The History of Competitive Wholesale Markets

The Need for COMPETITION

Before federal and state electric restructuring in the 1990s, the nation was dependent on vertically-integrated utilities with defined exclusive service territories. These utilities, many of which still exist today, generate electricity at central station power plants they own, move the power over their own high-voltage transmission lines to load within their service territories, and operate the local distribution wires over which that electricity reaches consumers.

As franchised monopolies, these utilities are subject to state cost-of-service rate regulation. Regulators set rates such that, at least in theory, these monopoly utilities are only allowed to recover prudently incurred costs and a rate of return based on their capital structure. While several regions remain dependent on such utilities, that is no longer the case in most of the country.

Serious concerns about how vertically-integrated utilities operated began to emerge in the 1970s and 1980s with vigorous debates in Congress and before state legislatures. Lack of competition and the cost-based nature of traditional regulation meant that utilities were rewarded for higher costs, not lower ones. Multi-billion dollar cost overruns and construction delays were increasingly common with attendant costs passed on to captive ratepayers.

Vertically-integrated utilities, often with relatively small geographic footprints, meant that each utility built more and more power plants to service its exclusive territories. This was rightfully seen as highly inefficient and ultimately costly for consumers. Sadly, history is repeating itself again today with several multi-billion-dollar cost-of-service, rate-based projects under way that are following the well-worn path of cost overruns, delays and higher consumer costs. Utilities controlled transmission lines which allowed them to block access to or through their systems by competitors. At the same time, greater reliance on market forces was largely working in transportation and telecommunications sectors, delivering dividends for decades.

Congress Takes action

Congress took the first steps toward competition at wholesale through the Public Utility Regulatory Policies Act of 1978 (PURPA) that among other provisions required utilities to purchase power from certain renewable and small power plants known as “qualifying facilities” (“QFs”). This law proved that power generation is not a natural monopoly requiring the same entity to control generation, transmission and distribution through the award of the exclusive right to operate in a defined customer territory.

Congress on a bipartisan basis added provisions to the Energy Policy Act of 1992 that directed the Federal Energy Regulatory Commission (FERC) to allow greater non-discriminatory access to the transmission system for power producers other than the vertically-integrated utilities. The 1992 law also created “exempt wholesale generators” to allow independent power producers to pursue larger scale projects than those allowed by PURPA.

FERC implemented the 1992 law through a series of landmark bipartisan orders. These orders imposed open access requirements on transmission owners so that new entrants independent of the vertically-integrated utility could get their power to customers choosing to purchase it. FERC also promoted the voluntary formation of entities to operate the grid independently of the owners of the transmission lines. These entities (Independent System Operators and Regional Transmission Organizations) began to run wholesale markets through which power plants are dispatched on a least cost basis regardless of who owns them so that consumers receive the benefit of the least cost mix of supply resources to meet demand for electricity at any given time. In addition, some states restructured their retail electricity systems, including by unbundling power generation from traditional cost-of-service rate-regulation, and allowing entities other than vertically-integrated utilities to sell power at retail.

market Reforms lead to consumer benefits

The combination of greater wholesale and retail competition fundamentally altered the economics in a way better suited to consumers. Instead of cost-plus rates paid by captive customers, suppliers within what became known as “organized markets” had to earn revenues through sales in competition with others. No longer would simply spending more mean making more in profits.

Predictably, with economic incentives better aligned, competitive power producers took over existing power plants, getting more out of them: capacity factors increased considerably, refueling times at nuclear plants shortened dramatically, and the fuel efficiency of coal plants increased substantially.

At the same time, new entrants deployed new technologies and resource types such as wind, solar and combined-cycle natural gas plants. It is undeniable that but for the courageous leadership of key policymakers in the 1990s (in Congress, the Department of Energy, and at FERC), and the risk-taking, competitive power sector entrepreneurs that then made the policy vision a marketplace reality through their own investments, the country would not be standing on the platform that exists today to usher in the next wave of cleaner, more reliable, and flexible sources of electricity.

The public policy lesson is clear: Investment decisions as to existing and new electricity resources are best made, as they are generally in a market-economy, through well-functioning markets that place much greater risks on, and commensurately reward, developers, owners, operators, and investors better able to manage those risks, as opposed to forcing those risks and their associated costs on captive customers with little or no choice but to pay up for mistakes and miscalculations made by others in their name.

Wholesale power markets today

The power sector is in the early stages of what will likely be a multi-year, even multi-decade, series of profound changes to how electricity is generated and consumed. For starters, the correlation between economic growth and demand for electricity has weakened so volumetric-based revenues weaken as well. While evolutionary in apparent pace, the end result could be revolutionary compared to the system today.

Wholesale competitive power markets have been decades in the making and continue to evolve while providing a range of demonstrable and quantifiable benefits to consumers, the environment and the economy. For this to continue, all electricity business models and their regulatory paradigms – whether cost-of-service regulation of vertically-integrated utilities or market design, tariffs and operator practices in “organized markets” – must rapidly improve to keep pace with the changes occurring due to technological, economic and policy developments that could upend the status quo.

Potentially disruptive technologies are poised to deliver substantial benefits for customer choice, decarbonization of the power sector, economic efficiency and growth, and greater resiliency. However, these changes will not happen overnight. A major challenge is how to ensure that different policymakers – at the federal and state levels – allow these resources to compete against regulated monopolies that continue to exist at the distribution level.

Regulatory models should welcome new entrants and ways of doing things, while recognizing that for years to come the bulk power system will need to accommodate both central station power plants and greater distributed resources (on and off the grid) to maintain reliability. The bulk power system is physically and financially interconnected in deeply entwined ways not present in other sectors of the economy where the “Internet of things” and the “shared economy” have taken greater root.  Nothing will  repeal the laws of physics and fundamental economic principles. Competition at all levels of the grid helps contain consumer costs.

Preparing for the market of the future

The rapidly changing electricity landscape is undeniable: natural gas production growth of higher volumes at lower prices; increased intermittent renewables because of lower costs, state government mandates, and federal tax credits; increased production and end-use efficiency; increased interdependencies, such as those between the electric and natural gas sectors; and heightened awareness of cyber and physical security.

EPSA has always stressed that reliability requires ample supplies of affordable and environmentally responsible electricity. This requires generation from a network of plants operating simultaneously with base load, mid-merit and peaking capabilities deploying a range of fuels and technologies because electricity demand fluctuates hourly and seasonally.

EPSA’s preferred solutions are market-based mechanisms that are fuel neutral. This means defining attributes and letting those who can provide them compete in well-functioning wholesale markets.  That is easier said than done given numerous, on-going federal and state policy debates, the outcome of which could undermine the ability of wholesale power markets to perform reliably and efficiently.  The most cost effective solution is to allow existing resources to compete with newer technologies on a level playing field.