Today's Electricity Markets are Not Sustainable

By John Anderson, President & CEO, ELCON

LARGE INDUSTRIAL USERS OF ELECTRICITY have believed for many years that traditional cost-of-service regulation produces limited benefits for consumers. Under this regulatory system, utilities have an incentive to increase their capital expenditures (and then justify those expenditures to the state utility commission), but they have little incentive to seek more efficient, lower priced generation options or to pursue innovative product offerings. There is little (or no) customer focus, because, in truth, utilities see the state commission, not the actual power consumers, as the customer.

In the 1980s, ELCON members began to advocate competitive electricity markets. Although the popular press often characterized the efforts as "deregulation," ELCON members preferred not to use that terminology. Others described the effort as "restructuring," but, again, ELCON members believed that also missed the point. Our objective was not simply to restructure or deregulate wholesale and retail electricity markets, our objective was to make electricity markets competitive. While we sought changes in the regulatory structure, we never sought to eliminate it entirely.

We believed then, and we believe now, that "true" or "real" competition in wholesale and retail electricity markets has the potential to bring significant benefits to consumers and the national economy. These benefits include competitive prices, innovative products, and an overall customer focus.

Unfortunately the road to truly competitive electricity markets was not as straight as we had hoped.

By 2000, almost half of the states in the United States enacted plans for competitive retail electricity markets, but most such efforts were unsuccessful when implemented, at least in part because the proper foundation — competitive wholesale markets — was not in place.

Most of the states that had attempted to implement retail competition are within organized power markets that come under the jurisdiction of the Federal Energy Regulatory Commission. These include PJM Interconnection, ISO-New England, the Midwest Independent Transmission System Operator (MISO), the New York Independent System Operator (NYISO) and the newly born (or, more accurately, re-born) California Independent System Operator.

What industrial users find interesting is that these markets all claim to be examples of competition at work. Moreover, they claim to be successful examples of competition at work. Industrial users emphatically disagree.

While today's organized markets — and, in fact, electricity markets in general — are very different from the markets of fifteen years ago, they are not necessarily any more competitive. Truly competitive markets must include the following conditions.

Prices must be established through an interaction of supply and demand. In today's markets end-use buyers do not deal with suppliers (generators). The market operator (the ISO or RTO) is the buyer since it is the one who is setting prices through stacked auctions and locational pricing. And the concept of demand response — encouraging users to decrease consumption at times of peak demand — is barely given lip service though its value is clearly evident.

New capacity must be "incented" through market forces, not administrative re-regulation. Unfortunately most of the organized markets have adopted capacity markets as a means of encouraging new generation. There are two problems: first, the capacity markets have cost consumers billions of dollars but have not been demonstrated to "incent" much new generation, and, second, capacity markets are not markets at all – they are simply a form of re-regulation.

Market entry and exit should be determined by market forces. In any competitive market, basic economics should force inefficient suppliers out of business. In the non-competitive wholesale electricity markets, inefficient suppliers are propped up and retained by a variety of financial mechanisms and administrative revenue streams in the name of "reliability." This creates a disincentive for new entrants to invest in more efficient facilities.

Consumers must be able to hedge future prices with long-term bilateral contracts. Today's markets discourage long-term contracts – and the liquidity that would accompany such contracts – since most generators know they can simply sell into the spot and day-ahead markets and earn significant returns. Most truly competitive markets make very little use of spot markets.

There must be adequate transmission structure. Today's grid is hamstrung by a number of significant congestion points which often keep lower cost, efficient generation from reaching end users. In addition, the joint ownership of generation and transmission encourages discrimination and gaming — all to the detriment of consumers.

Once the above conditions are met, wholesale price caps and bid mitigation measures may be relaxed. If there is (1) an adequate supply of efficient, low-cost generation, (2) a congestion-free transmission infrastructure, and (3) effective utilization of demand response, price caps — which politicians often support so consumers are not subject to price spikes — would then be unnecessary.

The failure of restructuring to provide discernible customer benefits has produced a considerable consumer backlash. As prices freeze and fixed price contracts expire, residential electricity consumers are becoming quite vocal in expressing opposition. Such outrage has been particularly visible in Maryland, Connecticut, Delaware, Illinois, Maine, New Jersey, Pennsylvania, Rhode Island and Virginia.

Other electricity stakeholders have also commented about the flaws in the organized markets. Municipal and cooperative utilities have contributed several studies. And The New York Times ran a series of articles highlighting electricity market shortcomings.

For today's manufacturers, the present structure and operation of the organized markets have been costly and burdensome. Several manufacturers have closed facilities in the organized markets, specifically citing electricity price increases as a primary reason. Policymakers, regulators, and other stakeholders must work together to explore all alternatives so that markets can provide benefits to all consumer classes. What steps should be taken?

Specifically, states that have not yet restructured should not do so. These states should wait until a wholesale market structure develops that can support retail competition.

Today's organized markets must be fixed. Unfortunately, as long as the organized markets' governing structures are skewed to benefit suppliers, the problems will not be self-correcting.

And, if today's organized markets cannot be fixed, all options, including a return to traditional regulation, must be explored.

This will be a difficult process. In areas where local distribution companies have sold generation there may be additional problems. Our preference is clearly that the existing markets be fixed. But something must be done, because the present market structure is simply not sustainable.