What are the essential characteristics of the system of governance that will be required for a new, North American electric industry with interconnected and interdependent transmission networks and trading areas?
Electric transmission networks are natural monopolies, as are the many independent network
control systems that coordinate the use of generators and loads and preserve system reliability. The organizations and assets necessary for the efficient exploitation of these natural monopolies are not likely to arise through the actions of rival firms.
Today we contemplate how to create organizations and rules that will permit unregulated, profit-maximizing generators in three nations to trade with users and distribution companies across complex transmission networks. Yet there exists no single governmental agency (or coalition of agencies) vested with the regulatory powers necessary to ensure the efficient planning, construction, and operation of transmission networks. Nor has such an agency existed in the past, ever since electric utilities first interconnected their systems across state lines.
The Electric Industry:
A History of Diversity
The absence of any suitable regulatory agency to take over the task of governance for the new electric industry stems from the historical development of individual companies and patterns of ownership.
Table 1 describes the diversity of the U. S. component of the North American electric industry. Although about 250 investor-owned utilities (IOUs) produce about 76 percent of all power produced for sale in the United States, the industry is composed of over 3,000 electric utilities.1 That diversity has been recognized in the current industry governance system and must continue to be recognized. In fact, persuasive arguments show that competition will increase diversity rather than reduce it.
In the 1930s, while the federal government was moving to
reverse the erosion of powers of the state public utility commissions (PUCs) over the IOUs by creating a complementary system of federal regulation, it was also expanding the role of federally owned (FOUs), publicly owned (POUs) and customer-owned (COUs) systems. Table 1 demonstrates current results. Since economic regulation was seen largely as a device for holding prices down rather than as gaining
efficient prices, PUC-type regulation was not imposed on FOUs, and seldom imposed on POUs.2 The Tennessee Valley Authority (TVA) was defined to be its own regulatory agency, and the power marketing agencies (PMAs) were executive branch agencies. The rural electric co-ops were regulated, but only lightly so, by the Rural Electrification Administration of the U. S. Department of Agriculture. Some state PUCs exercised limited jurisdiction over municipal and/or COUs in their state.
Since the TVA, the PMAs and the generation and transmission companies created by POUs and COUs built transmission lines for their own needs, and interconnected those lines with IOU transmission lines, transmission networks became economic entities that no government regulator (and no possible coalition of government regulators) had authority to oversee. The networks grew incrementally as pairs of utilities interconnected for their mutual
interests. The era following World War II saw an ever-growing number of utility interconnections. Not surprisingly, many of these interconnections connected IOUs and/or FOUs and/or COUs and/or POUs in different states and across the U.S./Canadian border, and later across the U.S./Mexican border.
Three logical consequences evolved from such interconnections: 1) a need for system standards and regulations for the interconnected utilities, 2) opportunities for power trades among utilities, and 3) opportunities for the growth of power pooling.3 Clearly, some regulatory organization, either government or private, was needed to ensure that the pieces of the industry fit together to make an efficient and reliable whole.
The Reliability Councils
The historical solution adopted by the industry, and acquiesced to by government regulators, took the form of self regulation by industry cooperating committees, later formalized in nine Regional Reliability Councils (RRCs) with a coordinating agency, the North American Electric Reliability Council (NERC). Events following the Great Northeast Blackout of 1965 solidified and firmly legitimized these nongovernment "regulatory agencies." The principal task of NERC and its nine RRCs is to ensure reliable and efficient operation of the networks by imposing "rules of the road" on the interconnected and interdependent control areas. NERC and RCC committees provide utilities with organizations through which they coordinate operations and planning.
These government-sanctioned, but "voluntary," organizations of utilities (including foreign and domestic FOUs, POUs, COUs, and IOUs) make up major components of the U.S., Canadian, and Mexican regulatory systems. Their self-created charters allow them to ignore, when convenient, legal forms of ownership and state and national boundaries. In fact, it is these regulators that consumers depend upon to keep the lights on, since government regulators, under current allocations of
responsibilities, have neither the power nor the competence to define and enforce rules necessary to ensure reliability of the system. At best they can help enforce the rules created by these "voluntary organizations."
The industry structure that has permitted the North American industry to work as well as it has was one of cooperating, vertically integrated utilities. This system was dominated by the vertically integrated IOUs. Those utilities, such as COUs engaged only in the distribution business and FOUs engaged only in the generation business, developed vertical integration through relatively long-term contracts that preserved the monopoly powers of the various firms in the system. While some of these firms (em municipal and cooperative utilities in particular (em supported competition between IOUs in the sale of power, all these firms agreed that the protection of their own monopoly powers was desirable. Since government regulators generally agreed that it was important to preserve existing monopolies, the system was permitted to function subject to the constraint that the powers of government regulators to control price and terms of service to users were not noticeably diminished.
With the development of wholesale markets, however, both vertical integration and the legitimacy of the generation monopoly become eroded. Enter the problem of governance.
The inherited governance system does not appear sustainable in a restructured industry with competitive generation dominated by nonutility generators (NUGs). Even competition among IOUs, which have dominated the old system, has undermined cohesion among utilities and the legitimacy of their decisions. Clearly, the North American industry cannot assume that the governance system and the system of self regulation that worked in the past will work in the restructured industry.
The industry needs a new regulator or set of regulators and a new governance system for the two natural monopolies that are truly interstate and international in character, the Eastern and Western Interconnections. Equally clearly, that new regulator cannot be the Federal Energy Regulatory Commission (FERC): The FERC's jurisdiction, although extended for some purposes to all transmitting utilities in the Energy Policy Act of 1992, does not extend to control over planning and building
transmission assets for U.S. utilities, and it clearly does not extend to Canadian and Mexican utilities that are included in the Eastern or Western Interconnections. Similarly, the Canadian National Energy Board and the Mexican Regulatory Commission for the Power Sector enjoy only limited areas of jurisdiction. If a government agency is to fulfill the governance role, it must be some partnership of all three, with the FERC's responsibilities expanded by legislation. More likely, a new form of self regulation needs to be developed. Existing reliability organizations will almost certainly be the foundation of the new structure.
To get a new regulatory and governance approach, the nation needs leadership. The FERC and the PUCs, by inherited position at this time in history, are in better positions than anyone else to provide that leadership to
Congress and to the nation.
Leadership in this context means facilitators of debate. The FERC's Mega-NOPR, the California PUC's "Blue Book" orders, and the many proceedings underway in state PUCs offer encouraging examples of such leadership. Almost universally, however, these proceedings focus on the question of how to organize a trading area. Only the FERC, in its proposals for regional transmission groups (RTGs), has addressed the need for a reformed system of governance for an interconnected industry. But for reasons discussed below, that initiative has produced, and will likely continue to produce, disappointing results.
Points of Agreement
The debates over the desired economic structure for trading within a single control area reveal many areas of agreement. No one, to my knowledge, has yet articulated a detailed proposal for operating an extensively interconnected network containing many interconnected PoolCos or many Bilateral Trading Areas or some PoolCos and some Bilateral Trading Areas. The areas of agreement of the proponents are, however, worth examining.
Proponents of PoolCo and bilateral trading models both agree on these points:
1. Transmission and distribution remain natural monopolies and must be regulated.
2. There are no significant economies of scale in generation that cannot be exploited by
competitive generators operating within an extensive transmission network (em if the network provides all necessary services. This big "if" marks the heart of the governance debate.
3. Unless a single control area exhausts the interconnection, there will be trading between control areas and there will be inadvertent power imports and exports into and from each control area.4
4. The task of coordinating use of the transmission system(s) remains a natural monopoly.
5. Competitive power markets will be furthered substantially by an independent system operator (ISO) that coordinates grid operations and preserves reliability. This ISO will be a regulated firm and will need great powers to act in emergencies, but it must also respect private property rights and competitive market positions to the extent possible. In particular, the ISO must owe no special loyalty to any subset of generators, distribution companies, or users. Its primary loyalty must lie with the operating rules and standards essential for preserving system reliability, on which a competitive power market will depend.
6. Interdependent ISOs will be required to cooperate with one another to preserve the reliability of the system, and to facilitate trades.
7. Interconnected ISOs will coordinate and cooperate under a set of objective rules that specifies their reciprocal obligations.
8. Creating new control systems for a competitive generating
sector, and redefining ownership rights in transmission lines and the rights and obligations of unregulated generators to complement a competitive generating sector, must all be accomplished before the full forces of competition are unleashed.
In recapitulation, the industry must preserve those elements critical to the exercise of discretion by network controllers, to the extent necessary to pursue subordinate goals viewed as necessary to ensure reliability. In the past, the range of discretion of controllers (i.e., their abilities to dictate generating outputs and to refuse to meet demands for transmission services) was legitimized by the public utilities immediately involved, acting through their RRC and NERC. As new players enter the industry, the discretion of controllers will likely need explicit approval from the FERC and/or Canadian and Mexican regulators.5 Price and access terms negotiated by buyers and sellers should not deter the preservation and legitimization of controller discretion necessary to preserve system reliability.6
The system in the future, as the system today, will, of technological necessity, be one in which ISOs with obligations to serve can satisfy that obligation with a reasonable degree of efficiency only with the help of neighboring ISOs. Efficiency and reliability in the electric industry demand the preservation and protection of cooperative organizations centered around NERC, or a replacement organization, until better ones can be devised. The "better ones" will probably coordinate regional transmission corporations, each one large enough to encompass all but the largest regional reliability council areas.7
RTGs: The New Source
The FERC's RTG proposal currently offers the "only game in town" for creating the needed governance systems for interconnected networks. Nevertheless, some criticism is warranted.
I endorsed the RTG initiative as useful when the FERC proposed it, and I still think the debate has proved constructive and educational. However, events during the last few years have persuaded me that the RTG effort will not end up sufficient to produce needed reforms. A new proposal is needed.
When circumstances are confused and objectives unclear, logic suggests creating a group representing all stakeholders. The FERC, behaving as a good regulator in the confused circumstances of early restructuring efforts, responded by encouraging the creation of RTGs. In contrast, when the problem is reasonably well understood and objectives are generally agreed upon, it is time to create an institution that can act and can be held accountable to national regulators for failures to act in a timely manner, including failures to plan properly or to anticipate unplanned incidents and prepare for them
with Network Size
Large transmission networks, such as the Eastern and Western Interconnections, may require several different control centers that serve generators, distributors and end users. However, neither control centers nor the governing body of an interconnection is likely to be able to legitimize the rules, fines, and penalties needed to permit such interdependent control areas to perform efficiently and reliably. Instead, both types of organizations must look to regulator(s) to provide forums in which all relevant interests can make their preference known and to make enforceable decisions.
By identifying interactions between control centers and the interests they serve, and shifting the focus on those interactions to the regulatory agency, the regulator can ensure that lines of authority and responsibility are clear. In particular, the regulator can make it unmistakably clear that the regulated monopolist remains fully responsible for ensuring efficient and reliable outcomes.
When regulators cannot design detailed pricing rules for efficient use of networks, they have gathered such networks into a single legal entity and have imposed clear responsibilities for efficient planning and operation. In the electric industry, this solution involves creating large regional transmission company monopolies (TransCos). If that can be done, the functions of the RRCs can be incorporated in the legal entity, and the NERC function can be
incorporated in a "voluntary" association of regional TransCos.
The principal advantage to this approach is that such an umbrella organization can make decisions (em decisions that might be reviewed in customary regulatory proceedings at a later date. Such an organization would not need to involve all stakeholders directly involved in the formulation of detailed operating rules.
Given the urgency of creating governance systems for electric interconnections, I believe the FERC can and should "coach" such organizations into existence. Any
successful coaching must recognize that transmission assets, when made a part of a larger regional TransCo, are "worth more" than when owned by a small firm, and must assure the parties that the FERC will recognize that increase in value when transmission assets are so transferred or merged. t
Charles Stalon works as a consultant in energy regulation out of Cape Girardeau, MO. He served as a Commissioner on the Federal Energy Regulatory Commission from 1984-90, and before that on the Illinois Commerce Commission.
Rules vs. Laissez-Faire
The idea that markets arise spontaneously in a free society and yield just and efficient results finds only modest support in history, restricted generally to 19th century European economists (and perhaps the U.S. during the 1980s).
Instead, the British and American traditions have insisted that a market system, like other social institutions and society itself, must be viewed as an artifact. This Anglo-American view finds support from Lionel Robbins, writing in his 1952 study. The Theory of Economic Policy in English Classical Political Economy;*
[A system of economic freedom] can only come into being if [things] are not left to take their course, if a conscious effort is made to create the highly artificial environment which is necessary if it is to function properly.
The invisible hand which guides men to promote ends which were no part of their intentions, is not the hand of some god or some natural agency independent of human effort, it is the hand of the lawgiver, the hand which withdraws from the sphere of the pursuit of self-interest those possibilities which do not harmonize with the public good.
*Macmillan & Co. Ltd., London, 1965, p. 56. See also, page 57, "But the fact that a mechanism is artificial dos not mean that it can be made to do anything. A steam engine is artificial; but its workings [are] still governed by the facts of its construction. And it was the central contention of the Classical Economist that, when the market conformed to the conditions which they postulated, then interference with its working was harmful and self-frustating."
1. Actual control of the IOU sector of the industry is more centralized than the number 254 suggests: some, perhaps 50, of these firms are nontraditional utilities, that is, independent power producers, and of the remaining, nearly one-quarter are subsidiaries of nine registered holding companies regulated under the Public Utility Holding Company Act of 1935.
2. Some state PUCs have some jurisdiction over some POUs.
3. When utilities form a group to examine their joint needs and resources and agree to operate and plan their systems for the best combined economy and reliability, they may be considered by "pooling" their resources and such a group is often referred to as a "power pool." See, FERC, Power Pooling in the United States, op. cit. p. 2.
4. Economic efficiency demands that there be only a single price at each point in space in each trading period (em e.g., every half hour (em and that the difference in price between any two points in space in a trading period should not exceed the cost of moving power from one point to the other. PoolCo proponents insist that with locational pricing that recognizes transmission congestion, both of these efficiency conditions will be satisfied for all points in the control area. Proponents of bilateral trading models, while not as explicit in their analysis, tend to build on analogies with the current North American natural gas industry, they assert that privately created markets will arise that will satisfy all conditions for efficiency. To my knowledge, their emphasis has also been on single control areas.
5. Government authority will prove especially important if the ISO or a nongovernmental industry governance agency is given authority to impose fines on generators (and perhaps distribution companies and users) for performance deficiencies.
6. Compare: "The control area load dispatchers are charged with maintaining the viability of the grid. In emergencies, they may have to take drastic steps on only a moment's notice. In that event, they should not have to worry about possible lawsuits. Time is short and there should be no hesitation when the grid is threatened. Hence, contract language should be drafted to give those utilities that are responsible for the grid, and their load dispatchers, full authority to direct emergency operations, and to indemnify them against damage claims resulting from emergency actions taken in good faith to ensure the integrity of the grid. Gordon Corey, "Some Observations on the Bulk Poewr Markets in the United States," Public Utilities Fortnightly, Sept. 14, 1989, p. 25, and Sept. 28, 1989, p. 12.
7. To preserve cooperation among such regional transmission corporations, the NERC, or a replacement organization that can fulfill the needed role, will remain essential.
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