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Overview Carnegie Mellon Electricity Industry Center (CEIC)

Beyond Blind Faith: Rethinking Electricity Restructuring Seth Blumsack Carnegie Mellon University blumsack@cmu.edu. Overview Carnegie Mellon Electricity Industry Center (CEIC). One of 27 Sloan Centers of Excellence in different industries

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Overview Carnegie Mellon Electricity Industry Center (CEIC)

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  1. Beyond Blind Faith: Rethinking Electricity RestructuringSeth BlumsackCarnegie Mellon Universityblumsack@cmu.edu

  2. OverviewCarnegie Mellon Electricity Industry Center (CEIC) • One of 27 Sloan Centers of Excellence in different industries • 17 Faculty and 22 Ph.D. students at CMU, 9 Ph.D.s granted so far. • Probably the largest effort of its kind in the world focused on interdisciplinary problems of the electricity industry. • Close cooperation with all stakeholders: Industry, regulators, government agencies, consumers, labor, national laboratories. • Strategic focus on issues of middle and long-term importance • Focus scientific knowledge to clarify the big picture issues and work though individual projects on: • Market Structure and Performance • Distributed Energy Resources • Advanced Generation and Transmission Technologies • Environmental and Sustainability Issues • Reliability and Security

  3. Overview • Deregulation or better regulation? • Why RTO markets may inherently raise costs • Retail competition has not lowered electricity prices • Investment: What can LMP tell us? • The good, the bad, and the ugly of LMP • Current RTO and market challenges

  4. Why Did We Need Deregulation Restructuring To Do Something in the First Place?

  5. U.S. Net Electric Generation 70 B kWh / year (10,000 MW/yr) 7¾ % / year

  6. Why Not Reform Regulation? • 1970s energy crises increased fuel costs, shifted demand growth from exponential to linear • Utility generation/transmission investments became “white elephants” • Regulators had no choice but to allow utilities to pass costs on to consumers, increasing prices • Consumer anger with utilities and regulators, accusations of “gold-plating” • Oil and gas deregulation followed by lower prices

  7. Effective regulation requires expertise and information – even the best regulators have less of both than the companies they’re trying to regulate!

  8. Creating Competitive Electricity Markets May Inherently Raise Costs

  9. Marginal and Average Cost Pricing

  10. Uniform Price Auctions

  11. Are Electricity Markets Competitive? The usual market concentration metrics (HHI, etc.) do not translate well into electricity markets. A better notion is the pivotal supplier – a single supplier or group of suppliers is pivotal if their capacity exceeds the spare capacity of the system as a whole – buy from them or suffer blackouts! • Example of a “pivotal” monopolist • Suppose that: • Total generation capacity is 100 MW; • Firm M controls 18 MW; • The ISO announces that it seeks to buy 90 MW; • Results: • Firm M knows that it has monopoly power! • If every other firm in the market had less than 1% of market share, the conventional HHI would be 324.

  12. Should We Worry About Groups of Pivotal Suppliers? Yes! Sarosh Talukdar has simulated markets that have 10 suppliers or 10 demanders, each with 10% of capacity Red: Inelastic Demand Blue: Elastic Demand

  13. Pivotal Firms in CA, PJM, NYISO, 2000/2001

  14. Mitigating Pivotal Suppliers • Have price caps & force generators to offer power at variable cost when demand is high • Build more generation • Build more transmission • Break up firms to keep them small • Change structure: Eliminate hourly auctions Each of these would work, but would involve substantial costs – many would be more costly than the ~10% efficiency improvements attributed to restructuring.

  15. Price Caps Current FERC regulations: • Price caps to keep price in control • Require pivotal firms to offer electricity at variable cost when demand is high • Firms could never cover their fixed costs and so no future investment

  16. Expand Generation Capacity This will do the job, but the costs can be substantial – would increase costs by at least 2 cts/kWh in any RTO. Assumptions: $600/kW capital cost, 10% discount rate (CAPM), all new generation is gas-fired with a 30-year economic life, capacity is on standby during hours with pivotal suppliers.

  17. Expand Transmission Capacity This will only work if cheap imports are readily available – could be true in California, but probably not in the Eastern Interconnect Demand correlation matrix – Western States Demand correlation matrix – Eastern Interconnect

  18. Force Large Generators to Divest This would reduce market power but might also reduce operational efficiency – there is evidence of this from the nuclear sector

  19. Increased Risk in a Capital-Intensive Industry • Merchant debt has dropped to junk; IOU debt below A grade • Public power debt still has A grade • For a new coal plant, capital is at least 2/3 of total cost. Investors demanding 15% or 20% instead of 10% can increase costs by 1 to 5 cts/kWh Source: The Brattle Group

  20. RTOs Are Costly Institutions • Startup costs for California ISO estimated at $500 million to $1 billion, with operating costs of $200 million/year • PJM has operating costs of $250 million/year Source: Public Power Council

  21. Retail Competition Has Not Lowered Industrial Electricity Prices

  22. Why Retail Competition? Restructuring in the electric power industry was supposed to lower costs, increase efficiency, and make markets more competitive. How have we done? “…more than $3 billion in savings in 2002 in the Mid-Atlantic (PJM) region…approximately $28.5 billion in future savings…additional macroeconomic benefits should double the direct customer benefits…” (Excerpts from Benefits of Competition in the Mid-Atlantic Region, Center for the Advancement of Energy Markets) Sounds Great!

  23. What is Really Going On? To the extent that retail prices have fallen, it is because regulators have mandated rate-cuts and freezes. Many of these expire soon… Some Proposed Retail Rate Increases Connecticut Light & Power: 22% Delmarva Power: 56% to 117% TXU Corp. (Texas): 80% (actual, not proposed) NStar (Massachusetts): 60% to 80% Baltimore Gas & Electric: 72% proposed, at least 15% actual

  24. We examine industrial sales and revenue data from EIA forms 826 and 861

  25. CA NV AZ OR WA

  26. RI NH MA CT VT

  27. Spot vs. long term Large Customers Should Have Been the Beneficiaries of Retail Competition • They have the option to purchase power in bilateral contracts through RFP / direct negotiation for block purchases; they can become their own load-serving entity and buy in the wholesale market. They are getting killed.

  28. What Can LMP Tell Us About Investment?

  29. Investment Issues Under Restructuring • Restructured markets have not had a stellar record encouraging investment. What is going on here? • Merchant generation investment and the gas bubble • Capacity markets, price caps, and resource adequacy • Transmission • What is the role of LMP in all of this?

  30. Restructuring and Natural Gas Consumption for Electricity Natural Gas Price

  31. Capacity Markets Out-of-market purchases, Reliability pricing model, etc…

  32. Capacity Markets and LMP • Uniform price auction used in RTO markets starves the peakers and transfers these “rents” to baseload plants. • LMPs are incredibly volatile, as are spot prices for every energy commodity – short-run demand curve is highly inelastic, and short-run supply curve is very steep near the capacity constraint. • Capacity payments are a political “second-best” solution to get peakers and newer generators into the market when the RTO uses caps and other mechanisms to keep LMPs low. • Does a depreciated 50-year old nuke with MC = 1.5 cts/kWh actually need a capacity payment?

  33. The Transmission Grid is Under Stress • TLRs increasing • Average and total congestion costs increasing in restructured systems • Investment in high-voltage lines declining

  34. Whatever Happened to Merchant Transmission? “The real difference between the U.S. and France is that American economists believe that markets work in theory but not in practice, whereas French economists believe that markets work in practice but not in theory.” -- Ezra Beeman of CERA (Paris) North American RTOs have been demonstrating a distinctly Gallic flair. They are still trying to attract merchant AC transmission investment, dangling FTRs as carrots.

  35. Merchant Transmission in Theory • Locational marginal prices (LMP) are investment signals; differences in LMPs tell investors where to upgrade existing lines or where to build new lines • Investors are given financial rights to the congestion revenue, in the form of point-to-point rights (Financial Transmission Rights or FTR) • The holder of an M megawatt FTR, defined between nodes a and b in the grid, at time t receives • FTR Revenue: M  (LMPa,t – LMPb,t)

  36. Merchant Transmission Critique #1 I can profit from building a line that causes congestion!

  37. Merchant Transmission Critique #2 • LMP differences do not capture the system cost of congestion • If the line is expanded, the LMP difference disappears. Why would anyone invest in a system like this?

  38. Merchant Transmission Critique #3 • Building line (2,3) causes congestion, but may provide a reliability benefit. • Merchant transmission assumes that congestion and reliability are independent.

  39. Policy Assumes Congestion and Reliability are Separable and Independent • Congressional, FERC, and RTO policy divides transmission investments into those which enhance reliability and those which reduce congestion: • Federal Power Act, Sec. 215(e): FERC has regulatory jurisdiction over economic transmission matters (i.e., congestion), and the ERO has jurisdiction over technical matters (i.e., reliability). • Merchant AC transmission via transmission congestion contracts, participant funding, congestion reduction, etc. • Cost allocation for new lines based on a reliability or congestion designation. Lines for reliability have their costs socialized, while lines for congestion are paid for by designated “beneficiaries.”

  40. Congestion and Reliability are Almost Never Independent • Simple simulations on a 118-bus network to isolate the contributions of individual lines to congestion and reliability. • Those that cause congestion also tend to increase reliability.

  41. Is Merchant Transmission the Problem? • Actually, no. The real problem is with using LMP to compensate transmission investment. • Merchant transmission has been the policy of FERC and RTOs for several years – FTRs have not gotten a single merchant line built! • Long-term contracts have gotten lines built (e.g., Neptune line)

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