The sound and fury over trading scandals, credit defaults, and market manipulation so far has drowned out much of the mind-numbing debate over a standard market design (SMD), and rightly so. Utilities understand (as does the press) that Enron, "Deathstar," and "Get Shorty" will always sell more newspapers than locational pricing or congestion management.
But the day of reckoning is upon us. The time has come to get back to basics. With the deadline now passed for filing initial comments with the FERC, the power industry once and for all must put up or shut up on SMD.
Up till now, FERC's initiative has left utilities, merchants, and regulators completely polarized. Some states still welcome competitive markets, but many others do not. Meanwhile, the experts warn that the two sides must cooperate-or risk doing even more damage to the industry's already dismal financial standing.
One only need recall regulated utilities Nevada Power or Avista, which experienced their own problems as a result of the California crisis, to make the point that malfunctioning "wholesale" markets affect regulated as well as unregulated utilities.
In a joint statement, David A. Svanda, NARUC president-elect, and EEI Chairman Erroll B. Davis Jr., summarized the challenges ahead and the need for standard markets.
"The current market turbulence presents a very real and tangible threat to the viability of the industry and the reliability of the nation's electric system. … Investors and customers lack confidence in the financial health of energy providers. Bulk power markets are listless, liquidity has evaporated and the movement to retail competition remains in transition.
"A potential path to create certainty lies in crafting a clear set of rules governing wholesale electricity markets. Properly designed and implemented, such a framework could send reassuring signals to investors and other stakeholders by providing a greater degree of regulatory certainty. A properly designed wholesale market could also help revitalize flagging energy markets and bring liquidity back to the sector."
Svanda and Davis propose a middle ground that some regulators have been seeking, namely that FERC develop rules that take into account regional differences and not impose a one-size-fits-all template across all regions in the United States.
Harvard professor William Hogan insists that states bent on old-style regulation should have nothing to fear from the SMD. He elaborated in comments he filed at FERC on Nov. 11, with colleague John D. Chandley, from the consulting firm LECG:
"With the core SMD feature in place, regions that have undergone restructuring and retail choice will have the necessary foundation. Other states could continue to operate much as they have in the past, with a mix of utility ownership of generation, long-term contracts and closed retails markets.
"The Independent Transmission Provider (ITP), unbiased grid operations and open spot markets would support all of these options, while eliminating the system of closed and discriminatory access to the transmission grid. Claims that the NOPR [notice of proposed rulemaking] would undermine traditional state utility regulation and the ability of state regulators to affect retail rates thus fundamentally misinterpret what the NOPR proposes and the commission intends," Hogan and Chandley write.
Furthermore, they say, "The NOPR correctly acknowledges that load-serving entities that purchase energy from the spot markets will probably pay aggregate prices composed of the load-weighted average of the nodal LMP [locational marginal pricing] process for a region. Given the experience in the East, the most likely aggregation is by utility service area, as defined by state regulators. … An LMP-based system created the opportunity for state and local regulators to improve the efficiency of rate design and enhance the ability of LSEs and retail customers to invest in demand-side responses."
As academics, Hogan and Chandley echo the ideas of regulators Svanda and Davis, who call for industry action:
"The commission must move forward with the core elements of SMD. The electricity system requires an ITP's visible but unbiased hand to coordinate the markets and assure reliability. Equally important, the present condition of the industry and the pervasive uncertainty this creates for investors require firm resolve to put the critical institutions in place at the earliest practical date."
Consider the views of Frank A. Wolak, professor of economics at Stanford University, who spoke before the Senate Committee on Governmental Affairs in early November. In his comments, he shows the need for Congress to reaffirm and clearly define FERC authority over wholesale markets.
Wolak believes the Western power crisis grew directly out of conflict between FERC and the state of California over the appropriate regulatory response to the extremely high wholesale prices in the summer and autumn of 2000.
He says the regulatory conflict does not appear to be over whether wholesale prices in California were illegal under the Federal Power Act. "Instead, the ultimate regulatory conflict that led to the California crisis appears to be over the appropriate remedy for these unjust and unreasonable prices," Wolak says.
Furthermore, FERC's perspectives on wholesale prices suggest a logical inconsistency, he says.
"In both statements and in its orders, FERC has stated that it is important to find the bad actors and punish them for causing unjust and unreasonable prices. While it is important to find market participants that violated market rules … these statements by FERC seem to suggest that bad behavior on the part of a market participant is necessary for unjust and unreasonable prices worthy of refunds to occur. However … the Federal Power Act does not specify that prices must be the result of malicious behavior by a market participant for a wholesale market to produce unjust and unreasonable prices.
"The Federal Power Act only requires that if FERC determines that the prices are unjust and unreasonable, regardless of the cause, then it must take actions to set just and reasonable prices and it must order refunds for any payments in excess of just and reasonable levels," he says.
Back in early November, FERC Chairman Pat Wood told a Senate committee that Congress should expand FERC's penalty authority.
"Congress could create stronger deterrents to anti-competitive behavior, market manipulation, and other violations of the FPA and Natural Gas Act, by adding or increasing civil and criminal penalty authority under the statutes."
This may not go as far as Wolak might want, but it definitely will help. Of course, confidence in the industry was certainly bolstered by the mid-term elections.
Recently, Steve Fleishman of Merrill Lynch wrote that the 2002 election results were "constructive" for a "badly beaten" utilities sector. He added that "a Republican-led Congress raises the possibility of a revived energy bill next year." Fleishman hopes for a repeal next year of the Public Utility Holding Company Act, as well as the elimination of double taxation of corporate dividends.
It appears 2003 may hold many of the answers for an industry with many questions about its future. I am looking forward to seeing how it all falls into place.
Happy holidays from all of us at the Fortnightly.
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