Electric industry governance: Reconciling competitive power markets and the physics of complex transmission interconnections

Resource and Energy Economics

Volumn 19, Issue 1-2, 1997, Pages 47-83

  Stalon, Charles G ^a  

^a Energy Regulation   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

COMPETITION; DECISION MAKING; ELECTRIC POWER DISTRIBUTION; ELECTRIC POWER TRANSMISSION; ELECTRIC POWER UTILIZATION; INDUSTRIAL ECONOMICS; LAWS AND LEGISLATION; MARKETING;

COMPETITIVE POWER MARKETS;

ELECTRIC INDUSTRY;

ELECTRICITY INDUSTRY; ELECTRICITY TRANSMISSION; INDUSTRIAL REGULATION; POWER MARKET;

NORTH AMERICA;

EID: 0031091551     PISSN: 09287655     EISSN: None     Source Type: Journal    
DOI: 10.1016/s0928-7655(97)00005-5     Document Type: Article

References (76)

1. Lionel Robbins, The Theory of Economic Policy in English Classical Political Economy (Macmillan, London, 1952), p. 56.
2. This paper builds on Charles G. Stalon, 'To pool or not to pool? Towards a new system of governance', Public Utilities Fortnightly, 1 March 1996, pp. 16-20. It also builds on 'The future course of NERC', a Report to the North American Electric Reliability Council Board of Trustees by the Future Role of NERC Task Force-II, accepted by the NERC Board of Trustees, 16 September 1996, and 'Options to ensure compliance with NERC and regional reliability council policies, standards and criteria', prepared by the NERC Compliance Team, 12 October 1996, henceforth cited as NERC Team, Options.
3. A bulk power system is defined as a set of generators and the transmission lines that interconnect them and, in turn, connect them to users and distribution companies. Such a system is commonly called an 'interconnection', or 'grid', although the latter term is also used to describe the transmission network and connected generators of a single utility. The word 'interconnection' has two common definitions: originally it meant a transmission line or set of transmission lines connecting one utility to another. The original meaning is still common. A second meaning is an alternating current transmission network in which all generators operate synchronously. The second definition encompasses the first. The context should make clear which meaning is intended. The four interconnections, in the last noted sense, that comprise the North American electric industry are described below.
4. Individual users have options for providing themselves additional outage protection. The two most obvious ones are (1) ownership of back-up oil, gasoline, and/or natural gas-fired generators on the user's premises, a strategy commonly used by hospitals, telephone exchanges and some rural citizens, and (2) back-up battery power for critically needed equipment, such as emergency lighting and computers.
5. See 'Blackout a caution sign on road to deregulation', New York Times, 19 August 1996, p. A.7 for a description of the 10 August 1996 failure that caused a loss of power in nine states in the Western System Coordinating Council area. See also 'Did competition spark power failures', Wall Street Journal, 19 August 1996, p. B.I. which notes: "During a 105-minute period Aug. 10, five trees came into contact with five lines in the Portland Area. There was also a mechanical failure at a power substation. The last straw came when a 600-megawatt hydroelectric plant that could have prevented the outage was kept partly off-line to allow salmon to migrate downstream on the Columbia River". This article notes that 4 million customers were affected. It also notes that the 2 July 1996 failure, in an overlapping area, affected 2 million customers. In the Secretary of Energy's letter to the President of 2 August 1996 reporting on the 2 July 1996 outages in the Western System Coordinating Council region, it was noted that these 2 million customers were spread over 14 states. One part of that letter states: "The outage was initiated when a transmission line sagged too close to a tree, creating a short circuit and causing the line to disconnect automatically. A protective device on a parallel line misinterpreted the short circuit and disconnected its line. Loss of the two lines activated an automatic procedure to shut down two large generating units at a nearby power plant served by the two lines because the generators' output otherwise would overload remaining transmission lines".
6. See 'Blackout a caution sign on road to deregulation', New York Times, 19 August 1996, p. A.7 for a description of the 10 August 1996 failure that caused a loss of power in nine states in the Western System Coordinating Council area. See also 'Did competition spark power failures', Wall Street Journal, 19 August 1996, p. B.I. which notes: "During a 105-minute period Aug. 10, five trees came into contact with five lines in the Portland Area. There was also a mechanical failure at a power substation. The last straw came when a 600-megawatt hydroelectric plant that could have prevented the outage was kept partly off-line to allow salmon to migrate downstream on the Columbia River". This article notes that 4 million customers were affected. It also notes that the 2 July 1996 failure, in an overlapping area, affected 2 million customers. In the Secretary of Energy's letter to the President of 2 August 1996 reporting on the 2 July 1996 outages in the Western System Coordinating Council region, it was noted that these 2 million customers were spread over 14 states. One part of that letter states: "The outage was initiated when a transmission line sagged too close to a tree, creating a short circuit and causing the line to disconnect automatically. A protective device on a parallel line misinterpreted the short circuit and disconnected its line. Loss of the two lines activated an automatic procedure to shut down two large generating units at a nearby power plant served by the two lines because the generators' output otherwise would overload remaining transmission lines".
7. Appendix A contains a list of acronyms and abbreviations.
8. A control area is a set of generators connected via transmission lines to a single control center and coordinated in use by a single control center. Each generator belongs to one and only one control area. The SO, sometimes called a 'controller' or 'dispatcher', is the agent of coordination. In the current industry the SO is an employee of the utility or group of utilities whose plants are being dispatched, or of the pool organization created by the set of cooperating utilities whose plants are being dispatched.
9. At least one holding company owns and operates utilities in more than one interconnection. It coordinates the plants in the two interconnections by use of a direct current (DC) line.
10. The statement is attributed to Clark Gellings of the Electric Power Research Institute. Compare: 'A modern power system is in fact one large machine', Paul L. Joskow and Richard Schmalensee, Markets for Power: an Analysis of Electric Utility Deregulation (The MIT Press, Cambridge, 1985), p. 41.
11. "When utilities form a group to examine their joint needs and resources and agree to operate and plan their systems for the best combined economy and reliability, they may be considered to be 'pooling' their resources and such a group is often referred to as a 'power pool'". Federal Energy Regulatory Commission, Power Pooling in the United States (Office of Electric Power Regulation, Washington, DC, December 1981), p. 2. PJM and NEPOOL are examples of a tight pool, that is, a pool in which two or more utilities use a single dispatcher to dispatch the plants of the coordinating utilities. Other pools such as the Mid-Continent Area Power Pool and the Florida Broker system facilitate trades among their members, but do not jointly dispatch member's plants. See Electricity Transmission: Realities, Theory and Policy Alternatives, The Transmission Task Force's Report to the Commission (Federal Energy Regulatory Commission, October 1989), pp. 14-15.
12. "When utilities form a group to examine their joint needs and resources and agree to operate and plan their systems for the best combined economy and reliability, they may be considered to be 'pooling' their resources and such a group is often referred to as a 'power pool'". Federal Energy Regulatory Commission, Power Pooling in the United States (Office of Electric Power Regulation, Washington, DC, December 1981), p. 2. PJM and NEPOOL are examples of a tight pool, that is, a pool in which two or more utilities use a single dispatcher to dispatch the plants of the coordinating utilities. Other pools such as the Mid-Continent Area Power Pool and the Florida Broker system facilitate trades among their members, but do not jointly dispatch member's plants. See Electricity Transmission: Realities, Theory and Policy Alternatives, The Transmission Task Force's Report to the Commission (Federal Energy Regulatory Commission, October 1989), pp. 14-15.
13. Compare: "The outcry after the blackout of the US northeastern states in 1965 and the New York blackout of 1975, and the political recriminations surrounding the UK blackouts of the 1960s taught utility executives to err on the side of caution when considering the trade-off between cost and reliability. To justify this caution, reliability appears often to have been elevated from the realm of economics to the spheres of morality". Max Wilkinson, Power Monopolies and the Challenge of the Market: American Theory and British Practice (Harvard University Energy and Environmental Policy Center, Discussion Paper E-89-12, September 1989), fn 67, p. 23.
14. Compare: "The close ties between transmission and generation make it potentially misleading to analyze either in isolation. Efficient changes in system configuration generally require changes in both transmission and generation facilities; ⋯", Joskow and Schmalensee, op. cit. p. 41.
15. Existing technology does permit some direct controls that retard power flows over particular lines. Phase shifters, in particular, can be installed and operated to limit flows over particular lines. Technology on the horizon promises other control devices. However, a free flowing transmission system has desirable stability characteristics, so those who place a high value on reliability demand a heavy burden of proof from those who want to install such control devices. If the industry finds it difficult to build additional transmission lines, or to upgrade the old ones, it is likely the industry will expand the role of direct control devices.
16. Utilities usually provide both firm and interruptible services. If the utility lacks capacity to satisfy all demands, service is denied to those customers who subscribe for interruptible services.
17. This language is potentially misleading; in actuality the SO coordinates use of generating plants and transmission lines that interconnect the generators and connect the generators with the distribution systems. If all generators were located at one spot, the minimum costs of generation output would be achieved when all on-line generators are operated with equal short-run marginal costs, and dispatching plants would be a good description of the task of the SO. If, however, plants are located at many different sites, each connected to a network of transmission lines delivering power to many distribution companies and/or to directly connected users, the cost of delivered power is minimized when the marginal differences in transmission costs are recognized. In that case minimizing the cost of delivered power requires that the difference in short-run marginal cost of any two plants is equal to the short-run marginal transmission cost of moving power between the two plants.
18. One obvious deduction from this technology is that in the absence of interconnections, and other things equal, a larger utility will have lower unit costs than a smaller one. A 1981 study stressed this conclusion by noting that "an isolated system with a peak load of 2000 MW ideally might have generating cost lowered by about one-third had it been planned and constructed as a part of 30000 MW peak load coordinating group. However, an isolated 10000 MW peak load system would be able to reduce its generating costs by only 15 percent had it been built as part of a 30000 MW peak load group". Power Pooling in the United State (Federal Energy Regulatory Commission, Office of Electric Power Regulation, Washington, DC, December 1981), p. 18.
19. For example, since a merger between an investor-owned utility and a federal government-owned-utility was not possible, the only way two such utilities could cooperate to gain desired economies of scale in generation was to interconnect their systems and coordinate their planning and operations.
20. Such a policy assumes one can assign responsibility for an inadvertent flow, not a simple task in an interconnection with many control areas, but efficacious regulatory conventions that provide useful incentives for all decision makers can be created.
21. A public good is one whose benefits cannot be limited to those who have contributed to its cost of production. National defense is one example, clean air is another.
22. This section relies in part on C.G. Stalon, 'The Historical Context of US Electric Industry Restructuring: Selections Emphasizing Public Policy Decisions', The NRRI Bulletin, Spring 1996 (The National Regulatory Research Institute, The Ohio State University, Columbus, OH), pp. 45-66.
23. -1 in 1935. The proportion of urban and rural non farm homes receiving electricity from a network increased from 47.4% in 1920 to 89.9% in 1935. Historical Statistics of the United States, Colonial Times to 1970, Bicentennial Edition, Part I (US Bureau of the Census, Washington, DC, 1975), p. 827, Series 116 and 111, respectively.
24. The 1920s saw two government efforts to deliberately restructure the industry to better exploit the technological potentials of high voltage transmission interconnections so that the industry could increase the proportion of large generating plants in its generating mix. Both failed. The Superpower initiative supported by and later led by the Secretary of Commerce, Herbert Hoover called upon utilities to cooperate in the creation of regional networks. The Giant Power proposal was supported by Governor Pinchot of Pennsylvania. This proposal was an attempt to use state power to create a transmission network within Pennsylvania (later expanded to include New York and New Jersey) that would exploit economies of scale in generation and simultaneously constrain the exercise of private monopoly power. See William J. Hausman and John L. Neufeld, 'Public policy and the structure of the electric power industry: Lessons from the past', Regulatory Responses to Continuously Changing Industry Structures, ed. Charles G. Stalon, Institute of Public Utilities, Michigan State University, East Lansing, MI, 1993, pp. 98-122.
25. 273 U.S. 83 (1927).
26. 16 U.S.C. 791a-825r.
27. Section 401 of the US Department of Energy Organization Act create the FERC within the DOE.
28. U.S.C. 7171. See also sections 204 and 402.
29. U.S.C. § 79 (1988).
30. See Section 11, 'Simplifications of Holding Company Systems', Public Utility Holding Company Act, 15 U.S.C. 79-79Z-6.
31. 16 U.S.C.2601 et. Seq. PURPA imposed on utilities an obligation to buy power produced by 'qualified' cogenerator and small power producers at prices determined by the utility's state regulator under guidelines set by the Federal Energy Regulatory Commission. The FERC made the judgement as to which cogenerators and small power producers were 'qualified'. Furthermore, the law was widely read to say that states and the FERC could 'encourage' such production. In the view of many utilities, several states encouraged cogeneration and small power production by overpricing power sold by PURPA generators.
32. POUs include municipally-owned utilities, state owned utilities, such as the Power Authority of the State of New York, and Public Utility Districts.
33. In 1927 there was one federal-owned utility, in 1993 there were 10. In 1927 there were no rural electric cooperatives; in 1937 there were 192 and in 1993 there were 941. In contrast, in 1927 there were 2135 investor-owned utilities, in 1993 there were 254. The total number of utilities in 1927 was 4334 and in 1993, 3212. The 1927 and 1937 data come from table 2.1 of Part I of The 1970 National Power Survey, by the Federal Power Commission (US Government Printing Office, Washington, DC, 1971), p. I-2-2. The 1993 data come from US Department of Energy, Energy Information Administration, Financial statistics of Major US Publicly Owned Electric Utilities (US Government Printing Office, Washington, DC, 1995), p. 3.
34. In 1927 there was one federal-owned utility, in 1993 there were 10. In 1927 there were no rural electric cooperatives; in 1937 there were 192 and in 1993 there were 941. In contrast, in 1927 there were 2135 investor-owned utilities, in 1993 there were 254. The total number of utilities in 1927 was 4334 and in 1993, 3212. The 1927 and 1937 data come from table 2.1 of Part I of The 1970 National Power Survey, by the Federal Power Commission (US Government Printing Office, Washington, DC, 1971), p. I-2-2. The 1993 data come from US Department of Energy, Energy Information Administration, Financial statistics of Major US Publicly Owned Electric Utilities (US Government Printing Office, Washington, DC, 1995), p. 3.
35. Compare: "Most transmission lines were built solely to bring electricity from generating plants to nearby urban load centers. But in recent decades, utilities have extensively interconnected their systems and in some cases formed power pools to improve reliability by sharing generation reserves and to provide one another back-up abilities in the event of outages and emergencies". EPRI Journal, April/May, 1986, p. 5.
36. Section 202(e) of the FPA assigned to the FPC the authority to regulated sales of US utilities across national borders. This authority was transferred to the DOE in the Department of Energy Organization Act. Interconnections between utilities can provide benefits to both parties without formal sales between them. Power exchanges between utilities, that is, exchanges in kind, are not sales in the jargon of the system. Obviously, an ability to buy and sell energy and capacity increases benefits of an interconnection.
37. NERC fact sheet, 'History of NAPSIC', Internet, http:\\www.nerc.org. (May 1996).
38. Quoted in NERC fact sheet, 'Milestones in NERC's history', Internet, http:\\www.nerc.org. (May 1996).
39. The RRCs are ECAR (East Central Area Reliability Coordination Agreement), ERCOT (Electricity Reliability Council of Texas), FRCC (Florida Reliability Coordiating Council), MAAC (Mid-Atlantic Area Council), MAIN (Mid-American Interconnected Network), MAPP (Mid-Continent Area Power Pool), NPCC (Northeast Power Coordinating Council), SERC (Southeastern Electric Reliability Council). SPP (Southwest Power Pool) and WSCC (Western Systems Coordinating Council). The Alaska Systems Coordinating Council (ASCC) is an affiliate of the NERC. The FRCC was created in September 1996.
40. A statement of objectives of the Mid-America Interconnected Network (MAIN) included in the 1994 Annual Report of the NERC reads as follows: "The purpose of MAIN is to promote the reliable use of the interconnected electric system with due regard for safety, environmental protection, and economy of service through coordinated planning, construction, operation, maintenance, and use of generation and transmission facilities on a regional basis by MAIN members individually and as member of power pools or subregional groups". MAIN Chairman's report, p. 25.
41. The qualifications in the following sentence dilutes the force of this assertion somewhat. It says, No such exemption may be granted if the Commission finds that such provision of State law, or rule or regulation - (1) is required by any authority of Federal law, or, (2) is designed to protect public health, safety, or welfare, or the environment or conserve energy or is designed to mitigate the effect of emergencies resulting from fuel shortages. Several other provisions of Title 2 of PURPA were directed towards strengthening the reliability of the electric industry by improving the system of coordination of interconnected control areas.
42. Compare: "ECAR [East Central Area Reliability Coordination Agreement] consists of 29 major electricity suppliers in eight east-central states serving more than 36 million people". And, "Membership [in ECAR] is voluntary, and full membership is open to those utilities whose generation and transmission have an impact on the reliability of the interconnected electric system in the Region". ECAR Chairman's report in the 1994 Annual Report of the North American Electric Reliability Council, p. 17. See also "The Electric Reliability Council of Texas comprises 74 members, which operate about 85% of the electric generating capacity in Texas and serve 73% of the area of the state. Membership is voluntary and open to all entities that own, control, and operate generation, transmission or distribution utilities". The ERCOT Chairman's report in that same NERC report, p. 19.
43. The NERC Compliance Team Options cited in footnote No. 2 vigorously urges the abandonment of the voluntary system and the development of powers to impose fines and penalties on users of the networks.
44. There are proponents of combining all of the Western Interconnection into a single control area, and there are proposals for reducing the number of control areas in the Eastern Interconnection to less than 10. One or more DC interconnections between AC systems does not eliminate the isolation since the terminus of the DC system is analytically equivalent to a generator at that site.
45. On 24 April 1996, the FERC issued its Order No. 888, the Final Rule in Docket Nos. RM95-8-000, "Promoting Wholesale Competition Through Open Access: Non Discriminatory Transmission Services by Public Utilities", and RM94-7-001, "Recovery of Stranded Cost by Public Utilities and Transmitting Utilities". 75 FERC 61080. This order committed the nation to open access transmission, but left many organizational issues unresolved.
46. One important exception to this statement is the effort by the FERC to create Regional Transmission Groups (RTGs). This effort has been directed, as its name suggests, at getting all the concerned interest groups involved in a discussion of how to organize and operate regional transmission systems. This effort may, ultimately, serve to facilitate the evolution of existing governance arrangements into needed new ones, but so far, it has merely provided debating forums for those who have been left out of the old ones.
47. This definition leaves open the possibility that some generators within a distribution area or within the confines of an industrial site may not be subject to control or even knowledge of the ISO if the distributor and/or industrial customer is always an importer of power from the network.
48. In this latter case the ISO may be called a network "Security Coordinator". See NERC Team, Options, p. 24.
49. If the ERCOT region of Texas remains "independent", the Texas Public Utility Commission may have some voice in the operation of ISOs in Texas. Similarly, if the Quebec industry remain "independent", the government of Quebec may have an important voice in the operations of ISOs (if any are created) in Quebec.
50. It is recognized by all that when multiple generators and multiple buyers are interconnected, it is meaningless, and potentially misleading, to suggest that energy flows by known or predictable paths. A direct bilateral contract will likely read, as contracts for the transportation of natural gas currently read, that the transporter agrees to accept input from the genco at a particular point or points and to deliver an equivalent amount (or the equivalent amount minus losses) at a specified point or points. There is no pretence that "power generated by the seller" and "power received by the buyer" are in any physical sense identical. This statement does not mean that regulators and trading parties may not, for certain purposes, define a point on the grid and construct a regulatory and/or contractual convention that power from a generator goes through that point.
51. In the California PUC order cited in the next footnote, the CPUC assigned the responsibility to manage the clearinghouse to the Power Exchange.
52. In the California PUC order implementing industry restructuring, this function was assigned to a Power Exchange. See The CPUC's March 13, 1996 Interim Opinion in Order Instituting Rulemaking on the Commission's Propose Policies Governing Restructuring California's Electric Service Industry and Reforming Regulation, T.94-04-031 and "Order Instituting Investigation on the Commission's Proposed Policies Governing Restructuring California Electric Services Industry and Reforming Regulation, I.94-04-032, both originally filed April 20, 1994. The prices announced in advance are called "ex ante prices". The actual price which develop may differ, they are called "ex post prices". Who pays ex ante prices and who pays ex post prices varies from one version to another of the poolco model. In the UK poolco system all buyers pay the ex poste prices.
53. Expository convenience sometimes calls for distinguishing between mandatory and flexible poolco models. In a mandatory poolco model all generators are required to bid into the ISO-created spot market and all buyers are required to buy from the spot market, or permit the ISO to estimate their demands. Several nations have followed the UK example and created mandatory poolco models. In a flexible poolco model the ISO accepts bids from all generators who wish to sell power and from all buyers who wish to buy power. The poolco model described in the text is a flexible one.
54. Sellers, buyers and third parties are free in all models to execute CFDs using any price they choose as the reference price, but such contracts are particularly important in poolco models. Buyers and sellers are also free to buy and sell energy futures. In all but the mandatory poolco model, buyers and sellers are free to implement direct bilateral contracts that specify not merely the price(s) the buyer will pay the seller but also the time pattern of the seller's delivery of energy into the grid and the buyer's withdrawals from the grid. In most models, but not in the mandatory poolco model, parties to a bilateral contract are free to select the point on the transmission system at which title to the energy is transferred to from the seller to the buyer. This freedom permits parties to direct bilateral contracts to assign responsibility for arranging for and paying for transmission services. For details of and pros and cons of these models see Charles G. Stalon and Eric C. Woychik, "What Model for Restructuring? The Competitive Power Market Working Group Debate", The Electricity Journal, July 1995, vol. 8, no. 6, pp. 63-73.
55. In particular, the ISO can be charged with a responsibility to anticipate uneconomic actions of market participants and include in filings with his regulator(s) requests for authority, either as an issuer of licenses for generators and/or buyers or as a system operator managing his system, to countervail such inefficiencies as he cannot otherwise remove.
56. See Eric Hirst and Brendan Kirby, "Electric-Power Ancillary Services" (Oak Ridge National Laboratory, ORNL/CON-426, February 1996) for a categorization of ancillary services useful for commercial purposes.
57. For example, the US air traffic control system often imposes delays and unexpected fuel cost on commercial airlines and private airplanes that use its services, but it does not compensate them for such losses. Such costs must be accepted as a necessary cost of flying.
58. In a federal system in which states or provinces are expected to be the dominant regulators of distribution systems, the federal and state regulators must either (1) define distribution as distinct from transmission or (2) allocate the revenue responsibility of transmission and distribution assets to transmission users (to be collected and disbursed under the supervision of federal regulators) and distribution users (to be collected and disbursed under the supervision of state regulators). In the US telecommunication system the latter approach has been used. It is called a "separations" process.
59. Note in particular, that the regulator, presumably the FERC in the US or the NEB in Canada, need not have any jurisdiction over discos or over gencos other than the power to require they obtain a license to participate in the industry. These licenses might be embodied in the tariff of the ISO (and/or a transmission company (transco) if the transco is in a different legal organization than is the ISO).
60. A rational generator in a flexible poolco model with a direct bilateral contract to produce at a rate at which his short run marginal cost of production is higher than the spot price of power will strike a deal with his buyer to reduce generator output until his short run marginal cost equals the spot price and to buy power in the spot market for delivery to the buyer. Similarly, if the generator's short run marginal cost is less than the spot price, he can increase his profits by increasing his output and selling the increment in the spot market. The gains from both types of rescheduling can be shared between the seller and buyer.
61. Regulation in a imperfect world must often be seen as an instrument for limiting freedom of some parties to respond rationally to incentives when rational responses will produce gross inefficiencies. Such incentives for inefficient behavior can arise from many different sources, e.g. old regulatory decisions, court decisions or legislative decisions made for earlier technologies or simply because a decision maker, be it regulator, court or legislator has assigned fairness a higher value than efficiency. Compare, "The Constitution recognizes higher values than speed and efficiency. Indeed, one might say of the Bill of Rights in general, and the Due Process Clause in particular, that they were designed to protect the fragile values of a vulnerable citizenry from the overbearing concern for efficiency and efficacy that may characterize praiseworthy government officials no less, and perhaps more, that mediocre ones". (Stanley v Illinois, 1972). Quoted in Gerald Garvey, Facing the Bureaucracy; Living and Dying in a Public Agency, (Jossey-Bass, San Francisco, 1993), p. 150.
62. See The NERC Team, Options, "Team Position: A single real-time authority in the form of an Independent Interconnection Operator (IIO) should be established to provide oversight, coordination, and direction as necessary to maintain the health and security of the full network" .p. 25.
63. Utilities do trade power in the current system, so existing SOs currently execute trades. What will be new in the restructured system is the increased number of generating companies and buyers.
64. One example is particularly enlightening. Since a DC interconnection between two control areas can be thought of as an AC generator at the delivery end, it would be difficult to deny to the owners of the DC line the right to offer power to the ISO in either control area and change that selection from hour to hour. Such DC lines will permit parties other than the ISOs to arbitrage power prices between control areas.
65. If, however, transmission services are priced by some average cost system, whether postage stamp or average energy losses, the second efficiency criterion will not be satisfied. Both methods tend to mis-price short run transmission services by standards of efficiency. Furthermore, unless some offsetting rules are imposed, incentives will be provided to generators to locate plants inefficiently far from loads, perhaps to take advantage of low cost of fuels. In the UK, the postage stamp pricing system for transmission services has encouraged generators to locate in the North of England where gas is cheap rather than near London where the principal loads exist. Professor William H. Hogan has been the leading developer of locational marginal cost pricing, see his "Electricity Transmission and Emerging Competition", Public Utilities Fortnightly, 1 July 1995, and "Electricity Transmission Policy and Promoting wholesale Competition", a statement to the FERC in Docket No. RM95-8-000. See also "Explanatory Statement of San Diego Gas & Electric Company" and "Appendices to Explanatory Statement of San Diego Gas & Electric Company", June 28, 1996, in FERC Docket Nos. EC96-19-000 and ER96-1663-000. Pacific Gas & Electric Co., San Diego Gas & Electric Co. and Southern California Edison.
66. If, however, transmission services are priced by some average cost system, whether postage stamp or average energy losses, the second efficiency criterion will not be satisfied. Both methods tend to mis-price short run transmission services by standards of efficiency. Furthermore, unless some offsetting rules are imposed, incentives will be provided to generators to locate plants inefficiently far from loads, perhaps to take advantage of low cost of fuels. In the UK, the postage stamp pricing system for transmission services has encouraged generators to locate in the North of England where gas is cheap rather than near London where the principal loads exist. Professor William H. Hogan has been the leading developer of locational marginal cost pricing, see his "Electricity Transmission and Emerging Competition", Public Utilities Fortnightly, 1 July 1995, and "Electricity Transmission Policy and Promoting wholesale Competition", a statement to the FERC in Docket No. RM95-8-000. See also "Explanatory Statement of San Diego Gas & Electric Company" and "Appendices to Explanatory Statement of San Diego Gas & Electric Company", June 28, 1996, in FERC Docket Nos. EC96-19-000 and ER96-1663-000. Pacific Gas & Electric Co., San Diego Gas & Electric Co. and Southern California Edison.
67. One of the ISOs, will reap revenues from the other in each period. The ISO who incurs a cost does so in the process of importing power and reducing the price to all gencos and users in his control area. The ISO who receives revenue does so in the process of exporting power and increasing the price of power to gencos and users in his control area. The market in each poolco is assumed to clear at its ISO-determined MCP defined to recognize imports or exports as the case may be. Each ISO will end the period with zero net gains. The revenue gained by the exporting ISO will be disbursed to generators who produced the power sold by the ISO and the cost incurred by the importing ISO will be recovered by sales of power to users in the importing control area.
68. Proponents of poolco models question the capability of private parties to create robust spot markets for power. To the extent that spot trades require increasing output of one generator while increasing the load of a customer or decreasing output of another generator at another point on the transmission network, the ISO must be informed and his consent gained. Similarly, to the extent that spot trades require the load of one user be reduced and another user's load at another point on the transmission network be increased, the ISO may need to be informed and his consent gained. In short, clearing spot transactions is a part of the natural monopoly of system control. Since the ISO, or some regulated firm, must maintain an electronic bulletin board, and the ISO must be an active participant in spot market decisions, it appears that ISOs have comparative advantages in creating and managing spot markets. Compare, "The control area concept continues to be the industry basis for control of generation to match load. As such, the control area must continue to be the responsible entity for generation control, for ensuring balance between generation and load, and for effecting transactions between entities" (emphasis added). The NERC Team, Options, p. 21.
69. Proponents of the bilateral model have insisted that the ISO not per permitted to offer a dispatching service. They would, however, permit private parties to enter the business of dispatching plants. This raises the problem of coordinating multiple dispatchers in a single control area or permitting a private, unregulated monopoly who dispatches for all generators in the control area. In the former case reliability is jeopardized, and in the latter case buyers and sellers are subject to monopoly exploitation as the monopolist becomes the defacto control area SO and, of necessity, conflicts with the ISO. While it might be possible, and perhaps even desirable, to have multiple SOs in a single trading area, especially if it is a large one, those SOs must be coordinated by an ISO who has overall responsibility to maintain system reliability. In such a system, the division of labor among the SOs requires that each SO have a well defined set of generators subject to its control and that each SOs activities be closely coordinated with all other SOs by the control area ISO, who, in turn, has obligations to coordinate activities in his control area with ISOs in interconnected control areas. In summary, the assertion that the business of dispatching plants can be competitive one lacks credibility. SOs, by definition of their roles must be monopolies, although often coordinating monopolies.
70. In the mid 1980s, when interstate natural gas pipelines were required to provide open access to unregulated gas merchants, the pipelines were also required to provide balancing services to those merchants. Natural gas local distribution companies who provide transportation services to users behind their city gates usually provide balancing services as a complement. Unregulated storage operators have arisen to compete with both LDCs and pipelines.
71. It is not unusual for one or more small utilities to "dispatch" their plants within the control area of a large utility, but they do not act as competitors to one another or to the large utility. They operate in close cooperation with the SO of the large utility and assume some of the responsibilities of a control area, namely, they match their generation and load and they schedule trades between one another with the principal control area SO.
72. Compare: "[T]he principal of marginal cost pricing must be at the very heart of any system of regulations intended to promote an efficient market", Wilkinson, op. cit., p. 44.
73. In this case it is assumed that each generator and each distribution utility is located in one and only one nation. International cooperation in siting or operating generators, beyond what is necessary to control their impact on the electric grid, is assumed not to be necessary.
74. Options, p. 26.
75. Compare: "Compliance has not been perfect; there have been many cases of non-compliance. Some have been dealt with effectively through peer pressure, but quite a few have not ⋯ Reliability has been maintained only because there have been enough entities willing to do 'more than their share' to offset the negative influence of those not in compliance". NERC Team, Options, p. 14.
76. When transmission lines were truly instruments for coordination use of generating reserves and maintenance schedules, the tariff for transmission services were of little relevance. Firms bought and sold a bundled service of power and transmission services. As the competitive market grew, unbundled transmission services were increasingly demanded. The contract path pricing model became important for the first time. No one, including the FERC, believed that power flows by a predictable path but the regulatory convention adopted by the FERC was that it did. Although general agreement exists that a new model is needed, the old one remains in place and allows knowledgeable parties to exploit its weaknesses for profit.