Michigan Morass

Fortnightly Magazine - June 2011

Michigan is a curious case study for market deregulation, a complicated tangle of caveats and countermeasures. The state unbundled T&D, but left generation tied to retail operations. A 2008 law allowed alternative energy suppliers into the retail market, but capped their participation at 10 percent of the market (see “Changing the Game,” February 2010).

The cap was reached more than a year ago, and has only intensified the debate over retail competition in Michigan. On one side of the argument are the state’s principal IOUs, Detroit Edison and Consumers Energy, who lobbied hard for the cap. On the other, competitive retailers and large utility customers say the cap has only whetted the state’s appetite for competition.

Fortnightly spoke recently with former FERC Commissioner Bill Massey, who is now a partner at the law firm Covington & Burling. Massey is counsel to the COMPETE Coalition, an association of more than 500 companies, predominately large utility customers, and is a staunch advocate of retail market competition.

 

Fortnightly: Describe the COMPETE Coalition and its position on the Michigan market.

Massey: We are keenly interested in Michigan. This coalition organized around the principle that electricity competition is good for consumers, good for our nation, brings efficiency and is good for the environment. Without a market-based approach, we can’t possibly hope as a nation to see the kind of innovation in this industry that we will need moving forward. The innovators are sort of like the barbarians at the gate, banging on the door and saying, “Let us into the marketplace. Just give us a level platform and let us offer our services.” Markets are essential to deal with the risk associated with new investment. Investors ought to bear that risk, rather than ratepayers. And it’s essential for the innovators. We’ve also seen a lot of interest from the renewable providers in a market-based approach. So we’re quite concerned about the 10 percent cap in Michigan.

 

Fortnightly: The cap was reached quite quickly. What does that say about competition in Michigan?

Massey: There’s a good deal of interest in increasing the cap among the companies that talk to the COMPETE Coalition and that are members. There was legislation pending in the last general assembly that was not enacted but that would’ve increased the cap. My hunch is that if that were passed, the new cap would soon be reached, because there’s just a large degree of interest right now in the value of competitive markets.

 

Fortnightly: The IOUs argue that because Michigan is not a completely decoupled market—because they’re still responsible for the generation as well as retail—that they need that cap to provide stability and invest in a market that’s not experiencing a lot of economic growth. How do you respond to that?

Massey: I was at FERC for over 10 years, from 1993 to 2003, and was actively involved in crafting Order 888. Those are the same arguments that are always raised by the incumbent. “Not now, not at this time. You’re going to see reliability problems. You’re going to see stranded-cost problems. We’re not going to have stability.” All of that. What’s happening in Michigan is that customers are saying “Look, just give us the choice.”

 

Fortnightly: The other issue the IOUs raise is that the alternative energy suppliers will come in and cherry-pick the safest, biggest customers, leaving them with the smaller and more risky customers to service, plus the responsibility of being a provider of last resort.

Massey: Again, anytime there’s a movement toward competitive markets, those arguments are raised. That is standard fare. If you talk to the Australians, if you talk to Great Britain, you talk to any system that has moved to a market-based approach, the same arguments are raised. The philosophical underpinning of competition—and the great American tradition—is just let the market decide. If the incumbents offer the best products and services, customers will choose them. There’s risk for alternative suppliers as well. They’ve got to go out and find capacity and energy and line it up and take the risk that they’ll sell it. They could have a stranded cost as well.

The real issue is who will bear that risk. Do you want the consumers to always bear the risk? Or do you believe that the risk ought to be more fairly borne by the shareholders of the investor? Let the investors take a look at the environment, take a look at the market structure, make a decision about whether to take the risk to innovate or to build and move forward. If they succeed, that’s terrific. If they don’t succeed, then their own shareholders bear that risk, not the consumers.

 

Fortnightly: Just how much competition would the COMPETE Coalition like to see in Michigan? Is it just a matter of raising the cap? Fully deregulating the market?

Massey: Well, we try to be realists. I mean, we would love to see the cap raised. What’s the right level? I don’t know. We would love to see a robust, vibrant marketplace for electricity in Michigan. What level of competition is required for that? Arguably, the answer is full competition. But we would be pleased to see this cap raised legislatively, and we think there’s a good deal of momentum growing for that outcome.

 

Fortnightly: Is there any risk in destabilization in the price of electricity if you get too much competition too quickly?

Massey: I’m not worried about too much competition too quickly. We know quite well that electricity markets have to be thoughtfully structured. There’s a lot of experience with that now. If Michigan wants to move in that direction, they can take a look at Pennsylvania, for example. Illinois is a success story, particularly with respect to commercial customers. They can look around and see what other states have done to successfully provide the platform for a well-structured market. A lot of experience has been gained over the past 15 years, admittedly through trial and error. But I think policymakers can figure out how to do this now and how to do it well. The least of our worries is too much competition.

 

Fortnightly: How would you rate the Michigan market compared to other states with at least some level of deregulation?

Massey: There’s a problem with any state that moves toward a market, backs off, goes to a hybrid, backs off, changes again. [As a market participant,] you need to know what the governing policy’s going to be—a not just today, but a year from now, and two years from now, and three years from now, so that you can project into the future. Can I enter this market and have a reasonable chance of success?

It’s a mistake for policymakers to create a Byzantine market structure where the participants can’t figure it out, don’t really understand all of the pieces, and wonder whether it’s going to be tweaked again next year. The best thing for any jurisdiction is to choose a regulatory model, stick with it and refine it over time.

That’s what FERC is doing. When I was at FERC and we were moving to Order 888, the average rolled-in, regulated utility rate was significantly higher than the marginal cost to bring the next unit online. That was because of the generation overhang created by the huge build-out of nuclear and coal-based generation back in the ’80s. And a lot of that was just put in rate base, so the average rolled-in utility rate was higher than the price of a new combined cycle gas plant.

So the munis and cooperatives and large industrial customers were banging on our door saying now’s the time to move to a market-based approach, and it made sense. That correlation flipped when natural gas prices were higher. Some of the same parties went back to the states, and back to FERC, and said “Wait a minute, you got it all wrong. What we really want is the lower of cost or market. Give us that.” Now natural gas prices are lower again and prices in the marketplace are low.

My point is policymakers can’t flip the regulatory paradigm every time prices go up or down. It creates way too much uncertainty. In the long term, a market-based approach will create the greatest efficiencies. It’s going to provide the space for innovators to come into the market—and we desperately need those. It will provide the greatest incentive for the renewable producers to come in, for the demand response providers to come in. And long term, it’s in the best interest of consumers and our country. We want policymakers to give serious consideration to competitive markets for electricity, move to that model, and once they do, continue to refine it and make it work.–SA