One critical question: Will FERC be able to implement the SMD?

Richard J. Pierce, Jr., George Washington University School of Law

I give FERC a lot of credit for continuing to pursue its restructuring agenda aggressively in the difficult political environment created by the combination of the California debacle and the Enron scandal. I am confident that implementation of some version of the Standard Market Design (SMD) FERC proposed in its Notice of Proposed Rulemaking (NOPR) has the potential to improve significantly the performance of U.S. electricity markets. The critical question is whether FERC will be able to implement the SMD in the present legal and political environment.

Thou shalt SMD

The Supreme Court’s 2002 decision in New York vs. FERC provides a solid legal foundation to support FERC implementation of the SMD. In fact, that decision strongly suggests that FERC must implement something like the SMD. The justices were unanimous in upholding FERC’s power to assert exclusive jurisdiction over all unbundled transmission transactions and its duty to exercise that jurisdictional power in ways that ensure that all market participants have equal access to the transmission grid.

Three justices would have gone a step further and required FERC to assert exclusive jurisdiction over all transmission, including transmission that is provided as part of a bundled retail transaction. The other six justices concluded that FERC was not yet required to take that step, but they strongly suggested that FERC would be so required if it finds that there is undue discrimination in the provision of transmission service in the context of the bundled retail sales market. As I interpret the preamble to the NOPR, FERC has now made that finding, so it is now required to engage in effective and exclusive regulation of all transmission in interstate commerce.

Regional reactions

The political foundation for FERC’s SMD initiative varies by region. FERC should experience little difficulty implementing the SMD in the Northeast and mid-Atlantic states. The basic building blocks are already in place, and both state regulators and market participants support the central elements of the SMD. There are reasons for optimism that the Midwest will soon follow the lead of the Northeast and mid-Atlantic regions. The same cannot be said of the South. Many state regulators in the South continue to oppose adoption of any version of the SMD, and many market participants in the South seem to be playing an interesting game in which they express support for the SMD in their communications with FERC at the same time that they quietly encourage their state regulators to continue to oppose the SMD.

FERC confronts widespread and powerful opposition to adoption of any version of the SMD in the west. Many state regulators and market participants in the Northwest oppose the SMD because they fear that it will reduce their preferential access to cheap, federally-subsidized hydropower. It is impossible to overstate the level of opposition to the SMD by California politicians. They have not yet threatened to secede from the Union if FERC applies the SMD to California, but I would not be at all surprised to hear such a threat from Governor Davis if it looks like FERC is about to take that action.

Because of the hostile political environment in the South and the West, I am not at all confident that FERC will be able to implement effective versions of the SMD in those regions. There is a good chance that FERC will respond to the political antipathy to its initiative in those regions by implementing an ineffective, watered-down version of the SMD in each. Even if FERC has the courage to implement a potentially effective version of the SMD in the South and the West, the restructured markets in those regions are unlikely to perform as well as the restructured markets in the east and Midwest. The SMD will yield excellent results if it is implemented in conjunction with complementary actions by supportive state regulators, but hostile or skeptical state regulators can take many actions that would frustrate FERC’s efforts to implement the SMD in an effective manner.

Pierce is Lyle T. Alverson Research Professor of Law at George Washington University and senior advisor to PA Consulting. He has written a dozen books and scores of articles about the effects of government regulation on the performance of markets, with particular emphasis on the markets for natural gas and electricity. He can be reached at 202-994-1549 or rpierce@main.nlc.gwu.edu.

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