2nd Annual Energy Roundtable

Summary of Workshop Proceedings

Questions/Issues in the Workshop Agenda

Introduction
Bert Foer, President, AAI Diana Moss, Senior Research Fellow, AAI
The practice of monitoring electricity markets in the U.S. is still relatively new. There remain many fundamental questions regarding its substance, process, and outcomes. The ongoing evolution of federal and state policies affecting electricity markets in the U.S., together with changing market structures and designs beg the fundamental question: How and what types of market monitoring best promote the development of competitive electricity markets? We hope to answer some of these questions today.

Morning Session: What to Monitor and Who Should Do It?
What criteria should be used to determine if market monitoring is needed? Should criteria be based on market structure and/or market design? How does the type of product and market geography influence the need for monitoring? How does the presence of centralized or decentralized market mechanisms affect the need for monitoring? Is market-monitoring here to stay? Under what circumstances could market monitoring be phased out? How can the objectives and implementation of market monitoring best promote competitive market development and outcomes? FERC recently announced that utilities in Commission-approved RTOs will not be required to file for or renew their authority to charge market-based rates. What does this policy imply for who will assume the bulk of the monitoring responsibilities? How will RTOs and FERC coordinate on monitoring issues and compliance? Are there other entities that are likely candidates for market monitors? How will FERC and the RTOs (or others) interact to ensure that market monitoring is performed consistently and effectively? FERC has established broad policy goals for implementing market monitoring programs? To what extent should FERC develop specific criteria to ensure consistent standards and implementation? To what extent should states develop monitoring programs for retail electricity markets? What can we learn from the market surveillance experience in the securities industry and other commodity markets?

Luncheon: Commissioner Nora Brownell, FERC Afternoon Session: Detection and Enforcement
What are the criteria for detecting deviations from firm conduct that promotes competitive market outcomes? How have those criteria been employed in current market monitoring programs? How do detection criteria compare/contrast across RTOs? How tightly are monitoring plans tied to market designs and what are the advantages and disadvantages of a system that does not employ standard criteria? Does it make sense for FERC to develop standard detection criteria? What analytical tools are employed in the process of monitoring markets? Are behavioral market models useful in evaluating firm conduct in market monitoring context? What issues arise in an environment where market structures and market designs change rapidly? What analytical tools are useful in such an environment? What is FERC’s likely role in the coordination of broader-scale monitoring efforts? How will FERC, the RTOs and other possible monitoring entities share monitoring information and data? Are there any lessons to be learned from the market monitoring experience to date? How do the antitrust enforcement agencies see their role in monitoring electricity markets? Under what circumstances would antitrust enforcement agencies independently pursue violations detected under market monitoring programs?

Proceedings:

1. Dick O’Neill, Chief Economic Advisor, FERC, “Encouraging Competition and Managing of Market Power in RTO Markets.”
2. Peter Fox-Penner, Chairman, Brattle Group, “A “Securities” Versus “Antitrust” Vision of the Competitive Power Industry and its Implication for RTO Market Monitoring.”
3. Joe Bowring, Market Monitoring Manager, PJM, “Market Monitoring in PJM.”
4. Robert Levin, Senior Vice President, Planning and Development, NYMEX
5. David Patton, President, Potomac Economics, “Detecting and Mitigating Market Power in Competitive Electricity Markets.”
6. John Hilke, Electricity Project Coordinator, Bureau of Economics, Federal Trade Commission, “Market Monitoring: Is the Glass Half Full or Half Empty?”
7. Keith Casey, Manager, Market Analysis and Mitigation, California Independent System Operator, “Overview of California ISO Market Monitoring Approach.”
8. Jade Eaton, Senior Trial Attorney, Antitrust Division, Department of Justice

The process of deregulation leads from regulation to a competitive market through a transitional phase. There are no easy models for the implementing the transitional phase. In 2000, AAI sponsored a multi-perspective conference on state and federal issues in electric restructuring. Today’s conference is a focused discussion on a particularly timely and important issue in the restructuring debate–market monitoring.
1. The major challenge today is transitioning from regulation to competitive markets.

A. Antitrust may not be ideally suited to ensuring the transition to competitive markets. Antitrust focuses on enforcement (not policy implementation or monitoring). Thus, antitrust works well for dealing with specific violations in competitive markets. However, antitrust is not as effective in addressing pre-existing monopoly or markets in transition (e.g., it lacks benchmarks that indicate at what point competition is “sufficient”).

B. Some form of regulation is necessary through the transition, but the traditional model could be improved. The traditional model of price/service regulation is a cumbersome approach to markets in transition. The “securities model” is an alternative regulatory model that might be more useful. The model focuses on a self-regulated market (i.e., focus on transparency and public disclosure of market dysfunction) with federal oversight, assisted by mandatory monitoring organizations to enforce compliance and audit business conduct.

C. Standards for deregulating electricity markets would be useful. Deregulation is proceeding without even a loosely defined set of standards for how and what to deregulate. For example, it is generally assumed that any alternative is better than continued price/service regulation. However, consumers may express a preference for continued regulation. Simultaneous deregulation of all segments of the industry is less desirable than a more incremental approach (e.g., large wholesale participants first, distribution and retail issues last, and continued efforts to promote open access). In light of the above, it is important in the process of transitioning to competitive markets to make mid-course corrections.

D. Open transmission access should continue to be a primary objective. Open transmission access encourages forward contracting, lower spot price volatility and promotes market reliability and stability. These factors are critical in creating confidence in markets, attracting new investment and encouraging innovation.

2. Market power in electricity markets is a difficult issue

A. Existing analytical tools for addressing market power in the transition phase may not be ideal. A number of features may make it harder to apply the DOJ/FTC Guidelines to electricity markets in the transitional phase. For example, electric markets are characterized by brief (and sometimes non-repeated instances), of market power in localized areas, volatile output, and frequently changing geographic markets dimensions. Capacity withholding may also occur for technical reasons, which must be distinguished from informed decisions to restrict output based data that was available for the decision-makers within the firm.

B. Structural reform in electricity markets is preferable, but difficult. Open access adopted a behavioral approach remedying market power. This is problematic because among other things, it requires transaction-by-transaction oversight and does not address incentives for exercising market power. Structural reform would be the preferable approach but is not without problems. For example, for divestiture to be effective, it would require the sale of large amounts assets. Divestiture is also politically unpalatable. Demand-side participation helps, but does not necessarily solve the problem.

C. There are other useful indicators that gauge the vulnerability of electricity markets to the exercise of market power. More intensive assessments of demand elasticities and barriers to entry would be helpful.

3. Standardized market design and monitoring within RTOs is needed.

A. RTOs should have a specific function, but the optimal scope and number of RTOs is difficult to establish. The RTO’s job is to manage congestion, resolve transmission capacity issues and review events, ex-post. RTOs should have no linkages with other segments of the production chain and their boards should be independent. Four to eight RTOs in the U.S. are probably with additional consolidation likely (e.g., Southwest and Northwest).

B. FERC should have a consistent overall approach. The California and Enron crises have not reflected particularly well on FERC, due largely to lack of consistency and standardization in addressing market problems. Based on the proposed “securities” model described in Section 1.B., one way to ensure consistency is for FERC should “monitor” the monitors, coordinate among the RTO’s, and support RTO’s in enforcement efforts. Market power mitigation schemes have also preceded standardized market design-a “cart before the horse” problem. While the monitors can provide feedback to FERC on market design issues, market design is (and should be) completely outside the purview of the monitors and should be standardized by FERC. For example, California lacked a capacity market, which might have had a mitigating effect on high prices and price volatility.

4. Monitors should have a clearly defined role.

A. There is little disagreement on the primary function of market monitors. Monitors are responsible for facilitating the functioning of markets based on a competitive model, improving open access and the transparency of market interaction. Monitoring is not meant to catch the “bad guys,” rather, to enforce the rules and to provide impartial market data. Potentially, monitors can assist FERC by reviewing performance, reporting on market variables, and identifying market design flaws.

B. There is a significant risk that ill-defined roles for monitors could cause over-reliance on monitors to ensure the effective transition to competition. For example, monitors operate in secrecy and apply unclear thresholds and rules that are complex and not universally understood. Monitoring is data-intensive, complex and calls for significant interaction with market participants. Generally, there is a lack of clearly defined benchmarks in monitoring markets. Market participants may perceive monitors as “price police” and erroneously assume that monitoring solves structural market problems. Relationships between the monitor and RTO are often vague and the ability of the monitor to go directly to FERC with concerns varies across RTOs.

C. Monitoring experience to date suggests room for improvement. One of the more important issues is continued clarification of the relationship between FERC and the monitors. Open channels between the monitors and FERC are essential. Monitors should act as “field offices” of FERC and report to FERC, share insights with antitrust agencies and recommend changes to the rules based on accumulated experience.