MARKETS, MODELS AND MUDDLES: ELECTRICITY RESTRUCTURING

MARKETS, MODELS AND MUDDLES: ELECTRICITY RESTRUCTURING

William W. Hogan Mossavar-Rahmani Center for Business and Government

John F. Kennedy School of Government Harvard University

Cambridge, Massachusetts 02138

26th USAEE/IAEE Annual North American Conference Keynote Address

Ann Arbor, MI

September 26, 2006

1

ENERGY POLICY ANALYSIS Markets, Models and Muddles

Energy markets present challenges and opportunities for policy analysis. Analysts use models to confront muddles.

Model (n).

1. A small object, usually built to scale, that represents in detail another, often larger object.

2. A preliminary work or construction that serves as a plan from which a final product is to be made. Such a work or construction used in testing or perfecting a final product.

3. A schematic description of a system, theory, or phenomenon that accounts for its known or inferred properties and may be used for further study of its characteristics.

Muddle (n).

1. A disordered condition; a mess or jumble.

2. Mental confusion.

2

ENERGY POLICY ANALYSIS Markets, Models and Muddles

Models provide varied tools for policy analysis.

• Frameworks o Supply, Demand, Incentives, and Equilibrium Conditions o Engineering Characterizations and Constraints. o Strategic Interactions.

• Transparency

o Energy Modeling Form (USAEE 2005 Adelman-Frankel Award) “The purpose of modeling is insight, not numbers.”

o Assumptions and Results DN: “6 and 4.” Nordhaus: DICE and global warming.

• Numbers o Project (In)dependence

Tougher environmental standards increase coal use. Oil import trends preclude autarky.

o E-K complementarity, sulfur limits, environmental double dividend, …

3

ELECTRICITY MARKET Electricity Restructuring

The case of electricity restructuring presents examples of fundamental muddles and a need for the power of models.

• Marriage of Engineering and Economics. o Loop Flow. o Reliability Requirements. o Incentives and Equilibrium.

• Devilish Details.

o Market Power Mitigation. o Coordination for Competition.

• Jurisdictional Disputes.

o US State vs. Federal Regulators. o European Subsidiarity Principle.

4


Ultimate success is an open question for the international experiment in using electricity markets for public purposes.

From Down Under “Plans for desperately needed new power generation are up in the air again. … [The New Zealand Labour Government's move] has the potential to up-end the electricity industry and turn back the clock to central planning. Electricity transmission is already centrally planned by state-owned Transpower. “‘The question is, should you centrally plan the alternatives,’ Mr Hemmingway [Electricity Commission chairman] says. ‘Do you give companies a leg-up in the form of a subsidy to undertake the alternatives? And, how would a package of centrally implemented alternatives distort the market? “‘How far we go down this slippery slope back toward central planning is a central question here. It's the key to our deliberations. We are aware of the slippery slope danger but we are also aware that if there are alternatives out there that are less expensive than the transmission line we ought not let them go to waste.'" (The Press, Christchurch, New Zealand, April 30, 2005.)

From Washington DC “After holding its draft transmission pricing policy statement for more than two years, the federal Energy Regulatory Commission now says it will issue a final statement in two months…. The policy statement should address which customers pay for transmission expansion, [Commissioner Suedeen] Kelly said. The more expansively costs are spread, the more transmission will be built, she added, indicating that the approach called ‘participant funding’ should be reserved for projects with isolated benefits. ‘I don’t really want to use the word ‘socialization,’ because I think there is an argument to be made that all those people [on the grid] benefit.’” (Power Markets Week, May 2, 2005, p. 9.)

5


Using electricity markets for public purposes …

From Boston MA “With deregulation, the theory went, enterprising power producers would foresee a shortage and, on their own, build or expand plants to fill the market need. … The theory hasn't worked. … There has to be a better way, and there is. ISO New England should conduct an auction in which power generators are invited to bid for the right to supply the new capacity, with the award going to the firm willing to do it for the lowest increase in rates. If this looks like a partial return to the old days of the regulated market, so be it.” (The Boston Globe, Boston, MA, editorial, July 19, 2005.)

From Washington DC

“Given the continuing development of voluntary RTOs and ISOs and the Commission’s expressed intent to look into revisions to the Order No. 888 pro forma tariff in a separate proceeding, we have concluded that the SMD NOPR has been overtaken by events. Accordingly, we will exercise our discretion to terminate this proceeding.” ( Federal Energy Regulatory Commission, Remedying Undue Discrimination through Open Access Transmission Service and Standard Electricity Market Design, Docket No. RM01-12-000, Order Terminating Proceeding, April 19, 2005, p. 3.) “The Commission is issuing this Notice of Inquiry to seek comments on whether reforms are needed to the Order No. 888 pro forma open access transmission tariff (OATT) and to the OATTs of public utilities to prevent undue discrimination and preference in the provision of transmission services.” (Federal Energy Regulatory Commission, Preventing Undue Discrimination and Preference in Transmission Service, Docket No. RM05-25-000, September 16, 2005, p. 1)

6


Restructuring (not deregulation) has produced dramatic changes across electricity systems around the world. Experience reveals many concerns with current progress and the basic idea of using markets for electricity.

• California Crisis

• Enron Implosion

• Northeast Blackout

• Price Increases

• Price Volatility

• Generation Resource Adequacy

• Transmission Investment Adequacy

• Transmission Cost Allocation

• Reliability Must Run Contracts

• …

A mixed bag of bad luck, bad policy, and bad press obscures real successes and real problems.

7

CommercialIncentives

ReliabilityRules

NetworkInteractions

Open AccessNon-Discrimination

EPAct 1992

Successful Market Design Challenge

SMD

ELECTRICITY MARKET Electricity Restructuring The public policy debate over reshaping the electricity industry confronts major challenges in balancing public interests and reliance on markets.

“The need for additional attention to reliability is not necessarily at odds with increasing competition and the improved economic efficiency it brings to bulk power markets. Reliability and economic efficiency can be compatible, but this outcome requires more than reliance on the laws of physics and the principles of economics. It requires sustained, focused efforts by regulators, policy makers, and industry leaders to strengthen and maintain the institutions and rules needed to protect both of these important goals. Regulators must ensure that competition does not erode incentives to comply with reliability requirements, and that reliability requirements do not serve as a smokescreen for noncompetitive practices.” (Blackout Task Force Report, April 2004, p. 140.)

• The emphasis should be on investment

incentives and innovation, not short-run operational efficiency.

• With workable markets, market participants spending their own money would be better overall in balancing risks and rewards than would central planners spending other people’s money.

• If not, electricity restructuring itself would fail the cost-benefit test.

8


The Federal Energy Regulatory Commission (FERC) reform proposals for Order 888 arise from frustration with electricity restructuring efforts and providing open access to transmission needed to support competitive markets. At its core, the debate identifies persistent disagreement about what open access means, and what models are available to achieve the purported benefits.

“Now, the goal of the NOI in this proceeding is very clear. It is spelled out in the title: Preventing Undue Discrimination and Preference in Transmission Service. We are not talking about market design. We are not talking about restructuring. We are talking about preventing undue discrimination and preference.” (Statement of Joseph Kelliher, Chairman, Federal Energy Regulatory Commission, Regarding Notice of Inquiry on Preventing Undue

Discrimination and Preference in Transmission Service, Docket No. RM05-25-000, September 16, 2005, emphasis added)

“The first time the Commission found Order No. 888 allowed undue discrimination and preference in transmission service occurred in 1999. The solution advanced by the Commission was restructuring: encouraging voluntary RTO formation, in Order No. 2000. … The second time the Commission found Order No. 888 allowed undue discrimination and preference took place in 2002. The solution advanced by the Commission at the time was also restructuring, this time mandating RTO participation and a standard market design. … The solution we advance today is not restructuring, but more effective regulation, reform of the open access rules themselves, for the first time in nearly a decade.” (Statement of Joseph Kelliher, Chairman, Federal Energy Regulatory Commission, Regarding Open Access Transmission Tariff (OATT) Reform (RM05-25-00), May 16, 2006.)

9

ELECTRICITY MARKET Electricity Restructuring The evolution of electricity restructuring contains a thread of issues related to counterintuitive market design requirements requiring coordination for competition.

• PURPA, 1978. The rise of the new generators. • EPAct, 1992. The 'camel's nose' of

wholesale competition. Issued in 1996, the Open Access Rule of Order 888 followed from a lengthy debate about the many details of electricity markets.

“Today the Commission issues three final, interrelated rules designed to remove impediments to competition in the wholesale bulk power marketplace … . The legal and policy cornerstone of these rules is to remedy undue discrimination in access to the monopoly owned transmission wires that control whether and to whom electricity can be transported in interstate commerce.” (FERC, Order 888, April 24, 1996, p. 1.)

Can open access not be about market design?

...Genco Genco Genco ...Genco Genco Genco...

...

Poolco

GridcoGridco

Competitive Wholesale Electricity Market Structure

Gen

erat

ion

Tran

smis

sion

Dis

tribu

tion

Regulated

Regulated

...Disco Disco Disco ...Disco Disco Disco...

Cust. Cust. Cust. Cust. Cust.Cust.... ...

System Operator

Regional Transmission Organization

10

ELECTRICITY MARKET Order 888 and the Contract Path Under Order 888 the FERC made a crucial choice regarding a central complication of the electricity system.

“A contract path is simply a path that can be designated to form a single continuous electrical path between the parties to an agreement. Because of the laws of physics, it is unlikely that the actual power flow will follow that contract path. … Flow-based pricing or contracting would be designed to account for the actual power flows on a transmission system. It would take into account the "unscheduled flows" that occur under a contract path regime.” (FERC, Order 888, April 24, 1996, footnotes 184-185, p. 93.)

Why is this important? A quick tutorial follows.

11

NETWORK INTERACTIONS Loop Flow Electric transmission network interactions can be large and important.

• Conventional definitions of network "Interface" transfer capacity depend on the assumed load conditions.

• Transfer capacity cannot be defined or guaranteed over any reasonable horizon.

OLDGEN

BIGTOWN

NEWGEN

300

MW

600=max

0 MW

900 MW

900 MW

POWER TRANSFER CAPACITY VARIES WITH LOAD(WITH IDENTICAL LINKS, TRUE CONSTRAINT ON LINE FROM OLDGEN TO BIGTOWN)

300

MW

900 MW? Or 1800 MW?

Is The "Interface" Transfer Capacity

OLDGEN

BIGTOWN

NEWGEN

600

MW

600=max

1800 MW

1800 MW

0 MW

1200 MW

INTER

FACE

INTER

FACE

12

NETWORK INTERACTIONS Loop Flow There is a fatal flaw in the old "contract path" model of power moving between locations along a designated path. The network effects are strong. Power flows across one "interface" can have a dramatic effect on the capacity of other, distant interfaces.

Transfer Capability Impacts1000 MW from VACAR to BG&E/PEPCO

Tran

sfer

Inte

rface

Impa

ct (1

000

MW

)

ECAR to MAAC

ECAR to VP

DUKE/CP&L to VP

ECAR to DUKE/CP&L

MAAC to VP

W.ECAR to OH

TVA to DUKE/CP&L

NYPP to MAAC

0.2

0.0

-0.2

-0.4

-0.6

-0.8

-1.0

-1.2

-1.4

-1.6

-1.8

-2.0

-2.2

-2.4

-2.6

Transmission Impacts Vary Across the Eastern System

Interface in Eastern Interconnected System

Source: VEM, Winter Operating Study, December 1993.

Contract PathAssumption(Impact = 0)

13

TRANSMISSION CAPACITY Definition Electricity restructuring requires open access to the transmission essential facility. A fully decentralized competitive market would benefit from tradable property rights in the transmission grid. However, the industry has never been able to define workable transmission property rights: "A primary purpose of the RIN is for users to learn what Available Transmission Capacity

(ATC) may be available for their use. Because of effects of ongoing and changing transactions, changes in system conditions, loop flows, unforeseen outages, etc., ATC is not capable of precise determination or definition. "

Comments of the Members of the PJM Interconnection, Request for Comments Regarding Real-Time Information Networks, Docket No. RM95-9-000, FERC, July 5, 1995, p. 8.

The problems are not unique to the U. S. They same issue arises in any meshed network, as in Europe and the regulations for European Transmission System Operators [ETSO]:

"Does the draft Regulation set the right objective when it requires TSOs to compute and publish transfer capacities? ETSO says both yes and no …in many cases the (Net transfer capacity or NTCs) may be a somewhat ambiguous information…The core of the difficulty raised by transfer capacities lies in the fact that they do not obey usual arithmetic: 'it makes no sense to add or subtract the NTC values…' Put it in other ways, in order to compute the maximal use of the network, one needs to make assumptions on the use of the network! This definition is restated and elaborated in ETSO (2001a) (p. 6)."

J. Boucher and Y. Smeers, "Towards a Common European Electricity Market--Paths in the Right Direction…Still Far From an Effective Design," Belgium. September, 2001, pp. 30-31. (see HEPG web page, Harvard University)

14

ELECTRICITY MARKET Order 888 and the Contract Path Under Order 888 the FERC made a crucial choice regarding a central complication of the electricity system.

“A contract path is simply a path that can be designated to form a single continuous electrical path between the parties to an agreement. Because of the laws of physics, it is unlikely that the actual power flow will follow that contract path. … Flow-based pricing or contracting would be designed to account for the actual power flows on a transmission system. It would take into account the "unscheduled flows" that occur under a contract path regime.” (FERC, Order 888, April 24, 1996, footnotes 184-185, p. 93.) “We will not, at this time, require that flow-based pricing and contracting be used in the electric industry. In reaching this conclusion, we recognize that there may be difficulties in using a traditional contract path approach in a non-discriminatory open access transmission environment, as described by Hogan and others. At the same time, however, contract path pricing and contracting is the longstanding approach used in the electric industry and it is the approach familiar to all participants in the industry. To require now a dramatic overhaul of the traditional approach such as a shift to some form of flow-based pricing and contracting could severely slow, if not derail for some time, the move to open access and more competitive wholesale bulk power markets. In addition, we believe it is premature for the Commission to impose generically a new pricing regime without the benefit of any experience with such pricing. We welcome new and innovative proposals, but we will not impose them in this Rule.” (FERC, Order 888, April 24, 1996, p. 96.)

Hence, although the fictional contract path approach would not work in theory, maintaining the fiction would be less disruptive in moving quickly to open access and an expanded competitive market!

15


The evolution of electricity restructuring thread ...

It won’t work in theory, but will it work in practice? • Order 888, 1996. Non-discrimination, Open

Access to Transmission. Contract path fiction would not work in theory.

• Capacity Reservation Tariff (CRT), 1996. A new model.

"The proposed capacity reservation open access transmission tariff, if adopted, would replace the open access transmission tariff required by the Commission ..."1

• NERC Transmission Loading Relief (TLR), 1997. The unscheduling system to complement Order 888.

• EPAct 2005. Continued support for competitive markets but conflicting signals on market design.

• Order 888 Reform NOPR, 2006. Too little. Too late?

1 Federal Energy Regulatory Commission, "Capacity Reservation Open Access Transmission Tariffs," Notice of Proposed Rulemaking, RM96-11-000, Washington DC, April 24, 1996, p. 1.

Contract Path Flow-Based Paths Point-to-Point

Contract Path Fiction Parallel Flows Flows Implicit

Transmission Capacity Definitions

OASIS Schedulesand TLR

Flowgate RightsFGs

Financial TransmissionRights

PTP-FTRsFinancialFG-FTRs

Obligations and Options

Physical

16

ELECTRICITY MARKET Order 888 Reform NOPR and ATC FERC’s Order 888 reform NOPR is largely silent on these issues. What little is said obscures the inconvenient truth. The Order 888 Reform NOI raised the question.

“In Order No. 888, the Commission stated that its use of the contract path model of power flows and embedded cost ratemaking was intended to initiate open access, but was not intended to signal a preference for contract path/embedded cost pricing for the future. The Commission further stated that it would entertain non-discriminatory tariff innovations to accommodate new pricing proposals in the future. Order No. 888 at 31,734-35. Should the Commission continue to use the contract path model in the future?” (FERC Order 888 Reform, NOI (emphasis in original), p. 13)

The resulting Order 888 Reform NOPR deflects the issue.

“…there are two main approaches to calculating [Available Transfer Capability] used in the industry. The first is the contract path approach, which is more commonly used by transmission providers in the Western Electricity Coordinating Council (WECC) region.[fn] The contract path methodology derives ATC directly from predetermined [Total Transfer Capability] … values derived consistent with contract path transmission rights. The second method is the flowgate[fn] approach, which is used more widely in the Eastern Interconnection.[fn] The flowgate methodology is based on physical power flow models. The flowgate calculation first determines [Available Flowgate Capability] and then converts AFC into ATC and derives TTC for the OASIS posting. The differences between the two approaches may not result in significantly different ATC values if consistent data inputs and industry acceptable modeling assumptions are used.” (OATT 2006 NOPR, pp. 79-80, emphasis added.)

17

ELECTRICITY MARKET Muddles The FERC has separate policies on many different topics related to electricity restructuring. These policies evolve with little or no consideration of their interactions.

Conge

stion

Manag

emen

t Balancing

Ancilla

ry

Service

s

Transmission

Rights

Electricity Market Muddles

"Details to follow"

SCED

ATC

Reliab

ility

Rules

ResourceAdequacy

18

ELECTRICITY MARKET Security Constrained Economic Dispatch Supply and demand equilibrium is the dual to economic dispatch. Security constraints define (many) limits on the feasible dispatch. Prices differ across locations to reflect the constraints.

“Market mechanisms should be used where possible, but in circumstances where conflicts between reliability and commercial objectives cannot be reconciled, they must be resolved in favor of high reliability.” (Blackout Task Force Report, April 2004, p. 139.)

MW

Energy Price(¢/kWh)

Q1 Q2 Qmax

Demand2-2:30 a.m.

Demand9-9:30 a.m.

Demand7-7:30 p.m.

Short-RunMarginal

Cost

Price at7-7:30 p.m.

Price at9-9:30 a.m.

Price at2-2:30 a.m.

SHORT-RUN ELECTRICITY MARKET LOCATIONAL SPOT PRICE OF "TRANSMISSION"

Pa = 51

Pc = 55

Pb = 66

Price of "Transmission" from A to B = Pb - Pa = 15Price of "Transmission" from A to C = Pc - Pa = -4

Price differential =

Marginal losses

+ Constraint prices

A

C

B

MW


Demand

Short-RunMarginal

Cost

MW


Demand

Short-RunMarginalCost

MW


Demand

Short-RunMarginal

Cost

Constraint

A decentralized market with supply and demand equilibrium over the network sets an ideal. But this “completely bilateral” market is not possible in the case of electricity.

19

ELECTRICITY MARKET Market Model (Re)formulating the model around the well-known principles of security-constrained economic dispatch integrates the pieces and simplifies or solves many of the most difficult policy problems.

Balancing

Ancilla

ry

Service

s

Conge

stion

Manag

emen

t

Transmission

Usage

Economic Dispatch

Security Constrained

Rel

iabi

lity

Rul

es

Tran

smis

sion

Cap

acity

Tran

smis

sion

Rig

hts

Res

ourc

e A

dequ

acy

Prices

Electricity Market Model

20

ELECTRICITY MARKET Coordination for Competition The Successful Market Design challenge dictates the need for some central institutions to support markets through the seeming oxymoron of “coordination for competition.” Central institutions differ in the degree of involvement and impact on the market. • Central Coordination. Organized markets required to facilitate exchange between willing buyers

and willing sellers in voluntary transactions. (E.g., energy purchase and sales in spot markets.)

o Design can be compatible with largely decentralized decisions. o Emphasis is on consistent incentives. o Evaluation remains neutral on market choices.

• Central Procurement. Administrative determination of required products and services with

imposition of mandatory payments as a condition of participation in the system. (E.g., operating reserves with charges collected through uplift payments.)

o Emphasis is on assured outcomes. o Central judgment and mandatory payment replace market forces. o Slippery slope could undermine broad purpose of electricity restructuring.

21

ELECTRICITY MARKET A Consistent Framework The example of successful central coordination, CRT, Regional Transmission Organization (RTO) Millennium Order (Order 2000) Standard Market Design (SMD) Notice of Proposed Rulemaking (NOPR), “Successful Market Design” provides a workable market framework that is working in places like New York, PJM in the Mid-Atlantic Region, New England, and the Midwest.

Poolco…OPCO…ISO…IMO…Transco…RTO… ITP…WMP…: "A rose by any other name …"

CoordinatedSpot Market

Bid-Based,Security-Constrained,Economic Dispatchwith Nodal Prices

The RTO NOPR Order SMD NOPR "Successful Market Design" Contains a Consistent Framework

07/05

Bilateral Schedules

Financial Transmission Rights

Lice

nse

Plat

e A

cces

s C

harg

es Market-D

riven Investment

at Difference in Nodal Prices

(TCCs, FTRs, FCRs, CRRs, ...)5/99

12/9907/02

22

ELECTRICITY MARKET Path Dependence The path to successful market design can be circuitous and costly. The FERC reform proposals for Order 888 illustrate “path dependence,” where the path chosen constrains the choices ahead. Can Order 888 be reformed to overcome its own logic? Or is FERC trapped in its own loop flow?

Paths to Successful Market Design

CoordinatedSpot Market

Bid-Based,Security-Constrained,Economic Dispatchwith Nodal Prices

Bilateral Schedules

Financial Transmission Rights

Lice

nse

Plat

e A

cces

s C

harg

es Market-D

riven Investment

at Difference in Nodal Prices

(TCCs, FTRs, FCRs, CRRs, ...)

888

TLR

ContractPath

ISOPX

Flowgate

Zonal

RulesExplode

SMD

"Simple,Quick"

"Last Resort"

ATCTransmission

RightsBalancing

Organized Market

888Reform

StandardizationTransparency

23

William W. Hogan is the Raymond Plank Professor of Global Energy Policy, John F. Kennedy School of Government, Harvard University and a Director of LECG, LLC. This paper draws on work for the Harvard Electricity Policy Group and the Harvard-Japan Project on Energy and the Environment. The author is or has been a consultant on electric market reform and transmission issues for Allegheny Electric Global Market, American Electric Power, American National Power, Australian Gas Light Company, Avista Energy, Barclays, Brazil Power Exchange Administrator (ASMAE), British National Grid Company, California Independent Energy Producers Association, California Independent System Operator, Calpine Corporation, Canadian Imperial Bank of Commerce, Centerpoint Energy, Central Maine Power Company, Chubu Electric Power Company, Citigroup, Comision Reguladora De Energia (CRE, Mexico), Commonwealth Edison Company, Conectiv, Constellation Power Source, Coral Power, Credit First Suisse Boston, Detroit Edison Company, Deutsche Bank, Duquesne Light Company, Dynegy, Edison Electric Institute, Edison Mission Energy, Electricity Corporation of New Zealand, Electric Power Supply Association, El Paso Electric, GPU Inc. (and the Supporting Companies of PJM), GPU PowerNet Pty Ltd., GWF Energy, Independent Energy Producers Assn, ISO New England, Luz del Sur, Maine Public Advocate, Maine Public Utilities Commission, Merrill Lynch, Midwest ISO, Mirant Corporation, JP Morgan, Morgan Stanley Capital Group, National Independent Energy Producers, New England Power Company, New York Independent System Operator, New York Power Pool, New York Utilities Collaborative, Niagara Mohawk Corporation, NRG Energy, Inc., Ontario IMO, Pepco, Pinpoint Power, PJM Office of Interconnection, PPL Corporation, Public Service Electric & Gas Company, Reliant Energy, Rhode Island Public Utilities Commission, San Diego Gas & Electric Corporation, Sempra Energy, SPP, Texas Genco, Texas Utilities Co, Tokyo Electric Power Company, Toronto Dominion Bank, TransÉnergie, Transpower of New Zealand, Westbrook Power, Western Power Trading Forum, Williams Energy Group, and Wisconsin Electric Power Company. The author benefited from comments by Jim Bushnell, Michael Cadwalader, Keith Casey, John Chandley, Debabrata Chattopadhyay, Ross Baldick, Steve Greenleaf, Andrew Hartshorn, Scott Harvey, Lorenzo Kristov, Yakout Mansour, Dmitri Perekhodtsev, Susan Pope, Mark Rothleder, Roy Shanker, Anjali Sheffrin, and Shams Siddiqi, among others. The views presented here are not necessarily attributable to any of those mentioned, and any remaining errors are solely the responsibility of the author. (Related papers can be found on the web at www.whogan.com).

MARKETS, MODELS AND MUDDLES: ELECTRICITY RESTRUCTURING

Documents

Transcript of MARKETS, MODELS AND MUDDLES: ELECTRICITY RESTRUCTURING