Pennsylvania Utility Regulator Holds Hearings on Flaws in Wholesale Power Markets

Concerned About Rising Wholesale Electricity Prices, Pennsylvania's State Utility Regulator Holds Hearings
The Pennsylvania Public Utilities Commission (PUC) is holding a series of en banc hearings on the effects of the functionally deregulated wholesale electric power markets. See Wholesale Energy Markets En Banc Hearings. Pennsylvania, along with New York and 13 other states, adopted restructuring schemes that led to the sale by traditional utilities of their all power plants to new owners, who in turn would sell their output at wholesale market rates under FERC jurisdiction.

On October 23, ISO/RTO proponents testified. The largest RTO, PJM Interconnection, claimed in its testimony that "rising wholesale electricity prices are being caused by changes in wholesale market fundamentals, including the rise in the costs of fuel, and not because PJM’s market is dysfunctional or incapable of containing prices to reasonable levels. PJM’s wholesale market is competitive, and the prices established in the market are fair and reasonable." This invocation of fuel price increases is deceptive, perhaps calculated to resonate with everyone's experience with high energy costs. It is a familiar refrain based on wishful market thinking that ignores the real impact of fundamental flaws in market design, flaws in ISO/RTO operations, gaming, market power, and high ISO/RTO costs incurred to run and watch their "organized" spot markets. See It was the [NYISO] Market.

Dominated by producers and sellers, the ISO/RTO could be seen as performing the functions of a legalized cartel, i.e., a combination of independent business organizations formed to regulate production, pricing, and marketing of goods by the members. In these markets, all sellers receive the same price, based on price demands and what the market will bear, rather than cost, regardless of the reasonableness of the charges.

On November 7, critics appeared and testified about the problems of the ISO/RTO markets.

Alcoa
Alcoa Corporation testified that "in many ways, the reality of retail electric deregulation and competition has fallen far short of the vision that we had for this experiment when we embarked upon it a decade or so ago." Alcoa graphically demonstrated that electricity costs at its Lancaster Pennsylvania aluminum plant are soaring far above the cost in other states that did not "restructure" like Pennsylvania and New York, and testified that it closed major industrial operations due to the impact of the FERC-approved spot markets in Maryland and Texas, which have market designs similar to those of the NYISO:

Alcoa has direct, first-hand experience with the havoc wrought by flawed market structures in both PJM and ERCOT. Our aluminum smelter in Frederick, Maryland closed in 2006 when Maryland’s move into the PJM market was completed and we were no longer able to obtain long-term, competitively priced power. Ultimately, this eliminated 700 great jobs and all of the things within that community that went with them. Just a few weeks ago, Alcoa announced that we have been forced to curtail production at our Rockdale, Texas smelter and eliminate 820 jobs because of local power price and supply issues driven by the ERCOT market.

I urge Pennsylvania to join Ohio and other states in the creation and appointment of a dedicated advocate at FERC. This role would be empowered to represent the consumers of the Commonwealth in FERC proceedings and engage with those states to form a coalition to correct the structural defects built into the FERC and “stakeholder” proceedings and bring back needed balance of interests.

Within the Commonwealth, this Commission should encourage and seek to require the electric distribution companies, load serving entities and utilities under its jurisdiction toobtain an increasing share of the power that they need to serve their ratepayers via longer termed contracts. This would reduce and eventually eliminate the impact of the daily and next-day clearing markets on the price paid by consumers for most of the electricity they need, while also lending needed stability and predictability to that pricing. * * * *

Finally, to the degree that forces seek to eliminate industrials from eligibility for stable, predictably priced supply from the utilities, the Commission should resist such forces to its full ability, and at every opportunity.

A recent malfunction of the NYISO markets due to gaming by unnamed market perticipants reportedly cost Alcoa an extra $5 million at its New York plant in the first half of this year. Agency Says Power Costs Inflated: Alcoa's Bill Jumps $5m in First Half of '08; FERC Probes Charges of Manipulation, Watertown Times, August 30, 2008.

ELCON
Significantly, the Electricity Consumers Resource Council, ELCON, which along with Enron and many others championed restructuring in the 1990's, testified that the changes it and policymakers in the 15 restructured states had hoped for -- real competition and lower prices -- did not materialize:

ELCON was perhaps the earliest national group to advocate increased competition in the electric utility industry. Our members operate in competitive global markets and appreciate the efficiencies of open competition compared with poorly regulated centralized markets. However, after roughly a decade of experience with restructuring there are clear indications that the ISO and RTO markets are too costly, not truly competitive, and fail to deliver net consumer benefits.

**** Real competition has not been realized, and if it had, it should be self-evident. Restructuring has replaced a state regulatory regime that had at least some end-user focus and rates based on average costs with a costly ISO/RTO federal regulatory regime that has no end-user focus and rates based on the highest accepted bid, which need not be based on marginal cost.

* * * *We originally envisioned a market in which both suppliers and consumers would hedge commodity price volatility with long-term bilateral contracts. Long-term forward markets decrease spot market prices and enhance efficiency. In fact, one of the authors of nodal (LMP) pricing assumed the same. *** The robust, liquid forward market created with those contracts would provide investors with the same or better price security as a traditional utility rate base. It didn’t happen. Instead, for all practical purposes, consumers that need to hedge the commodity price risk simply can’t do so. Their choice is simple. Take the unbundled spot price (the highest bid clearing the market) or take a contract based on estimates of the same spot price bundled with a huge risk premium. That is not a hedge – and it certainly is not the result of a competitive market.

According to ELCON, its "member companies consume nearly six percent of all the electricity used in the United States." Some retail "big box" store chains, who make extremely large sums for coordinating their air conditioning use on hot days, and who may have on-site generation of their own, still support the restructured system, but with the defection of ELCON, it is increasingly rare to find any bona fide consumer proponents of the deregulated electricity markets.

Dr. Kenneth Rose
Kenneth Rose, Ph.D, an economist and researcher who performed annual reviews of the results of restructuring for the Commonwealth of Virginia for many years, testified on the main explanation for high wholesale electricity spot market prices put forward by market proponents, viz., that they are due to rising natural gas prices.

While natural gas cost does appear to be correlated to the electricity energy prices, natural gas only accounted for 7.7 percent of the generation in PJM during 2007. Coal and nuclear sources accounted for almost 90 percent of the generation. *** The typical explanation for this disproportionate impact of natural gas on wholesale power prices is that natural gas is often the marginal fuel. In PJM, as in several other RTOs, the price for the units selected for dispatch is set by the highest offer price from a dispatched unit, or the marginal unit. During peak hours relatively more expensive units are used to meet demand and often these units use natural gas. As a result, the wholesale price can climb quickly and to hundreds of dollars per MWh when these units are dispatched.

However, while natural gas may be on the margin often and during peak times, it is not the fuel that is most often on the margin during the year in PJM – coal is on the margin for more hours. For total hours during the year in 2007, coal was the marginal fuel 70 percent of the hours, while natural gas was for 24 percent, and a mix of several different energy sources was used for the remaining 6 percent. Again, as with percent of generation, natural gas appears to have a disproportionate impact on the price of electricity.

* * * * I am in complete agreement with [PJM Market Monitor] Joe Bowring, when he states that, “Given higher fuel prices, higher electricity prices do not mean that there is something wrong with the wholesale power market.” This is true, you cannot draw conclusions based solely on the fact that prices have gone up, or down for that matter. He continues, “In a perfectly competitive market, changes in input prices will change the price of the final product.”*** This is true as well, however, it is also true that with monopoly or oligopoly, changes in input prices will change the price of the final product. Simply put, electricity price changes and its correlation with fuel costs is not a substitute for careful analysis of market performance.

Dr. Rose called for release of cost data to determine if, in fact, the spot markets are operating as in theory they should, or if sellers are exercising market power.

PJM Industrial Customer Coalition
The PJM ICC testimony showed how wholesale power from the same power plant is priced higher when it is sold in the PJM market, and how the benefits of lower cost power plants have been transferred from consumers to producers due to the wholesale market design in which all plants are paid the price demanded by the last plant needed to clear the market:

Consider the following real-life example. A customer has two plants, with nearly identical operating characteristics, one in an area of Maryland in which customers are directly exposed to PJM market prices and one in West Virginia, where rates are still regulated based on actual costs. Both plants are customers of the same utility – Allegheny Power System (APS). The only difference is that one plant has the good fortune of being located in West Virginia and the other has the burden of being located in Maryland where customers are directly exposed to PJM prices. In 1997, the two plants paid nearly identical prices – just over 3 cents per kWh. However, as of August 2008, a very large rate differential has developed between the 2 plants. The West Virginia plant now pays just under 4 cents per kWh, an increase of less than 33% over the 9-year period. The Maryland plant, in sharp contrast, now pays more than 7 cents per kWh, an increase in excess of 100% over the same 9-year period. When all variables are isolated except for exposure to organized market prices, it becomes clear that customers are not benefitting from the PJM market design and many are being seriously harmed.

* * * *So, we are left with a design that is premised upon a "no generator left behind" pricing policy. Instead of targeting customer payments to the actual revenue requirements of each unit in the fleet, we are now ignoring revenue requirements altogether except for the revenue requirement of the most expensive unit needed to reliably serve load. We then pay all generators as if they, too, carried that most expensive revenue requirement.

In addition to the energy spot market design, PJM ICC and other witnesses were critical of the PJM capacity market intended to induce new resources indirectly. Various capacity market schemes have been created by the ISO/RTOs which have greatly increased prices without achieving much in the way of results. See Cornell Professor Gives Low Marks to NYISO Electricity Markets, quoting Professor Timothy Mount:

the LICAP market has been an expensive and an ineffective way to maintain generation adequacy. In 2005 and 2006, customers paid over $1 billion/year in the LICAP market in NYC and merchant investors were still reluctant to commit to specific in-service dates for new generating units that have already received licenses for construction. This amount of money is enough to finance over 12,000 MW of new peaking capacity at a capital cost of $80/kW/Year (from Table A1 in the Appendix), and this amount of additional capacity would more than double the installed generating capacity in NYC.

PJM ICC noted that the Ontarioa Independent Electricity System Operator is "moving away from reliance on single-clearing price markets to accomplish the reliability objectives that single clearing price markets were not designed to cost-effectively accomplish."

APPA
Historically, The American Public Power Association (APPA) fought hard to open up equal access to the bulk electric power transmission grid because its members, many of whom are local municipal utilities, often had difficulty in buying power from sources other than the owner of the transmission lines, or in transmitting power across lines owned by other utilities. APPA testified about how the new ISO/RTO markets had driven up prices for its members that had to rely on wholesale power purchases:

[P]ublic power systems have experienced first hand the difficulties of obtaining reasonably priced and reliable wholesale power supplies. For example, wholesale power costs for the municipal utilities in New Jersey doubled between 1992 and 2007—and then doubled again in 2008. ***Public power systems in Maine have witnessed significant increases as well, including one which experienced a tripling of its power costs within a two-year period. Other public power systems are taking “offensive” action to reduce their reliance on wholesale power markets. American Municipal Power-Ohio, the joint action agency providing wholesale power supplies to 122 public power systems in Ohio and five other states (including 26 public power systems in Pennsylvania), has embarked upon a program to build and own new generation, including both coal-fired generation and run-of-the-river hydro. ***The purpose of these measures is to insulate its member public power systems and their retail customers from the volatile wholesale electric market to the maximum extent possible, by reducing AMP-Ohio’s overall dependency on wholesale market purchases of electricity to meet demand.

In contrast, in New York the PSC is still insisting that utilities get rid of their power plants and buy energy for their customers in the wholesale markets influenced by NYISO spot market prices. See PSC Typical Electric Bills Show Trend of Higher Prices and Volatility.

APPA testified that in contrast to their grid coordination functions, the FERC-approved ISO/RTOs have not succeeded in their market operations:

Supporters of the current market structure, including unregulated generators and their affiliates, characterize RTO-run power supply markets as “competitive.” They strenuously charge that critics of RTO markets are opposed to “competition.” But APPA makes no apology for its EMRI effort, or for its advocacy effort to spotlight problems with RTO-run centralized wholesale power markets. These are highly complex, bureaucratic, centrally administered markets subject only to the lightest-handed regulation, with little true data transparency. Contrary to claims advanced when FERC approved these markets, retail consumers have suffered from the removal of regulatory protections. To quote the popular bumper sticker, “[i]f you are not appalled, you haven’t been paying attention.”

APPA faulted FERC for refusing to examine the workings of the ISO/RTO markets in a recent generic rulemaking case regarding the "organized markets," saying that "in failing to undertake in the rulemaking proceeding a comprehensive review of RTO-run centralized wholesale power markets, and the prices those markets produce, FERC . . . failed to carry out its statutory responsibilities to protect consumers."

Further Hearings
The Pennsylvania PUC is holding further hearings on December 18. Audiocasts and testimony are available at the PAPUC web page for the hearings. These hearings represent a healthy curiosity on the part of a state regulator that handed much of its powers over to federally deregulated markets. New York's PSC, still enthralled by deregulation, remains in the "three monkeys" mode, i.e., "see no evil, hear no evil, speak no evil" about the NYISO markets.