Federal Restructuring News
Spring 2003

The Proposal
In the face of fierce opposition from consumer groups, public power utilities, many traditional investor-owned utilities and nearly half of the states, the Federal Energy Regulatory Commission (FERC) continues its push for national deregulation of transmission grids. The commission has proposed "standard market design" (SMD) rules that would change how power prices are regulated and induce utilities to purchase electricity and access to transmission on the open market.

SMD is the latest in a series of federal laws and regulations meant to encourage competition in wholesale power sales (see On-line Journal, October 2002 for a history of the pertinent laws and regulations). Traditional regulated utilities build the transmission needed to serve their customers and charge other utilities that move or "wheel" electricity across their service areas. Although FERC regulates these charges, the agency feels that they inhibit wholesale markets by "pancaking" transmission charges – that is, charges stack up as power is shipped over multiple utilities’ systems.

In the early 1990s, FERC began requiring entities that owned transmission lines to grant access to companies who wanted to move wholesale power across them. Subsequent regulations set up a process to create regional transmission organization (RTOs), which are supposed to coordinate power flow among different users of the same transmission grids.

Although utilities are not required to turn control of their power lines to the FERC-monitored RTOs, those that do not join lose the right to sell wholesale power on the open market.

Initially, FERC envisioned four RTOs – in the Northeast, Southeast, Midwest and West. However, this version proved too unwieldy to address regional differences. There are now three RTOs on the East Coast – ISO New England, serving the six New England states, ISO New York, serving that state, and PJM Interconnection, serving the Mid-Atlantic States, Pennsylvania and parts of Ohio. After Western states objected to being included in a RTO with crisis-plagued California, the agency proposed three RTOs in the West – one in California, one in the Pacific Northwest, and one in the Southwest. A Midwest RTO is near completion, and a Southeast RTO has been proposed.

Even as it initiated the RTO process, FERC decided that further action was needed to smooth the way for wholesale power transactions. It noted that utilities were purchasing more wholesale power to meet their loads rather than relying on power they generated themselves. According to commission estimates, public utilities’ purchases of wholesale power increased from 18 percent of total available electricity in 1989 to more than 37 percent in 2000.

When it introduced its SMD proposal in 2002, FERC announced that it intended to provide "a level playing field" for everyone participating in wholesale electric sales by implementing a "market based marginal pricing transmission congestion management system." This system would set a standard charge for access to transmission, along with charges based on transmission capacity – that is, the local RTO would establish a market-based system in which the highest bidder would be granted access to available transmission capacity.

The system, FERC claims, would have two advantages: First, this new type of transmission charge would identify areas of congestion, where new transmission capacity is needed – the southwest corner of Connecticut, for example, where there are not enough high-voltage transmission lines needed to serve the populous New York City suburbs in that part of the state. Second, the SMD assumes that the higher prices charged for transmission in congested areas would attract investment in more transmission capacity, thus solving the congestion problem.

Because utilities are now relying on wholesale power purchases for close to 40 percent of their total supply, on average, the wholesale power market has become an extremely important part of electricity supplies in the United States. The SMD rules envision a wholesale power market driven by real-time demand: Utilities that could not cover demand with their own generation or long-term power contracts would seek power on the wholesale market, paying short-term prices and bidding against other buyers.

The spot market system would include "day-ahead" markets, in which utilities would bid, buy and sell the day before the service would be provided, and "real-time" markets, in which bidding, buying and selling would take place almost immediately as power was produced and moved across the grid. Short-term buyers would seek power from merchant generators – independent power producers who build or buy generating facilities and then sell wholesale power.

FERC sees this wholesale market as a means to send financial signals about where new power sources should be built. For example, in an area with limited generation resources, utilities with few long-term power contracts would be forced to bid for more expensive short-term power on the wholesale market, driving up rates for their customers. Those higher rates would "tell" merchant generators that this is an area that guarantees a good rate of return on new power facilities and thus encourage construction of new power plants in the areas that need them most.

Trying to head off criticism about leaving development of new generation entirely to the market, FERC included a resource adequacy requirement in the SMD. RTOs or another "regional entity" would be required to forecast a region’s future power needs, and assess how well existing power sources meet a region’s needs.

To protect utilities and consumers from the sort of power market manipulation experienced in California in 2000 and 2001, the SMD proposal includes market monitors in each RTO to watch for tactics such as withholding power to drive up prices. The monitors would report to FERC’s new Office of Market Oversight and Investigations, created "to understand energy markets and risk management, measure market performance and analyze market data with an eye to recommending market improvements, investigate compliance violations and, where necessary, pursue enforcement actions."

FERC has proposed that the standard market design be in place by September 2004.

The Criticisms
The SMD proposal generated a barrage of criticism from state utility regulatory agencies, consumer groups and public utilities, even making its way into congressional committees. By the SMD’s comment deadline of January 10, 2003, 22 states had asked FERC to abandon SMD because it would overreach the agency’s authority over wholesale power rates, demand forecasting, resource planning, demand-side management and marketing, and "the ability to ensure that transmission is available to meet retail service obligations."

Opposition is particularly widespread in Southern and Northwest states, which have plentiful power resources and low electric rates. These states fear that their cheap power will go to the highest bidder, siphoning electricity to other states and raising rates for local consumers. They are also concerned about the possibility that their power resources – hydroelectric, coal and natural gas – will encourage construction of more wholesale merchant power plants, which, in turn, will require more transmission capacity to transport the power to out-of-state buyers. Who, the states ask, is going to pay for that additional transmission?

Consumer groups oppose the SMD because they feel that it guarantees neither lower prices nor reliable service. They argue that the existing transmission systems give preference to the customers the grids were originally build for -- the so-called "native load." The SMD system, with its emphasis on encouraging wholesale markets, could mean that locally generated power would be sent out of state, rather than used to provide reasonably priced energy for local consumers.

In an extensive evaluation of the FERC proposal, the Consumer Federation of America (CFA) and Consumers Union maintained that the SMD’s proposal to force utilities to turn to spot markets for power "ensures that every electron sold to consumers fetches the highest price the market will bear." The evaluation also expressed skepticism about FERC’s ability to prevent the big merchant generators from manipulating or "gaming" the system as they did in California, covertly withholding power to drive prices up.

Publicly owned utilities, such as municipal systems and electric cooperatives, oppose the SMD because it would force them to participate in a deregulated market. These utilities, which serve one-quarter of the nation, have largely avoided any form of deregulation and its consequences.

Another federal agency – the Environmental Protection Agency – submitted comments questioning the environmental impacts of SMD. It notes that the demand response provisions of the proposal would make it easier for back-up diesel generators to run during power supply "crunches." Diesel generators emit more pollution than conventional power plants, and the EPA is worried that generators might use the SMD provision to avoid compliance with clean air regulations.

Critics of SMD took their complaints to Congress, where incoming Senate Energy Committee chairman Pete Domenici threatened to halt the proposal with a rider on the 2003 omnibus-spending bill. Domenici agreed to drop the rider after FERC Chairman Pat Wood said that the commission would not act on SMD regulations until it issues a white paper spelling out the benefits of the new rules, to be followed by another round of public comments. The white paper is due in April.

However, FERC continues to promote SMD, most recently with a proposal to boost the return on equity for investor-owned utilities that agree to build new transmission lines and join a regional grid. Utilities would receive a 50-point increase for joining a RTO by December 2003, a 150-point increase for building a new power line and a 150-point increase for forming an independent transmission company (which would then become part of the local RTO).

How well the SMD proposal ultimately fares may depend on how well FERC justifies the new rules in its upcoming white paper. It may also depend on how well, and even whether, members of Congress and the public understand the proposal. As Senator Dominici commented, the rules "are not clearly understood. As a matter of fact, I am not sure anybody understands it. And that’s not good."

Web Resources 
The Federal Energy Regulatory Commission maintains a web page on its Standard Market Design proposal, including a history of the rule making process, the original SMD press release (which provides a detailed and well-written explanation of the proposal), and all subsequent documents.

The Consumer Federation of America and Consumers Union submitted joint comments on SMD, alleging that FERC proposed SMD in response to the meltdown in the western electricity market in 2000 and 2001, which was caused, in part, by FERC's failure to properly oversee companies operating in that market. CFA and CU stated that the proposal violates the Federal Power Act's requirement that electricity rates be just and reasonable and would not protect consumers from the type of manipulative behavior engaged in by energy traders such as Enron during 2000 and 2001.

The Alliance of State Leaders Protecting Electricity Consumers is a coalition of more than 50 state utility regulators and other public officials from 18 states who want to protect "customers from the risks of new experiments in untested and complex electricity market structures that are centrally designed and uniformly imposed by the Federal Energy Regulatory Commission (FERC) without regard to distinctive state and regional policies and circumstances." The alliance opposes new regulations and centrally planned market designs that usurp the ability of states and regions to pursue their chosen electricity policies by transferring many aspects of each state’s planning and ratemaking authority to the FERC. Its website features a detailed position statement opposing Standard Market Design and links to news coverage of the issue.

Northwest Power Works is a campaign sponsored by a coalition of utilities and other organizations opposed to federal proposals to bring "California-style electricity market restructuring"—and electric rate increases—to the Pacific Northwest. Its website provides information and resources to the public, grassroots campaign leaders, and the media.

The report of the National Governors Association Task Force on Electricity Infrastructure provides an overview of state concerns about federal authority over transmission lines, particularly the recent effort by the Federal Energy Regulatory Commission to form Regional Transmission Organizations (RTOs).

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