benefit of counsel: do the benefits of competitive wholesale markets truly exceed the costs?

Michael Kessler and Kevin Pooler, Powell Goldstein Frazer & Murphy

During the last several years, the Federal Energy Regulatory Commission (FERC) has undertaken a variety of initiatives to promote the development and implementation of regional independent transmission system operators (RTOs) and market-based mechanisms to manage congestion and promote efficiency in energy markets. There is significant support, and a growing base of data, for the proposition that truly competitive electricity markets, with transparent market pricing and congestion management functions, provide cost savings and increase the resource options (both supply and demand) for the benefit of the consumer. The proponents of RTOs and competitive markets point to PJM, NYISO and ISO New England as evidence of the economic efficiencies and grid reliability that can be gained from application of centralized grid management measures and of locational marginal pricing (LMP). Moreover, the Midwest ISO recently obtained FERC approval to implement its Transmission and Energy Markets Tariff, which builds on the major features successfully implemented in the other RTOs, including centralized security-constrained economic dispatch, LMP and appropriate market monitoring and mitigation measures.

Still, debate continues over whether the movement from cost-based to market-based energy markets is proving to be beneficial to consumers. Those skeptical of RTO-based grid management and market-based electricity pricing often cite the well-publicized problems of the California energy markets, the Enron debacle and the August 2003 blackout as evidence of the types of market power abuses and inefficiencies that can result from a move away from traditional regulatory schemes to a market-based system. Although the wholesale energy markets are continuing to evolve and the debate on the efficiency will certainly rage on, the proponents of RTOs now have credible economic data demonstrating the ultimate benefits to electricity consumer in a variety of ways.

At the heart of competitive wholesale electricity markets is LMP, which is a methodology for calculating the marginal cost of supplying the next increment of electricity demand or load at a specific location (e.g., point of delivery or point of receipt) on the electric grid or network, taking into account both the marginal cost of generation and losses, and the physical aspects of the transmission system capabilities. LMP creates helpful pricing signals reflecting the time and location value of the next increment of electricity and provides a precise market-based “bid/offer” method for effectively and efficiently pricing the electricity cost at each location point. In essence, LMP facilitates a real-time transparent wholesale price market for electricity, which also creates efficiencies and transparency in the corresponding value of the economic dispatch of electricity across the electric grid or network.

LMP benefits the wholesale electricity markets by facilitating reliable generation and operations. Generators are provided price signals and must, in turn, raise or lower their output in order to achieve least-cost dispatch and/or bring flows back into security limits. LMP also establishes a reference price against which the efficiencies of demand-side measures can be evaluated and, where cost effective, implemented. LMP price signals discourage transactions that worsen congestion and encourage parties to enter into transactions that reduce congestion. The economic redispatch of generation also results in an efficient allocation of generation resources with built-in cost efficiencies. The price signals also can result in increased efficiencies in capital investment in transmission system upgrades, as new transmission system upgrades or generation resources can be constructed at those locations where the market indicates they are the most needed.

Importantly, the efficiencies of economic dispatch in an LMP-based market have been shown to result in substantial savings to consumers, who are benefiting from the use of more reliable generation (or demand) resources at a lower economic cost. These benefits have been documented in two recent studies, one of which evaluated potential savings relating to implementation of the Midwest ISO energy markets, and the other in the PJM markets. The first study, undertaken by the Midwest ISO, consisted of a series of cost-benefit studies to analyze the economic impact their planned LMP-based market on electric consumers within their region. The results of these studies were presented by Dr. Ron McNamara, vice president of regulatory affairs and chief economist for the Midwest ISO, in testimony presented to the FERC. Dr. McNamara’s testimony indicates that implementation of LMP-based markets in the Midwest ISO will result in potential annual cost savings to consumers of $255 million throughout the Midwest ISO region. In addition, the LMP-based market’s efficient use of existing transmission and generation assets is anticipated to subsequently lower spot market prices and put downward pressures on bilateral contract prices, resulting in potential annual cost savings to consumers of approximately $713 million. In addition to the studies presented by the Midwest ISO, a recent study was performed by the Center for the Advancement of Energy Markets of the PJM market. That study indicates that customers in that region (i.e., Pennsylvania, New Jersey, Maryland, Delaware and District of Columbia) saved $3.2 billion in 2002, which translated into a 15 percent reduction in their electric bills.

These studies provide substantial evidence that real-time and day-ahead energy markets, implemented by an independent RTO, can produce significant efficiencies and cost reductions relative to markets subject to traditional utility regulation. The result is more efficient pricing and cost savings that benefits customers today, and promises to provide additional benefits to a growing number of consumers as RTOs develop across the country.

Kessler and Pooler are attorneys in the energy practice group at the law firm Powell Goldstein Frazer & Murphy LLP. They can be reached at mkessler@pgfm.com and kpooler@pgfm.com.

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The Clarion Energy Content Team is made up of editors from various publications, including POWERGRID International, Power Engineering, Renewable Energy World, Hydro Review, Smart Energy International, and Power Engineering International. Contact the content lead for this publication at Jennifer.Runyon@ClarionEvents.com.

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