Market Design

This paper decomposes the effects of the transition from an average cost distribution tariff to a cost causation based distribution tariff, in terms of time and location, that uses nodal prices to recover losses and an “extent-of-use” method to recover fixed network costs based on use at coincident peak. Our decomposition is designed so that the effects of using coincident peak and location for fixed network charges, as well as using marginal losses under constraints recovering the exact amount of losses, and recovering exactly the cost of network service in total can be isolated and analyzed separately. We apply our tariff transition and decomposition method to an example network with data from Uruguay to isolate the various effects with and without a distributed generation (DG) resource. We show moving to coincident peak charges and to fully charging for marginal losses while rebating the merchandising surplus through the fixed charges have the greatest effects on changes in distribution tariff charges. DG provides countervailing cost changes to distribution tariffs for loads through loss reductions and the implicit “creation” of new network capacity for which it is paid. The interaction of all these effects may lead to outcomes that are counter-intuitive, which further supports the need to decompose the tariff changes to fully understand the reasons for the direction and magnitude of changes in tariff charges in the transition to tariffs based more on cost causation.

Executive Summary

In the framework of the EC Regulation 1228/2003, the goal of this background paper is to provide a description of the different market based solutions available for transmission risk hedging in congestion management. This paper presents three different transmission risk hedging products that can be offered to the market in the field of cross-border trade and congestion management. Due to various facts several price zones exist within the overall European electricity market where the demand of each zone is met in real time by the production of the respective zone and a zone specific market price is found (e.g. on the respective Power Exchange). This raises the question of how a market player wishing to buy electricity in a certain price zone and to sell it in another one can hedge the risk of a price difference emerging between those zones. This paper describes the three main kinds of transmission risk hedging products identified by ETSO: • Physical Transmission Rights (PTRs); • Financial Transmission Rights (FTRs); • Financial Contracts for Differences (CfDs); The paper also provides a first evaluation of the different solutions adopting a markets’ perspective. From a practical perspective, the implementation of forward PTRs only requires a minimum of market infrastructure and contractual arrangements. This is probably the reason for this product to be widely and successfully implemented on most European interconnections. However, Market Splitting or Coupling or co-ordinated implicit auctions would be the main prerequisite towards the implementation of marketbased FTRs and CfDs in Europe. Vice versa, in case Implicit Auctions (Market Splitting or Coupling) are introduced FTRs form a reasonable complement to those schemes for transmission hedging.

U.S. Department of Energy. National Electric Transmission Congestion Study. August 2006.

Wilde, Dean. Electricity Markets Outlook. 30 November 2006. Presentation, 12 pages.

Ott, Andrew. HEPG Discussion: RTO: Fox or Hedgehog? 30 November 2006. Presentation, 10 pages.

Museler, William. Embracing the Future (Commentary on NY State Electricity Markets). 4 April 2001. Presentation, ,br>24 pages.

Harris, Philip. PJM Overview. 4 April 2001. Presentation, 5 pages.

"ISO New England and New York ISO. The Option 1M Implementation Plan. 10 September 2001. Presentation, paper, 15 pages."

The Federal Energy Regulatory Commission (Commission) is amending its regulations under the Federal Power Act (FPA) to advance the formation of Regional Transmission Organizations (RTOs). The regulations require that each public utility that owns, operates, or controls facilities for the transmission of electric energy in interstate commerce make certain filings with respect to forming and participating in an RTO. The Commission also codifies minimum characteristics and functions that a transmission entity must satisfy in order to be considered an RTO. The Commission's goal is to promote efficiency in wholesale electricity markets and to ensure that electricity consumers pay the lowest price possible for reliable service.

Riley, Rick. Overview of the Partnership SPP RTO. 8 December 2000. Presentation.

Hogan, William. The RTO Millenium Order: Following Through or Falling Apart. 8 December 2000. Presentation.

Raskin, David. Grid South Transco, LLC. 8 December 2000. Presentation.

Stagliano, Vito. Regional Transmission Organizations. 21 January 2000. Presentation.

"Hogan, William. Regional Transmission Organizations: Designing Market Institutions for Electric Network Systems. 21 January 2000. Presentation."

Berry, William. Regional Transmission Organizations: The Rulemaking and the Rules. Presentation to the Twenty-First Plenary Session of the Harvard Electricity Policy Group, 21 January 2000.

"Wolak, Frank. Designing and Monitoring a Regional Transmission Organization: Comments on FERC Order 2000. 21 January 2000. Presentation."

Crane, Cindy. RTO West. 8 December 2000. Presentation.

Nunnally, Ron. RTO Development: California Perspective. 16 March 2000. Presentation.

Szwed, Stan. The Transition to Regional Transmission Organizations: The Alliance RTO. 16 March 2000. Presentation.

The Commission identified the key role of RTOs in supporting competitive electricity markets. No matter what the name or governance structure, there must be an organization responsible for key coordination activities needed to make a market work. This is not an option, and the market cannot solve the problem of market design. Hence the most important part of the Commission's Millennium Order is the description of a workable framework for competitive electricity markets. A competitive electricity market can be the vehicle for pursuing the public interest, but only if the market structure addresses the particular characteristics of the electricity system with its complex mix of essential facilities and large network externalities. The central design requirement is easy access to a coordinated spot market. There are certain critical functions that must be provided by the system operator. When these functions are organized within the framework of a bid-based, securityconstrained economic dispatch with locational pricing, the tools are available to deal with the most important network complexities that otherwise confound electricity markets. Once done, many of the other problems in the electric network would either disappear or would be greatly simplified.

TXU. Restructuring the Texas Electric Industry. March 2000.

Kelly, Susan. If This Transco is the Key, Let's Find Another Door. American Public Power Association. January-February 1999.

Hogan, William. The RTO NOPR: No Mandate But a Plan that Works Public Utilities Fortnightly. 1 July 1999.

The Federal Energy Regulatory Commission has addressed a wide range of issues in its analysis of and request for comments on the design of Regional Transmission Organizations (RTO). The RTO NOPR covers a great deal, and says a great deal, going a long way in defining the minimum characteristics and functions that must be provided in support of an open, reliable, and robust competitive electricity market. However, the NOPR does not go far enough. As is perhaps inevitable in the process with a document intended to address so many contentious issues, some of the most important ideas of the RTO NOPR call out for further development and an unmistakable commitment. The key ideas are there, but they need greater emphasis in the design so as not to be lost in the blizzard of paper that will surely follow. The key ideas are there, but they need greater priority in the schedule so as not to be foreclosed by the unanticipated consequences of seemingly unrelated decisions.

While many other issues such as the form of ownership, governance structure, regional boundaries, independence of market participants, or incentive regulation can be significant, they should be fashioned nevertheless only in the service of well-designed market institutions. The fundamental guiding principle of RTO design should be to serve the public interest. A competitive electricity market can be the vehicle for pursuing that public interest, but only if the market structure addresses the particular characteristics of the electricity system with its complex mix of essential facilities and large network externalities. Importantly, the rules for access to essential facilities and pricing, to provide consistent and efficient incentives, are not mere technical details that can be deferred or left themselves to be discovered through the magic of the market.

Wolak, Frank, Robert Nordhaus and Carl Shapiro. Preliminary Report on the Operation of the Ancillary Services Markets of the California Independent System Operator (ISO). 19 August 1998.

Kaplan, Susan. Ancillary Services - A Brief Comparison of Four ISOs. Background Memorandum for the Harvard Electricity Policy Group's 17th Plenary Session. 31 August 1998.

Emery, N. Beth. Memo: Transco's vs. ISO's - A Personal Perspective. 9 November 1998.

Federal Trade Commission (Bureau of Economics). Docket to Consider Competition in the Precision of Retail Electric Service. Before the Public Service Commission of the State of Mississippi. 28 August 1998.

Just before the April conversion to the use of locational marginal cost prices, the PJM system produced data that address two questions. Is transmission congestion insignificant? Are there only a few zones with meaningfully different prices?

Macias, Jim. Summer 1998, California's Experience. 9 September 1998. Presentation.

Angle, Stephen. Talking Points for Discussion. 20 November 1998. Presentation.

Northern States Power. An Independent Transmission Company: Conceptual Tariff Structure. 20 October 1998.

Cramton, Peter and Robert Wilson. A Review of ISO New England's Proposed Market Rules. 9 September 1998. Presentation.

Landgren, Dale. Regional Boundaries and Regional Institutions. 20 November 1998. Presentation.

Hogan, William. Synopsis of Proposed Comments. FERC Public Conference Concerning the Commission's Policy on Independent System Operators. 15-16 April 1998.

Vasington, Paul. Setting the Standard for Standard Offers. 25 September 2003. Presentation, 22 pages.

Excerpt from the Executive Summary:

The Department of Public Utility Control should require the electric distribution companies to procure a variety of Alternative Transitional Standard Offers that will promote the generation of electricity through renewable sources or the efficient use of energy resources in Connecticut. Such alternative Offers have significant potential to improve market stability and efficiency for all customers, to ameliorate environmental impacts of many kinds by reducing the combustion of fossil fuels, and to eventually reduce customer bills.

Schriber, Alan. The Standard Service Offer. 25 September 2003. Presentation, 7 pages.

Excerpt from the Executive Summary:

Overall, the electric supply industry’s struggles continue for a third year. The string of events began with the price run-ups in California and the West in 2000 and 2001, continued with Enron’s disclosures and collapse in late 2001, was followed by disclosures of accounting improprieties and data misreporting, and has continued with the “credit crunch” the industry still faces. As if this was not enough to contend with, as this report was being finalized, the most widespread electrical blackout in North American history occurred. While the cause has not been determined at this time, it has already sparked a debate about possible causes and solutions and has renewed interest in federal energy legislation that was already under consideration by the U.S. Congress.

Cullen Hitt, Carrie Setting the Standard for POLR. 25 September 2003. Presentation, 11 pages.

Cullen Hitt, Carrie. Retail Markets: A Failed Experiment, or an Essential Reform Just Beginning? 27 September 2002. Presentation, 10 pages.

Excerpt from the Executive Summary:

 

WHEN YOU ARE HEADED IN THE WRONG DIRECTION, GOING FASTER DOES NOT HELP

Institutions Should Fit the Facts

Electricity is a unique industry. It is a complex, real time network that requires cooperation and coordination to deliver a vital service. Demand for electricity is inelastic. Consumers faced with high electric prices cannot simply stop using electricity or switch to something else. Supply of electricity is also inelastic. Substantial new power plants take long lead times to construct. The transmission system cannot be expanded easily. Once produced, electricity cannot be stored very efficiently. As a result, it is deeply “affected with the public interest” and requires a balance of public and private responsibilities and incentives to keep it running smoothly. Restructuring and deregulation have undermined these values in the electricity industry. State policymakers recognized these problems and slowed down or reversed the irresponsible rush toward deregulation. Unfortunately, federal policymakers are charging ahead with deregulation policies such as the Electricity Title of the Energy Bill and the Standard Market Design proposal put forth by the Federal Energy Regulatory Commission.

All Pain, No Gain

States have been convinced to slow down or stop restructuring based on a mountain of evidence that restructuring and deregulation of the electricity industry offers enormous risks for consumers and virtually no rewards. Restructuring and deregulation has unleashed abuse of market power, excessive scarcity overcharges, inefficient transactions costs, and a sharp increase in the cost of capital. These cost increases swamp efficiency gains projected for deregulation.

Excerpt form the executive Summary:

Half of the states in the U.S. have enacted laws to open their energy markets to competition since 1996. Yet, with only a couple of exceptions, these laws brought about the dramatic price reductions and competitive energy markets that many policymakers anticipated. Those exceptions are notable, however, and offer lessons about keeping electricity costs low while bringing the benefits of competition to a large number of small customers. Ohio and Massachusetts -- recently followed by Rhode Island -- enacted laws that allow a process known as optout aggregation. This is a public process that allows a municipality, county or other local branch of government to assemble the electric load of all or a part of the customers within its jurisdiction, and bid that load out to the best bidder. The citizens of the aggregating entity become part of the buying group unless they affirmatively “opt-out” by saying that they do not want to be part of the group. Opt-out aggregation is a low-cost way to pool the buying power of a large number of customers. Part Two of this study examined aggregation programs in Ohio and Massachusetts, which are the two states that have allowed opt-out aggregation and have programs in operation. The two case studies provide data that reflect significant savings and a high participation rate and also provide some conclusions and lessons learned.

Excerpt from the Executive Summary:

The five state programs examined in Part One include: Georgia’s natural gas competition program at Atlanta Gas Light Co., New York’s Consolidated Edison’s electric restructuring program, Massachusetts’ electric competition program (statewide), Ohio’s electric competition program (statewide), and Texas’ electric competition program (statewide). Part One analyzes the terms of service provided to residential customers through both Default Service and the offers made by competitive suppliers; the consumer protection programs and policies adopted by each state; the extent of the development of the retail market; and the scope and type of competitive suppliers who have sought to obtain residential customers.

Electric Power Supply Association. 2000 Data Update: Assessing the Good Ol' Days" of Cost-Plus Regulation. 3 April 2002. Paper, 17 pages. Appendix: Utility by Utility Data on Inflation Adjusted Prices/KwH 3 April 2002. Appendix Report, 336 pages."

Centolella, Paul. The Impact of Missing Price Signals." Presentation to the Harvard Electricity Policy Group's 83rd Plenary Session. Cambridge, MA, June 2, 2016."

Kelly, John. Dynamic Pricing." Presentation to the Harvard Electricity Policy Group's 83rd Plenary Session. Cambridge, MA, June 2, 2016."