California refund case before FERC, and also the cost of monitoring and responding to market power abuse. The ISO looks forward to the day when these costs can be reduced or eliminated. Meanwhile, the ISO is keeping the lights on and keeping a tight lid on spending.
In short, the California ISO is creating a fair and level playing field in the market, while managing costs that are fair to all parties and approved by FERC. The average monthly residential utility bill in California is about $76. The ISO's costs account for less than half of one percent of that typical bill, or about 50 cents. Services rendered by the California ISO should be considered a bargain-not a burden.
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