The debate over the merits of pool-based markets as opposed to reliance on bilateral transactions and the invisible hand of competition began without much care taken to define the details of the bilateral alternative. On closer examination, however, we find the two approaches have much in common, being more like different pews than different churches. A further debate that emphasizes only the few differences would not inform so much as distract from solving the common problems. We should put the debate to rest and move on.
The organization of the pool-based wholesale market can be found in a number of variants that differ across countries. What the several "PoolCo" variants have in common is the ability to simplify the development of bilateral transactions. An efficient PoolCo needs and aids in the development of a bilateral contract market. The PoolCo model assumes that virtually everything that happens in the competitive market happens through commercial bilateral markets, including virtually all investment decisions for new load, generation, and transmission facilities. The exception and the focus of the PoolCo is in the coordination of physical delivery and pricing of the associated services, over the very short term, say on a half-hourly basis. The PoolCo operates only in the short-run to deal with system interactions and charge users for the real costs of using the system. The details of PoolCo operation and spot-market pricing can and should be designed to impose virtually no constraints on the terms and conditions of commercial arrangements in bilateral contracts. One reasonable test to apply to the design of the PoolCo could be that it would permit any economically efficient bilateral transaction.
Contrary to the presumption underlying the extreme version of the invisible hand model for electricity dispatch, the electric system with current technology requires the very visible hand of the system operator to manage the short-term power flows and associated dispatch. The basic pool functions will always be there, somewhere. A system coordinator or pool is required to support a competitive market. This insight derives from experience with the operation of competitive electricity markets in other countries. For example, Norway is often mentioned as having a system with a high use of bilateral contracts to execute the commercial activities of the market. However, despite the acknowledged importance of the contract and negotiated business agreements, Jan Moen, the Norwegian regulator, has explained in detail that "[t]he importance of effective pooling arrangements in a competitive [electric supply industry] cannot be overstated."1 The focus is not on short-term efficiency and a better dispatch; rather, the real value of the pool and the bid-based economic dispatch is in providing the various elements that facilitate bilateral contracts and would be hard to obtain in any other way.
The False Dichotomy
From this perspective, the debate over the choice of a market structure based on pools or bilateral contracts is misplaced and misleading. As the figure illustrates, there is no proposal for a competitive market with a mandatory pool. The existing tight power pools in the United States, such as the New England Power Pool (NEPOOL), should retain their most important features of coordination and dispatch, but will require modification of their participation and pricing rules to make them compatible with a competitive market. The actual PoolCo proposals envision voluntary participation with dispatch and pricing based on customer bids. Within this framework, a wide range of bilateral contracts can develop through contracts for differences that separate the financial instrument from product delivery.
Furthermore, under the PoolCo proposals, the use of special bids for which generators effectively declare certain plants as "must run" allows participants to create the same outcome as bilateral physical contracts that match certain plants with certain loads. Hence the PoolCo model permits both types of bilateral contracts in the wholesale market. The PoolCo provides open access to the transmission system and the power dispatch, leaving the independent operator to separate ownership from usage.
From the other direction and perspective, a strictly bilateral reliance on the invisible hand is not possible. After some initial confusion, the participants in the continuing analysis of the electricity market recognize that the characteristics of the electricity system require the continued existence of a system operator. The only issue is the scope of the system operator's functions. At a minimum, the system operator must coordinate the actions of the market participants (em to avoid violation of short-term system operating constraints (em and provide balancing services that ensure both load following and backup for uncontracted demand. To preserve a possible distinction from the PoolCo models, we might refer to the system operator functions under the rubric of an OpCo model.
Three Questions
These OpCo balancing functions require that the system operator have operational control over a minimum number of flexible generating plants and loads. The precise minimum number is difficult to define (em views range from many to few. However, it may not be necessary to define the number, depending on how we answer three remaining questions about the nature of the services provided under the OpCo. We start with the nature of the balancing function. For the flexible plants and loads, the balancing function is a dispatch function. The only issue here is whether the OpCo should operate the flexible plants to achieve the lowest possible cost under an economic dispatch:
Should the system operator
be allowed to offer an
economic dispatch service
for some plants?
The alternative approach would be to define a set of administrative procedures and rules for system balancing that purposely ignore information about the costs of running particular plants. There are feasible options (em such as minimizing the use of the transmission wires (em that would preserve reliability and maintain system balance; however, the costs would be high. If we are to find an economic dispatch, then the argument runs that the system operator should be best suited to do it. Although there are minor differences between textbook definitions of natural monopoly, the common theme is that a single firm can provide the lowest total cost in serving a particular market. The economics (em the costs (em are essential: The distinctive characteristic of a natural monopoly is not the lack of an alternative to a monopoly, but rather that providing supply through a monopoly is the lowest-cost solution. The arguments underlying the PoolCo proposals stand squarely behind the proposition that economic dispatch is a natural monopoly. Therefore, the natural answer is that the OpCo should be able to consider costs and provide an economic dispatch for some plants and loads, at least those belonging to the flexible components that must exist at some minimum level.
Once the economic dispatch service is available for some plants, access rules must be established to determine who can participate. Hence, the second question about the role of the OpCo:
Should generators and customers be allowed to participate in the economic dispatch offered by the
system operator?
The arguments for the bilateral end of the market emphasize that the minimum number of flexible plants is a very small fraction of the total. The prediction may be that only the minimum number will participate. Or, the argument may imply that participation in the economic dispatch should be restricted to the smallest number of plants possible. However, the natural extension of open access and the principles of choice suggest that participation should be voluntary. With only the caveat that a minimum number of plants must be kept flexible, the principle should be that market participants can evaluate their own economic situation and make their own choice about participating in the OpCo economic dispatch or finding similar services elsewhere in the market.
Because the OpCo is a monopoly, it will be subject to some form of regulation, and its pricing rules a matter for public oversight. If the OpCo does consider costs and choose an economic dispatch for the flexible plants, there is an issue involved in setting the prices that will apply to the associated power flows. And these same prices will play a central role in defining comparable transmission tariffs for those who do not participate in the economic dispatch. Which brings us to the third question about the role of the OpCo:
Should the system operator apply marginal cost prices for power provided through the
dispatch?
The simplest conceptual approach would be to set an administrative price or penalty for the power obtained through the OpCo economic dispatch. If set too low, however, the price will be an incentive for participants to rely too much on the supply from the OpCo, constituting a subsidy that the OpCo may not be able to support. Set too high, the administrative price becomes a penalty that provides incentives to avoid
the economic dispatch and raise overall system costs. The alter-native of marginal cost pricing based on participant bids has obvious appeal. Under an economic dispatch for the flexible plants and loads, it is a straightforward matter to determine the locational marginal costs of additional power. These marginal costs are also the prices that would apply in the case of a perfect competitive market at equilibrium. In addition, these locational marginal cost prices provide a consistent foundation for the design of
a comparable transmission tariff for all uses of the transmission system.
I pose the three questions to isolate what is reasonably left to be decided under the OpCo variants that might be different than the PoolCo model. If the answers follow the recommendations here (em just say yes (em the OpCo will provide an economic dispatch service that is open to anyone who wishes to participate. Pricing will apply marginal cost principles based on the voluntary bids of the participants. And these same prices would apply to all uses of the transmission grid under a comparable, open-access transmission tariff. Bilateral contracts would be fully available. With this voluntary approach, the OpCo and PoolCo models almost merge. The only remaining difference between the two would be in the accounting for bilateral physical contracts. Under the OpCo model, the system operator would monitor individual contracts and check for individual contract imbalances that have to be met by other contracts or through the OpCo economic dispatch. Under the PoolCo model, the system operator would not monitor the contracts, and all bilateral transactions would be handled through separate contracts for differences and customer control of bids for specific generation and loads.
These contract accounting differences may be important, but they are small differences compared to the common problems that remain in implementing either the PoolCo or OpCo approach. Both must specify the terms and conditions of the pricing and access rules, develop procedures for bidding and nomination of transmission uses, define transmission rights and allocate the existing transmission system, provide new rules and procedures for making network infrastructure investments, negotiate new interconnection agreements that are compatible with the competitive market, and so on. The remaining choices have more common challenges than differences. Progress in defining a competitive wholesale market depends on progress in dealing with these common problems. t
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