FERC Standard Market Design: Restoring momentum to deregulation

Chris Crosby, OM

The Federal Energy Regulatory Commission (FERC) Standard Market Design (SMD) Notice of Rule Making (NOPR) is best described as a “back to the basics” initiative that is intended to restore deregulation momentum in the United States and all of North America. The SMD NOPR proposes initiatives to specifically address root causes of the California energy crisis, Enron’s and other energy traders’ implosions, and the objections by low-cost regions of the country toward deregulation in general. SMD clearly indicates that FERC’s main remedy for electricity markets in North America is to focus on promoting fully open transmission access and stabilize spot electricity prices and supply adequacy.

FERC’s careful measures in SMD, however, seem to have adverse effects on promoting liberal participation in electricity markets or creating liquid trade through organized power exchanges. There are a number SMD NOPR elements that excel at opening the transmission lines, but run the risk of sacrificing eventual market liquidity, including:

“-Independent transmission service provider footprint. Introduction of new entities called independent transmission providers (ITP) ensures open access to the transmission system of all FERC jurisdictional utilities. ITPs essentially have the same responsibilities as their predecessors, the regional transmission organizations (RTOs) and independent system operators (ISOs), except there are no requirements for an expansive regional footprint; even a single utility could create its own ITP. This measure should address the concerns of some utilities and state public utility commissions that have opposed participation in geographically expansive RTOs and ISOs. A smaller footprint for electricity markets, however, could reduce the liquidity of the spot markets that these ITPs are mandated to run.

“-Long-term resource reliability requirement. Enforcement of long-term resource adequacy requirement (LRAR) on all load serving entities (LSE) effectively brings electric resource planning back to former utilities (which constitute the bulk of the LSE community today). LRAR covers actual/long-term load forecast plus at least 12 percent reserve margin. This feature of SMD is expected to reduce price volatility in the spot market and improve the supply adequacy going into real-time operation. However, LRAR’s complex and strict requirements can create a strong barrier to entry into the energy retailing business.

LSEs are required to meet their LRAR through direct ownership of supply or demand response resources through long-term bilateral contracts. This forces the majority of all wholesale and retail energy transaction volumes, even more than before, to be through self provision or bilateral markets. The resulting impact could be a lack of liquid electricity markets in both spot markets and market run by organized financial or physical exchanges.

“-Conditions for market participation. In an effort to rid the market of fly-by-night businesses with less than stellar credit scores, SMD prescribes very stringent eligibility requirements for participants and their conduct in the electricity markets. These requirements are intended to stabilize electricity prices and improve supply reliability; but in fact may further raise the barrier to entry for some legitimate entities that want to actively participate in electricity markets and can further adversely impact overall market liquidity.

“-Locational marginal pricing (LMP). Prescription of nodal-based LMP scheme for pricing spot energy and transmission congestion will have the intended consequence of making energy payments and credits more in line with value of such commodity in the face of transmission constraints. Even though FERC allows market participants to define “energy hubs” and enables ITPs to calculate weighted average prices for such hubs, this requirement can make it more difficult to launch established reference prices for use by organized power exchanges for forwards or derivative trading or even for bilateral trades.

“-Strict and proactive market monitoring regime. SMD prescribes regional market monitoring units (MMU) for each forming or existing ITP. MMUs, that are only accountable to the FERC with informational ties to their corresponding ITP, will have sweeping investigative powers that, if properly implemented, can go a long way to monitor and mitigate participants’ market power or potentially ITP’s “anti-competitive behavior.”

The potential pitfall is MMUs could readily prevent electricity markets from flourishing if they fail to function properly due to inexperience or overprotective tendencies. Introduction of a number of static and dynamic price caps for the spot markets with the specific objective of stabilizing spot electricity prices can further discourage development of new generators and discourage participation of these generators in spot or exchange type markets.

“-Voluntary physical forwards market operation by ITPs. In addition to their assignment to run spot electricity markets, ITPs are given the option to run a physical forwards market for energy and ancillary services. The brief history of electricity markets around the world seems to indicate that only successful forward electricity markets with sufficient liquidity and price stability are those that are run by the same entity that runs the spot physical market. This feature is intended to further stabilize electricity prices.

Should ITPs launch these forwards markets, they can further discourage creation of organized independent power exchanges that could operate on a more expanded regional basis than the ITP markets.

FERC should be applauded and supported for its “back to basics” approach to restore confidence in competitive electricity markets. We believe that the industry will ensure that those elements of FERC SMD that may restrict entry to the market and expanded its liquidity will be mostly resolved as part of the NOPR review process or soon after competitive electricity markets have stabilized across North America.

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Crosby is senior vice-president, sales for OM, Americas. For more than 22 years Crosby has developed global strategy for energy corporations. At OM, Crosby is responsible for launching the company’s transaction technology solutions for wholesale energy markets in North America. He can be reached at 704-341-5972 or chris.crosby@om.com.

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