Competition Without Chaos

California heralded the New Year with a wave of rolling blackouts, spiraling wholesale electricity prices, and at least one utility bankruptcy. California, which symbolizes the electronic age and represents an eighth of the U.S. economy and its population, faces electricity supply issues not seen since the Great Depression and the collapse of the great utility holding companies. To what extent is California the bellwether for the restructured electric industry in the United States? We do not believe that the recent crisis in California is a signal that competition and deregulation have failed. Indeed, it remains our firm belief that market-oriented restructuring of the electric industry remains the best opportunity to provide consumer benefits and to develop reliable new sources of supply. After all, a major impetus for introducing competition into the generation and marketing of electricity has been the previous failures in long-term planning decisions made by public utilities and their regulators. The regulated monopoly regime simply did not provide the correct economic incentives for a company to provide electric service efficiently. To what extent can other states that have restructured their electric industries expect to see California-like dramatic sustained price increases and supply shortages resulting in rolling blackouts? The root cause of California's problems was its long-term failure to build generating plants during the most sustained economic boom in the state's history. California's most significant restructuring problem was also a local issue. The California restructuring law required utilities collecting stranded costs to retain fixed price obligations to retail customers, while preventing them from hedging their price risk in the wholesale market by entering into long-term supply contracts. The California market design flaws have been avoided in the restructuring legislation enacted by the twenty-four states and the District of Columbia that have restructured electricity markets. Among these states are Pennsylvania and Illinois, the states where Exelon conducts public utility businesses. The restructuring efforts in these other states are generally yielding results quite different from those in California and demonstrate that thoughtful, market-oriented, evolutionary restructuring can work well for all parties. This is not a reason, however, for complacency. Government agencies, utilities and all market stakeholders must work hard to make sure this answer remains valid a few years hence. This work includes establishing appropriate pricing and incentives to encourage the building of new supply and the development of demand-side management programs; establishing regional transmission organizations in order to support the expansion of and appropriate pricing for transmission; establishing appropriate rules and pricing regarding the utilities provider of last resort or default supply obligation. The default supply issue is one of the most significant challenges to the transition to competition. If the delivery companies retain primary responsibility for arranging supply and thus lock up most of the generation sources, the result is reliable service and stable rates for customers. However, new market entrants' access to supply sources will be limited and at high prices, making it difficult for them to compete. To resolve this dilemma, we propose a bifurcated approach to default service offerings and pricing. For large customers, who have the most desirable service characteristics to competitive suppliers and thus more opportunity to hedge their price risk, the utilities' only default service obligation would be unbundled energy at a market price. For mass market customers, who lack hedging ability because of limited, if any, market development, the utilities would provide a fixed price, multi-year energy supply offering. The price for both offerings must include a risk premium adequate to compensate the utility for the risk it assumes and to avoid rates that are too low to allow alternative suppliers to compete. We believe our default supply resolution will achieve the competing goals of price stability, reliability, and the development of a mature competitive market. The California experience is not an accident or the product of bad luck. It is the product of choices, long-term choices about siting generation and transmission, and the more recent choice of a market design that imposed asymmetric risks on utilities to the ultimate detriment of all. If other states make similar choices, similar consequences can be expected to follow. In short, the California experience is no reason to reject restructuring; it is rather a forceful lesson on the importance of doing it right.

Deregulation of the Energy Industry

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The Resource Adequacy Requirement in FERC\u27s Standard Market Design: Help for Competition or a Return to Command and Control?

Although electricity markets\u27 march toward competition has not been a complete success, the Federal Energy Regulatory Commission ( FERC ) remains committed to easing wholesale electricity markets toward that goal. Indeed, FERC\u27s Standard Market Design Notice of Proposed Rulemaking makes some headway: Locational marginal pricing, for example, will force load to internalize the congestion costs of its consumption and will signal the need for new transmission and generation. FERC, however, has embraced price caps in spot markets and, to make the markets work despite the price caps, has proposed a Resource Adequacy Requirement ( RAR ) to ensure that adequate generation exists to deliver electricity to load. If RAR achieves FERC\u27s objective, it will stunt the growth of demand response, a necessary component of stable competition. Further, RAR will permit the perpetuation of the current price-cap regime, which distorts price signals. The claim that RAR together with price caps are only temporary measures to help put wholesale markets on surer footing seems misguided; until price caps are raised significantly above present levels, load-serving entities and load itself lack the incentive to invest in technologies necessary to make demand response a reality. If this were not enough to counsel against promulgating the PAR, the proposal is internally contradictory and, according to the relevant statutes, lies outside FERC\u27s jurisdiction to implement or enforce. FERC should discard the RAR and current price caps and instead adopt a reformist program that will better allow scarcity spot prices to ensure generation adequacy

Electricity Markets: Consumers Could Benefit from Demand Programs, but Challenges Remain

A letter report issued by the Government Accountability Office with an abstract that begins "The efficient and reliable functioning of the more than $200 billion electric industry is vital to the lives of all Americans. As demonstrated in the 2003 black- out in the Northeast and the 2001 energy crisis in the West, changes in the cost and availability of electricity can have significant impacts on consumers and the national economy. The Federal Energy Regulatory Commission (FERC) supports using demand-response programs as part of its effort to develop and oversee competitive electricity markets. GAO was asked to identify (1) the types of demand-response programs currently in use, (2) the benefits of these programs, (3) the barriers to their introduction and expansion, and (4) instances where barriers have been overcome. Additionally, GAO examined the federal government's participation in these programs through the General Services Administration (GSA).