Study says U.S. market needs work to become competitive

Washington, D.C.

A series of 12 policy and structural changes are the minimum steps needed to move the U.S. electric power industry beyond its current crisis of confidence into a workable, deregulated industry, according to Energy Restructuring at a Crossroads, a new study by Cambridge Energy Research Associates (CERA) sponsored by Accenture and involving more than 40 energy companies, industry associations and regulators.

“The time has come for political leadership to build a consensus around the lessons from the power markets that are working,” said CERA Senior Director of North American electric power Larry Makovich. “This is not the time to reinvent the wheel. It is not a coincidence that wholesale power markets such as PJM Interconnection [Pennsylvania-New Jersey-Maryland] and ERCOT [Electric Reliability Council of Texas] are working well because these markets evolved with legacy rules and institutions reflecting the unique underlying characteristics of the power business.”

The study recommends action in 12 areas—at least some potentially requiring congressional action—to build the necessary structural elements of power markets:

“- Define bounds of wholesale markets. FERC should use the boundaries of existing regional transmission grids to draw regional power market boundaries.

“- Design wholesale markets to achieve critical mass participation. Participation levels need to ensure rivalry and to involve voluntary bidding with mandatory registration, scheduling, dispatch, settlement and disclosure. FERC should not implement competitive power markets if the regional market lacks critical mass in participation.

“- Expand RTOs’ mission to tightly integrate systems operations and market operations. Because economic dispatch of energy is integrally tied to constraints of network topology and electricity system physics, RTOs must act as auctioneer, conductor, traffic cop and referee, and must be governed by a strong, independent executive entity rather than a stakeholder committee.

“- Create regional wholesale spot markets. It is not enough just to set up a RTO and guarantee open access; real-time and day-ahead spot markets must be established proactively with standard products and procedures to promote commercial convenience and minimize seams issues across markets. FERC should require that each RTO set up spot markets within its wholesale market region.

“- Create capacity markets. Capacity markets balance supply and demand in the long run. Beyond providing long-run reliability, they mitigate extreme price volatility and thus help avoid political intervention. Capacity markets require rules for capacity requirements, capacity measurement and verification as well as capacity deficiency penalties.

“- Adopt pricing mechanisms to manage transmission congestion. Transmission systems are complex and network services require complex pricing mechanisms, particularly to provide price signals for congestion. An approach working in some networks utilizes locational marginal pricing (LMP) to locationally price energy and thus also price transmission congestion. LMP should be accompanied by a system of financial (or firm) transmission rights (FTRs), which allow locational price differences to be hedged, and thus provide transmission price certainty. For the sake of market standardization and efficiency, FERC should encourage RTOs to move toward LMP/FTR.

“- Stimulate appropriate transmission system planning and investment. Transmission planning must be done at the grid level. Measures need to be adopted to encourage greater investment in the transmission system.

“- The CFTC should retain and expand its oversight of energy derivative markets. Given the common body of participants, the commonality of trading methods, and market linkages, the Commodities Futures Trading Commission (CFTC) should be the common regulator of all commodity markets, including power.

“- FERC should backstop RTO market monitoring. FERC should look for abuses across cash markets that any single RTO might not detect, deal with serious cases, and seek harmonization of regulatory arrangements between cash and forward markets.

“- Rationalize energy infrastructure siting and permitting. To avoid de-facto barriers to entry and forced technology choices that have resulted from past state siting and permitting review processes, states and the RTOs must set siting and permitting targets in line with supply needs, as well as demonstrating annually that targets are being met. To reconcile conflicts, FERC needs eminent domain authority to address transmission siting issues.

“- Coordinate wholesale and retail transitions. Big bang deregulations are too risky in an industry as complex as electric power. In moving to wholesale markets, vesting contracts that expire gradually over the first years of the market provide time for participants to move up the learning curve.

“- Minimize distortions of market price signals. Price caps have the effect of distorting economic activity in any market. If wholesale price caps exist in any form, they should be set above the highest possible incremental cost of production. Similarly, price freezes at the retail level should be thawed in order to reconnect demand to the market.

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