Energy Markets:

Elcon's Anderson, SWR's Tezak debate regional markets' pricing, performance

Are organized regional power markets fair to consumers? What could be done to make sure they moderate prices while increasing supply reliability? Joining OnPoint are industrial power users representative John Anderson and Stanford Washington Research's Christine Tezak for a debate on whether political issues are keeping regional wholesale power markets set up by FERC from serving the needs of consumers -- plus possible ways to improve the situation.

Transcript

Mary O'Driscoll: Welcome to OnPoint. I'm Mary O'Driscoll. Regional wholesale electric power markets, do they work or not? That's the question we're asking our guests today, Christine Tezak, senior vice president of Stanford Washington Research Group, and John Anderson, president and CEO of the Electricity Consumers Resource Council. Thank you both for joining us today.

Christine Tezak: Thanks for having us.

Mary O'Driscoll: John, I'm gonna throw the first question to you. Your organization represents industrial users of electricity, and you recently issued a report outlining a variety of problems that your members have encountered in trying to get into regional wholesale electric power markets around the country to buy electricity and to secure supplies that they need. I wanted to take the big picture first. What -- can you give us a brief explanation of what it is that your research, that your report found out?

John Anderson: We are very much in favor of wholesale markets and competitive markets. The problem that we see is that there just isn't any real competition out there. There's a lot of stuff out there that's called competition, but, to us, it isn't competition. The industrial buyers of electricity also buy many other commodities. They know what competitive markets are like, and they know that what they're into with the RTO markets out there is just not competition.

Mary O'Driscoll: What makes it not competition?

John Anderson: There's a whole variety of things that we outlined in the report, but first of all, it has a variety of revenue streams. It has a capacity market, as well as an energy market. There's no commodity that I know of that has capacity markets, so we have multiple streams that way. There's no real demand side. In the markets that are out there, suppliers don't deal with customers. What they deal with are what are called markets, so they make sales to the various regional transmission organizations, RTOs, but they don't have to deal with customers at all. What we would like to see is suppliers going to customers and saying what is it that you need, come up with products that meet your need, and try to satisfy those sort of things. That's what a competitive market does.

Mary O'Driscoll: So you're saying these are markets, but there are no customers. They're just markets kinda selling to themselves and, oh, by the way, we have this here that this is what you're going to have to use.

John Anderson: There's no customer focus at all.

Mary O'Driscoll: No customer focus.

John Anderson: They don't have to deal with customers, and they don't -- therefore, they don't deal with customers.

Mary O'Driscoll: OK, Christine, what's the situation with customers and markets out there? I mean it doesn't sound very fair the way John's explaining it.

Christine Tezak: Well, I think that John's members make some important points. They're frustrated with what they're looking at in the current wholesale markets, and one of the things that wholesale markets in electricity share that we don't see in other commodity markets is the influence of politics and regulation to the extent we see it in electricity. And I think that in many ways, the problems that they outline in their report throw into very stark relief that the problems we have with politics and how they're frustrating the economics.

Mary O'Driscoll: OK, well, I mean -- that's going to be intrinsic in this. Is there any way to be able to reconcile that at all? I mean you've got regulation of the electric power markets. It's going to be that way for the foreseeable future at least. I mean how -- is this something that they just have to deal with? Are they gonna have to suck it up and do the best they can?

Christine Tezak: Well, I think what we're really gonna have to do is see what we can do to get the concerns that customers like John's members have, and get them resolved in the political forum. I think at this point there's still a lot of cross talking. I think that there are important issues that need to be dealt with, but there are important issues for other customers, too. And some of the things that John's customers would really -- John's members would really like to see as far as much greater variability in pricing, because it makes demand response that much more interesting to an industrial customer. It's something that makes, perhaps, retail customers far less comfortable, and the retail customers' regulator far less comfortable. And so I think that there is a big problem we still have resolving the policy issues, and that's contributing significantly to why these markets are perceiving as not quite making it up to potential. But I do think there's plenty of good things that they have accomplished.

Mary O'Driscoll: OK, well, maybe -- let's kind of sit back for a second and kind of look at this. You've got several regional markets around the country. You have them in the New England, New York, the mid-Atlantic region, PJM. You have it in the Midwest, the upper part of the Midwest, or at least it's the beginning up there. So you have these different markets around there where wholesale, where this is where utilities are selling in the wholesale market to other utilities. They're selling from power suppliers to utilities and that kind of thing. And then also to some of your customer -- some of your members, which are large industrial plants, big manufacturers and that kind of thing. So that's kind of the lay of the land. You said, when you issued your report, that you were at the mercy of the utilities 10 years ago.

John Anderson: That's right.

Mary O'Driscoll: You remain at the mercy of the utilities. It's just that the utilities go by a different name, called an RTO, or regional transmission organization. Why is that? After 10 years, shouldn't we have been able to evolve beyond that kind of a structure?

John Anderson: We certainly hope so. We thought so. We'd been advocating competition in electricity for a long, long time; and I think your question and I think Christine's answer is really right on target about politics. The suppliers have tremendous influence in the political environment. And, unfortunately, regulation has become quite political in this area, too. So there's been attempts to try to keep the suppliers whole in many instances. They may or may not have worked, but to try to keep them whole, it just caused customers a whole lot of trouble, and we just haven't been able to see that that's -- that the customer's voice is yet accepted and implemented.

Mary O'Driscoll: Christine, what about you? I mean is this something, as I said before, are they going to have to suck it up? Is this something that's kind of the normal course of trying to form markets over a period of time?

Christine Tezak: God, I hope this isn't something that's normal. I'd like to think that this is a very novel experience we're going through in electricity. There is -- I would disagree with John's contention that this is all, you know, a political problem with the suppliers. The political problems are far deeper than that. I think there is a supplier class that has been struggling financially, and they are looking for ways to accommodate the political reality -- that their business model needs a lot more price volatility than politicians are willing to permit.

Mary O'Driscoll: OK, when you're saying the supplier class, you mean like the merchant power suppliers --

Christine Tezak: Yeah, there's more than just --

Mary O'Driscoll: That have been really --

Christine Tezak: When you talk about suppliers, you have a wider group of folks. We don't -- we no longer have a homogeneous group of folks supplying the wholesale market for electricity. We have independent players that have different risk profiles and have different business goals and different business models from unbundled, vertically integrated -- from unbundled utilities and then those who remain vertically integrated. All three of these components make up the supplier side, and I think that what you're seeing is issues related to funding investment that are running up against this political problem of volatility. And I think that this is where we're having a problem. And the solution so far has been we're going to put in administrative programs like installed capacity markets, which is one of the few things that John and I, I think wholeheartedly dislike together. Or, you know, these other administrative solutions. And my concern is that someone looking at investment flows is that administrative programs are going to be very hard to do well.

Mary O'Driscoll: OK.

John Anderson: I just have to comment, and I think she's exactly right saying that there's a variety of different types of suppliers out there. But one of the problems that's causing us great concern is that, in the markets that are out there, we have a single clearing price. Everybody bids in, and they are dispatched until one clears the market, but then everybody gets paid that price. And, on top of that, they get paid for capacity in the capacity market, so they get two different revenue streams on this sort of thing. For the gas fire generator that's at the margin, that generator's having a difficult time financially right now. But for a vertically integrated utility, or a utility holding company that has a fleet of generators, many of them depreciating coal and depreciating nuclear, they get paid the gas fire price. They're making a lot of money. And, in fact, just yesterday, Exelon announced that Exelon Generations profits in the first quarter tripled from a hundred some million to 300 and some million dollars, and that was due, in my view, since they joined one of these organized markets and started selling their product in those organized markets. I agree with Christine completely. Those generators on the margin are having a terrible time, and they're going to continue to have a terrible time, by the way, as long as we have markets where there is no forward curve out there. There is no -- there are no bilateral contracts that go into the futures, so Wall Street feels comfortable that there's going to be a stream of income. In the markets we have out there, almost all the transactions are in the day ahead or hour ahead market. I don't think anybody from Wall Street's going to want to finance a new power plant that has a long life on such a short-term revenue stream.

Christine Tezak: Well, they'd do it if it wasn't in a capped energy market.

Mary O'Driscoll: Yeah.

Christine Tezak: I think that what we're seeing part of the symptom that -- of the pricing and the profitability that John's looking at, when you look at different fuel mixes going into those portfolios is that we have seen a shift, even in the very mature market of PJM towards more and more spot transactions as commodity prices have forced a bit of -- the commodity prices are pushing prices up one way, but the current over capacity we have in many, not all areas of PJM, was pushing prices down another way. And so when you look at where we were three years ago, folks started becoming less interested in contracting long-term, because they could see that we were building capacity, and we're going to bring plants on, and pricing environments would improve. And so it's a natural part of the cycle that that market shifted more into the short-term. Well, now, with that commodity price coming up and biting us in the behind in natural gas and even in coal, you're starting to see an interest in, gosh, I really would have like to have booked those prices before. And so we're at an uncomfortable period in the market where it's working out. And if you do have low cost supply in competitive markets, you generally tend to be the one with the biggest profits.

Mary O'Driscoll: OK, I want to change the subject a little bit to the issue that you have fingered in your report, and that a lot of people, this is -- we've been hearing this forever. There's no transmission capacity. That we've got bottlenecks, and that's where the big problem is. You fingered that as --

John Anderson: Right.

Mary O'Driscoll: As the primary culprit, because there's just no signal, no -- the price signal that's supposed to be done in these markets to build new transmission capacity isn't working.

John Anderson: Yes, that's one of -- we pointed out six things, one of which was inadequate transmission system. One of the advantages, supposedly, of this locational, marginal pricing scheme that is in most of the Northeast and Midwest markets, is that the prices of transmission should show where the congestion is, and should incent, then, new transmission to mitigate, or new generation to mitigate those constraints. What we see now are congestion costs that are approaching a billion dollars a year in PJM and in others, and yet the transmission constraints are not being mitigated. Frankly, we knew where the constraints were before we had LNP. Now that we have LNP, we still know where the constraints are. We see that an awful lot of money is being paid, but we're not getting the results that we need. It's another one of the failures. We argue that if we had an adequate transmission system, it would be a major step forward; but it still wouldn't solve all the problems in and of itself. You still have other things that need to be solved, as well as the transmission system.

Mary O'Driscoll: What do you think about that?

Christine Tezak: Well, I think the fundamental problem with building transmission infrastructure is that, as a country, we won't come to agreement about how we'd like to pay for it. And I think that part of the problem we see, even in PJM, is that still nearly 90 cents of every transmission dollar is still recovered at a retail rate base. This is not a regional service being provided on a regional system. This is a regional service being passed along on a local tariff system. And unless and until we start looking at changing how the RTO markets are tariffed, then I don't think we're going to see significant augmentation to regional transmission. You look at an example like what you have in Wisconsin and the upper peninsula of Michigan, where the state regulators created -- caused the most amazing thing to happen when they actually gave all of their oversight of the transmission rates to the FERC in order to form the American Transmission Company. That company had no problem going out raising a half a billion dollars to go and build transmission, because they had a single rate, and it was provided over that whole entire region. We don't do that, not even in the most advanced markets in this country yet. And I think that that's the real impediment to transmission investment, and that impediment is not caused by economics, and it's not caused by pricing, and you can't do anything with the pricing, because the politics and the regulators aren't prepared to let go of that transmission rate and have the faith to give it to FERC and have it be reorganized as the regional system that it is and not the local system we've been working on an ad hoc basis.

Mary O'Driscoll: Well, that's a -- you made that point, is that the independent transmission system owners is the way to go, but we're just not seeing them formed. It's a political impediment to forming them?

John Anderson: Sure, it's a major one. As Christine said, the states -- when the rates are all bundled, the states have control over the entire pot of money.

Mary O'Driscoll: Right.

John Anderson: But as soon as you pull transmission out into a standalone transmission company, then the states don't have jurisdiction anymore. They have given up their jurisdiction to the federal government, FERC, and this is something that many, many states are opposed to. One of the six points that we mentioned in our report was the terrible tension that's going on between the federal and the state regulators, and this is one of the areas that is really highlighted. And I agree with Christine completely. That if we could get stand-alone transmission companies, their total motivation for making money is to get more kilowatts and more kilowatt hours satisfied through their wires, and that's just not the case with a vertically integrated, and especially if a vertically integrated company owns the transmission constraint and happens to have a generator that is protected behind that constraint. They actually have a significant disincentive to mitigate the transmission constraint. Because if they mitigate it, then their generator is subject to competition, and this would hurt them financially.

Mary O'Driscoll: OK.

John Anderson: We really have a -- it's a real problem, and I don't see a solution yet. But it is a real problem we've got to deal with.

Christine Tezak: Well, I think the solution is there. The problem is, is we don't yet have that political consensus to make it happen. There's a lot of criticism laid at FERC's door, that they should do this, and they should do that. And every time FERC has an initiative, the Hill lands on them like a ton of bricks, and I think that what we're seeing is, you know, a very significant industry with a lot of dollars at risk, whether it's the IPPs or the vertically integrated utilities. This is real money, and folks are positioning themselves to the best they can to protect what they see as their vested interest. What we have not decided, I would say we have not even decided uniformly as consumers, the system we really want to see.

Mary O'Driscoll: OK, well, now, you are -- Alcon is not the first group to make these criticisms about these markets. APPA came out with its criticisms early this year, in December and January. The Cato Institute came out and actually, you know, had the -- made the intellectually challenging argument that maybe they should just go back to the regulated world if nothing else can be done, which I thought would be interesting and make great news, but I think would be almost impossible to do. Why -- is this having any effect on the debate at all, the fact that some of these groups like your own, like APPA, the American Public Power Association, like Cato, are starting to come out and say, "You know, wait a minute. This isn't working. There are some real shortcomings here that are causing problems."

John Anderson: We hope that it is. That's one of the reasons, one of the main reasons we issued the report. We hope that it'll have an impact. We felt -- we have been strong supporters of the creation of these markets. We have been strong supporters of the creation of RTOs, regional transmission organizations. We feel very strongly that the operation of the transmission system should be independent of the other functions, and this is a great way, we think, to get it. The problem is, what's out there, it just isn't doing that. What we have now are markets out there that are run by the same people that operate the transmission system. To me, that's like saying United Airlines should be the air traffic controller for Chicago O'Hare. They should sell seats on airplanes and decide who can land and when they can land and when they can take off. That doesn't make sense. We've got problems. We felt it was time to say the emperor has no clothes. Let's call it. We work. We've been very patient. We've worked behind the scenes. We've filed comments at FERC. We've filed comments with the RTO organizations and that sort of thing, and we're just not getting the kind of results that we think are absolutely essential. And, frankly, I have some members who believe very strongly in competition, but say, "If this is the best we've got, we ought to try to go back. If this truly is the best that we're going to be able to obtain, is what's out there now" -- now we're not all there yet, and it's still -- but that's how strongly they feel that this is a -- that this is just not working.

Mary O'Driscoll: OK, but I mean haven't we seen this in other kinds of markets, as well? We're seeing these kinds of struggles going on in the natural gas market, too, where they've got these kinds of promises forming the market.

Christine Tezak: Well, I would say in the natural gas market, we had a very, very ugly event to get it all started, and that was the horrible take or pay workout that existed, and it was very painful. It was very painful for investors, as well. However, there was a consistency that, first off, we had a single jurisdiction to begin with in gas, and it was federal, because it was interstate commerce. And, second, Congress helped push that through, and Congress stood behind FERC when they did that. And we don't have that situation now. Two of the constituencies John left off his list of working behind the scenes are two of the ones that I think are creating the biggest problem right now. That's Congress and that's the state PUCs, and until they get comfortable and decide that they're onboard with something, we are not going to get any better than what we have, and that's the status quo.

Mary O'Driscoll: Well, I was going to say, yeah.

John Anderson: Could I just pick up and say that I agree with what Christine says about this. Keep in mind the gas industry was vertically separated to begin with. There were producers of gas. Then there were pipelines, and then there was -- then there were local LDCs, the local distribution companies in the marketing affiliates. We start with vertically integrated electric utilities, and one thing I think we have agreed is, it's very, very difficult to divide that -- those vertically integrated utilities now. Not to take away from what you're saying about Congress and the state PUCs. Which I certainly agree with also. But if we could see more of this vertical separation, particularly the transmission taken -- not just the operation of the transmission, but the operation and the ownership of the transmission taken out. I think we would see some things going along, moving much faster, but I'm not optimistic that, in the political climate we have now, we're going to see any federal mandates for breakup of the vertical integration anytime soon.

Mary O'Driscoll: Right, I mean it seems like FERC, for some years, was kind of dancing in that direction, but really wouldn't kind of say anything about that. Well, I wanted to know. There's going to be a change at FERC. Pat Wood, the chairman, is leaving this summer. Do you see that any possibility for any kinds of change of direction from then the commission coming down, although I guess we pretty much said that the -- all the decisions are being made at the state level and at Congress. But do you see any kind of change in direction coming from FERC?

John Anderson: Well --

Christine Tezak: Go ahead.

John Anderson: I first think that Pat Wood needs to be complimented very highly for his vision, what I know very good and well what he has tried to accomplish, and I don't want this to be a criticism of Pat Wood. As Christine said, every time he tried to do something that we thought was good, Congress came down on him terribly hard, and so that's something that was way out of his control and that sort of thing. It's kind of hard to say. I think there will be changes. I don't think that somebody will be put into that position that has as strong a commitment to try to move toward competition that Pat Wood has had. I don't know who will be there. I mean there's a possibility that Commissioner Kelliher will be the next chairman. There's a possibility somebody new will be the new chairman.

Christine Tezak: Right.

John Anderson: So we'll have to wait and see.

Mary O'Driscoll: OK.

John Anderson: But I think there will be a change at FERC in policy direction.

Mary O'Driscoll: OK, Christine, you get the last word.

Christine Tezak: Well, as we've said in our outlook this winter, Mary, I call it detente. I think what we're going to see is we're going to see a continuation of the stratification between parts of the countries that are moving toward markets, and then the parts of the country that don't want to have that particular structure superimposed on them, and I think the challenge, from our perspective, what we'll be looking at as investors, is, is one option going to materially outperform the other, and that remains to be seen.

Mary O'Driscoll: OK, well, that's going to have to be the last word for today, although I don't think this debate's going away any time soon. I'd like to thank our guests, Christine Tezak of Stanford Washington Research Group, and John Anderson of the Electricity Consumers Resource Council. I'm Mary O'Driscoll. We'll see you next time on another edition of OnPoint.

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