United States of America Before the Federal Regulatory Commission: Comments on Wholesale Competition in Regions with Organized Electric Markets

Abstract:

Excerpt from the Introduction: 

The Federal Energy Regulatory Commission is considering potential reforms to improve the operation of organized wholesale electric markets. The purpose of this paper is to discuss a larger framework for evaluating issues of regulation and market design in electricity markets. Regulation and competition are essential elements of electricity policy. The special requirements of electricity systems create a dual challenge: First, regulation must address issues of market design; markets cannot solve the problem of market design. Second, regulation must complement competition; inconsistent choices in either can undermine the foundations of reliable electricity supply at market prices and subvert the goals of organized electricity markets.

Organized electricity markets are developing with many advanced features that address the technical requirements of electricity systems. Initial defects in market design are being addressed in a continuous process of learning and improvement. As experience accumulates, inevitably problems arise that present challenges for regulators. In some cases, the problems can be addressed through the use of markets and incentives. In other cases, the problems require regulation and mandates. A critical task for the regulator is to provide a proper balance of regulation and markets. This challenge is complicated through the unintended consequences of decisions in each realm. Market design can have significant effects on the outcome of regulation. In turn, regulation can have significant effects on the operation of markets. Whenever regulators must act, there is a choice in the type of action. Big “R” regulatory solutions often call for mandates and subsidies for favored programs. Little “r” regulatory solution would emphasize reforms of market design to improve incentives or limits on regulatory mandates to support rather than replace market choices. Regulation may be unavoidable, but there is flexibility in the type of regulation.

A framework for evaluating issues of regulation and market design in electricity markets helps regulators identify regulatory choices that minimize the unintended consequences in markets, and identify market design features that can support the goals of regulation. A concern is that major regulatory decisions are being made without consideration of the interaction with markets and market design. The result is both a failure to resolve the immediate problems and collateral damage to operation of the market. The cycle precipitates more problems and more need for regulatory mandates to counter the effects of poor incentives in market design.

This is an avoidable problem. The discussion here illustrates the type of problems that arise in organized markets and provides examples of innovative approaches addressing the problems that balance regulation and market design.