Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 1

Electricity 101: Understanding Maryland's Electricity Market

Tim BrennanProfessor, Public Policy and Economics,

UMBCSenior Fellow, Resources for the Future

brennan@umbc.edu

Maryland Public Policy Institute

Annapolis, MD

March 20, 2008

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Many issues; few answers?• A little Electricity 101

• What’s in Maryland’s control?

• Residential not the whole picture, either for or against

• Why electricity’s distinctive features matter

• The pillars of Maryland policy

• Some thoughts on “decoupling”

• Last words: reliability, and “yes, this is really hard”

• Skipping environmental policy considerations (e.g,. RGGI) but can discuss (some) in Q&A

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A few “Electricity 101” basics• Separate wholesale and retail markets

– Wholesale: Bulk energy delivered over high voltage transmission lines to “load serving entities” LSEs (including local utility)

– Retail: The market in which end users choose their LSE

• Supply must equal demand at all times– Too expensive to store– Capacity has to be in place to meet demand at any instant– Top 15% in place used during only 60 extreme peak hours– A problem with “non-dispatchable” sources, e.g., wind

• It’s all one big grid– One failure to meet demand can bring down the system– It’s not like cars – reliability is a collective enterprise

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“Electricity Regulation” 101: The wires are regulated• Local distribution

– Don’t need multiple providers digging up the streets– Rates regulated by MD PSC

• Long distance transmission– Nominally separate lines, BUT …– Transmission interconnected into three big “interties” –

Eastern, Western, and Texas– Electricity takes all paths – why it is one big grid– FERC sets rates, access policies, rules for wholesale

markets

• Generation/transmission separation the wholesale issue– Fear of discrimination against entrants– FERC defines “Regional Transmission Organizations” – Functional, full, or no separation? Coordination vs.

competition

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What can Maryland control?• Many question regulation

– The California fiasco– The Northeast blackout– The run-up in prices– Low residential take-up

• But Maryland controls only the retail side– Can regulate rates customers pay– But has little control on upstream cost of

electricity

• Part of the PJM wholesale market– Competitive market, FERC-approved RTO– Multiple markets (day ahead, spot)– Zonal vs. nodal– Capacity markets (“Reliability Pricing Model”)

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Where Maryland gets its electricity – PJM’s territory

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Residential isn’t everything• Residential nationally about 1/3 of the market

– Commercial and industrial (C&I) 2/3– Source of impetus for opening markets– C&I advantaged even under old top-to-bottom

regulation– Credible threats to leave – like tax breaks

• C&I seems to work in MD, but not residential– Less than about 3% of residential served by new

suppliers– 70% C&I, 94% large C&I

• Why the residential reluctance?– In some cases, retail price held down as part of dereg.

bargain– But maybe they don’t want to be bothered!– Leave shopping to the MD PSC?

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Alberta

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Non-storable: What prices should users see?• Why electricity’s non-storability matters

– 15% of use during 60 extreme peak hours, less than 1%– Have to recover those costs in less than 1/100th time– Extreme peak prices can be 50 times normal price

• Case for allowing “smart metering”– Time of day, seasonal pricing only partial solution– Need ability to monitor use, tie to prices

• Focus smart metering on C&I– Enterprise benefits exceed costs of metering

• Political alternative: Pay not to use– Give people $1/kwh for electricity not used at extreme

peaks?– Sources of funds?

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Pricing leads to Maryland Energy Policy• Pillar 1: Electricity prices are too high

• Pillar 2: People consume too much electricity– Stress on system at peak times: Only about .2%– Environmental harms, e.g., greenhouse gases

• Seemingly irreconcilable, to an economist– Excessive consumption means price below cost

• Believe it or not, prices may be too low, as we’ve seen

• Economic ideal: Charge the “right” price– Real time, environmental surcharge (e.g., carbon permit

price)– Potential painful distributional effects, however!

• If pricing stays low, possibly justifies conservation subsidy– Watch out for rebound effect!!

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Do consumers make wrong decisions …• Could result in excessive consumption

• First explanation: Insufficient information– Information on net savings from energy efficiency, e.g.,

CFLs– Is there really an information shortage? Internet, TV, etc.– Perhaps for residential, less so for C&I (worth finding

things out)– Real uncertainty regarding payoff—will energy prices stay

up?

• Second explanation: Do buyers/consumers not make self-interested decisions?– Often assumed on the policy end– But consumers may have quality preferences, e.g., CFLs– Judgment over validity of preferences for energy-intensive

consumption

• Economists lean toward giving people “right prices”

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… or do the utilities make us do it? “Decoupling”• Claim that we consume to much because utilities

encourage consumption

• Rationale for “decoupling” utility revenues/profits from amount we use – The utilities make money the more we use– Take away the profit, they won’t encourage us to use as

much

• A few cautionary notes– Any evidence that utilities influence demand away from

what is in the consumer’s interest (given the right prices?)

– The relationship to wholesale price probably drives utility marketing efforts more than

– Deregulation blamed for Isabel repair delays because utilities weren’t getting profits from generation. Will decoupling help?

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Reliability• Greatest risk to grid on-peak

• Reallocating—not even reducing— a small fraction of overall energy use can have a big effect on reliability, prices– 15% of use during 60 extreme peak hours is about .2% of

overall annual use

• Big reliability gains obtainable at far less than 15%

• Leaves aside environmental reasons for reducing use

• But main reliability questions wholesale– Transmission grid operation– Transmission/generation separation– Control vs. competition

• “Have markets met their match”?

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It really is hard – reasonable people can disagree!