SMD drawing RTO battle lines

Ashley Brown, Harvard University

Much controversy has surrounded the question of whether FERC’s proposed Standard Market Design (SMD) is preemptive of the states on transmission issues. Some state regulators assert that SMD constitutes an unparalleled preemption of the prerogatives of the states. Others contend that the adoption of SMD would actually make little difference in the balance of authority between state and federal regulators. Curiously, unlike many such battles in the past, the alignments on each side of the debate are less than monolithic. It is not simply a matter of state regulators on one side vs. federal regulators on the other. Rather, many state regulators, particularly in the Midwest and Northeast, have aligned themselves with FERC, while many counterparts, particularly in the Southeast and Northwest are bitterly opposed. Why has “states’ rights” not served as the rallying cry for state regulatory unity as it has in the past?

This is my side

The dividing line on SMD, indeed, on electric restructuring in general, has not been along state and federal lines. Rather, it has been, with some exceptions, a split between high cost and low cost states. It is certainly no accident that most of the states that have restructured have been burdened by higher than average costs for electricity. Those blessed with lower costs have preferred maintaining the status quo. The real stakes are fears by the low cost states that the full blossoming of a competitive market and the requirement that the grid be managed by a competitively neutral entity will cause rates to levelize. In short, low cost states will see their rates rise while those in higher cost jurisdictions will drop. Thus, in context, the debate is really not whether SMD is preemptive, but whether low cost states will be able to retain their cost advantage. That being said, however, the state federal issues are worth examining.

Those who see preemption in SMD, particularly in the context of mandatory utility membership in RTO’s, argue that the captive ratepayers of each utility paid for the assets to be built for their benefit and assumed all of the economic risks for the assets. Accordingly, it is contended that captive ratepayers ought not be subjected to a degradation of reliability or higher cost service. They also contend that there is a high probability that reliability will be compromised because the network was not planned for carrying out the functions an RTO will inevitably demand of it, and that wresting control from the load serving entity will both reduce regulatory oversight and substantially increase transaction costs. They also argue that many of the transmission lines were sited and certificated on the basis that the benefits and costs of the facility, economic and social, would be balanced within the same jurisdiction. Unbundling and dedicating transmission services to multi rather than single jurisdictional use, some contend, will effectively undo the bargain that was struck to enable construction. Finally, it is argued that SMD will force states to open up to retail competition, a subject well beyond the scope of FERC’s authority.

That is your side

On the other side of the debate, are a variety of policy and legal arguments, as well. From a legal point of view, it is argued that the U.S. Supreme Court, in New York vs. FERC, held that the FERC had jurisdiction over unbundled transmission, and seemed to suggest (the Concurring Opinion explicitly stated) that FERC had jurisdiction over all transmission services. If that is the case, SMD, insofar as it relates to transmission assets, does not constitute any preemption that Congress did not authorize years ago when it passed the Federal Power Act. Moreover, SMD supporters contend, many years of state jurisdiction over bundled transmission rates had failed to produce any innovations in pricing or other incentives.

Indeed, the practice of the states of passing all revenues from non-jurisdictional use of the grid, to captive ratepayers had the effect of nullifying any real incentives while placing undue risk on those same consumers. Rather than risking reliability, SMD by providing for tighter coordination, regionalization of supply, better pricing signals, and formal reserve requirements, may well have the effect of enhancing reliability. In fact, SMD supporters worry, rather than mandating retail competition, the reserve requirements proposed may inhibit opening retail markets.

The fears of low cost states that their rates will be levelized with those of their high cost neighbors, SMD proponents argue is not really a problem because, in the short term, state regulatory authority I sufficient to protect retail tariffs, and, in the longer term, the roles may well be reversed anyway. In fact, it is asserted, opening access to broader supplies will, in the long term, have beneficial reliability and price effects for consumers. Arguing the contrary, SMD proponents would contend, is to see the market as being static, rather than the dynamic entity that it is. The certification argument, it is claimed, is irrelevant, as every state would have its situation improved by removing the incentives for parochialism inherent in existing siting regulations. While siting cannot be part of SMD because FERC lacks any such jurisdiction, the net effect of SMD would be to make state siting requirements less parochial.

The real question emanating from the arguments is whether we will continue the trend of recent decades of viewing electricity markets as competitive and regional in scope, or whether we should return to the past view of the market as being parochial and monopolistic. Part of that debate is policy and legal, but perhaps a bigger part of it is technological, economic, financial, and practical. The state vs. federal jurisdictional issues must be seen in that context. On both sides of the debate, partisans analyze jurisdictional issue in terms of the desired result. The issues merit consideration, but must be seen in context.

Brown is the executive director of the Harvard Electricity Policy Group at the Kennedy School of Government, Harvard University. More information can be found at www.ksg.

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