Electric Market Restructuring in the 21th Century trading old for - - PowerPoint PPT Presentation

Electric Market Restructuring in the 21th Century trading old for new shibboleths

Richard O’Neill Chief Economic Advisor Federal Energy Regulation Commission Regulation, Industry Structure, and Market Power Conference Gold Coast, Australia 1 August 2003

December 11, 2008 2

Transitioning from Transitioning from planning and planning and dispatch to auction dispatch to auction and market power and market power mitigation models mitigation models

December 11, 2008 3

Cultural Cultural Shibboleths Shibboleths

It takes a decades to change a cultural paradigm Old timers are hard to convince but they often have good insights Don’t let the model dictate the answer

Hammer looking for a nail Assume Nash (no collusion) behavior when there is collusion

Jargon traps you in the old system

Use cost-based approach language in a auction based model

Small rules matter; all are not written

Mafia and the insurance

Culture matters

competition between gov’t corps (New Zealand ) Utility execs become non-utility execs Crown corp. becomes private corp.; buy corp jet and raise salary

Analogies often are often self-serving

December 11, 2008 4

Fool me once shame on you fool me twice shame on me

Old culture:

government control of commanding heights (Lenin) Sunk-cost-based pricing becomes costly

Transition paradigm: Thatcher-Reagan-Hayek

Laissez faire (almost) for commanding heights Weak institutions lead to outlaw culture and abuse

New paradigm: where is the Tipping Point

market-based regulation for commanding heights Keep prices in competitive range; Ignore sunk costs Deal with externalties; transition to less regulation

December 11, 2008 5

All markets are regulated the policy question is how?

☯Contracts and Property rights : common law

☯eminent domain

☯Institutional rules: SEC, CFTC, … ☯Antitrust (monopoly): collusion

☯Does Nash behavior violate antitrust law? no

☯Utility regulation: just and reasonable prices ☯Punishments for illegal behavior

☯Restrictions on behavior ☯disgorgement of profits ☯compensation of harm ☯Fines and jail time

December 11, 2008 6

Twenty-first century Luddites

Old testament: vertical integration with cost-of- service regulation is efficient Technology innovation

Scale economies in generation have declined Information technology has lowered scope economies

New testament: market structure amenable to more competition Requires shift in regulatory authority from

Cost-based to market-based regulation State to federal

Luddities stand in the way

December 11, 2008 7

Market-based v. cost-based regulation: it’s all about incentives

Imperfect regulation v. imperfect markets Hayek/Lerner debate: which is more efficient $200 billion in stranded cost Cost-benefit test is soft Tipping point for market-based regulation? Market structure determines the tipping point Market structure is dynamic Depends on concentration, supply and demand therefore the mitigation tools are dynamic Dynamic mitigation has dynamic guard rails

December 11, 2008 8

Cost-based v. market-based regulation

approach Cost-based Market-based Fixed costs Allocated to customers Recovered in the market Variable costs Allocated to customers Used in bid caps market design Discounting Negotiated rates Market clearing auctions

Market power mitigation

Recourse rate (rate cap) Bid cap

December 11, 2008 9

Market structure dictates efficient regulation

☯Concentration ☯Supply functions depend weather, e.g., precipitation ☯Demand functions depend on weather, heat and cold ☯Market mechanisms ☯Contract structure ☯credit

December 11, 2008 10

The 20th century utility regulation in a nutshell

FPA (1935) and NGA (1938): ‘just’ rates Must give the opportunity to recover prudently (efficiently) incurred costs Until late 1980s, cost-based regulation Markets grow geographically Scale economies decline Franchised monopolies/fiefdoms Late 1980s, tipping point switch to market- based regulation jurisdictional turf: states v. feds

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Analogies usually fail Analogies usually fail.

.

electricity is electricity is not

not air traffic, natural gas or telephone

air traffic, natural gas or telephone

telephone: hush-a-phone and spectrum air traffic controller:

no Kirchhoff laws a reservation changes seats available

• n all other flights

natural gas: no valve; no storage lead to a socialization of the market

subsidize real-time market subsidize congestion subsidize trading

December 11, 2008 12

The Enron phenomenon

Wall Street encourages Enron clones Instead of a measured transition in California, we jumped to reasonably unfettered markets designed by Enron and its aspiring clones with intense lobbing and without any transition mechanism. Result: Rube Goldberg market rules Memo to Cal. strategies Enron online: Enron told the Comm it was a bad idea?

December 11, 2008 13

gencos Transco/ Gridco/Isos LSEs/discos

RTO

iou

system operator security coordinator tariff administrator Market operator for commodity capacity tx rights

What did we do before we went back to the drawing board? ENRON creates ether money; ENRON creates ether money; wall street believes! wall street believes!

December 11, 2008 14

Pre-day-ahead markets

for transmission rights: CRT/TCC/TRCs/FGRs for generation capacity/resevres (ICAP) market power mitigation via options contracts

day-ahead market for reliability(valium substitute)

simultaneous nodal market-clearing auctions for energy,

ancillary services and congestion

allow multi-part bidding higher of market or bid cost recovery allow self scheduling allow price limit bids on ancillary and congestion

Real-time balancing myopic market markets are nodal-based LMP with fish protection

December 11, 2008 15

Role of Transmission in Electric Markets

Traditional approach: Integrated Resource Planning

Plan system Build assets Add costs to rate base Roll-in the costs

Order 888

Rolled in v. incremental ‘And’ v. ‘Or’ the ‘but for’ for cheap expansion

SMD and Merchant transmission

December 11, 2008 16

Merchant expansion Merchant expansion

Public good: Eminent domain and environment Test: contestability or no withholding Operation under control of RTO/ISO:

• pen breaker option

system is no worse off

TX property rights without withholding FTR and Flowgate rights Choice seems to be DC subnetworks

December 11, 2008 17

Transmission rate design and Transmission rate design and revenue requirement revenue requirement

Transco/Gridco does revenue requirement Cost-based: traditional v. PBR

Incentive compatible Benchmarking (EU): percent availability

RTO does rate design

Total revenue requirements via access charge TX rights auctions for forward rights Congestion fees

system expansion must go thru planning process transmission property rights via RTO auction

December 11, 2008 18

TX rights auctions TX rights auctions

Joint TX and generation auctions

San Fran nomogram Hedging phase shifter settings

Point(s) to Point(s): FTR/TCC/FCR/CRT

“perfect” hedge except losses If constraint set is nonlinear, no options contracts

Flowgate rights: elements or combinations Option v. obligation contracts Approximations

Linear: PTP decomposable Nonlinear: PTP not decomposable; no PTP option

December 11, 2008 19

ELECTRIC WHOLESALE MARKET PLATFORM FERC White Paper Issued April 29, 2003 Why Issue A White Paper? Let the industry, states, and others know Commission views about the scope and direction of a final rule Explain changes in the proposal based on the comments and our outreach Address legitimate concerns while moving forward to better wholesale markets

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The Commission Rule That Would

Establish a wholesale market platform with good

market design and market power mitigation

Require public utilities to join an RTO or ISO

Allow regional flexibility in policies & timelines

Establish regional state committees to provide

state input on FERC issues

Not require an element of the wholesale market

platform if its costs outweighs its benefits

Not set retail rates, irrigation, flood control, … Bottom up approach

December 11, 2008 21

Wholesale Market Platform Goals Wholesale Market Platform Goals

improved wholesale competition Reasonable transparent prices Prevent market manipulation Prevent transmission owners from favoring their own wholesale power sales Encourage needed investment Improve reliability Recognize the regional character Provide for federal and state cooperation

December 11, 2008 22

MARKET PLATFORM ELEMENTS MARKET PLATFORM ELEMENTS

Market Power Mitigation and Monitoring Regional Independent Grid Operator Regional Transmission Planning Process Fair Transmission Cost Allocation Spot Markets Efficient Grid Congestion Management Firm Transmission Rights Facilitate Resource Adequacy Approaches

December 11, 2008 23

Market design and mitigation

Surrogates for demand side

Sellers exercise market power Demand curve for reserves

Entry conditions

Property Environment Interconnection

Mitigation

Ex-ante structural analysis creates guard rails Reat-time mitigation enforces guard rails Ex-post penalties for physical withholding

December 11, 2008 24

REGIONAL STATE COMMITTEES

would have strong roles in deciding: Transmission cost allocation

Existing costs: e.g., License plate v. postage stamp Costs across RTOs: e.g., export fees v. no fees New costs: e.g., rolled-in v. participant funding

Transmission planning resource adequacy (generation, tx & demand) Firm transmission rights allocation and assurance Market monitoring Transition process: e.g., time line and budget

December 11, 2008 25

Should we subsidize competition?

☯The purpose of market design is efficient and fair markets ☯Market power in electricity markets is dynamic (function of the weather) ☯Generators start in life as inframarginal and often migrate to marginal (old oil and coal)

December 11, 2008 26

Mother ship brings home the prodigal children

beam me up Scotty Utilities buy power and assets from affiliates under questionable circumstances Cinergy utility buys plants from affiliates Ameren utility buys plants from affiliates Entergy and Southern buy power from affiliates under competitive RFP ‘auction’ Was the competition fair? Makes affiliate generation less risky Where are the customer benefits Will others enter in the future?