Competition in the Electric Industry: Emerging Issues, Opportunities, and Risks for Facility Operators (1996)

Wilbur C. Earley

Federal Energy Regulatory Commission

The Federal Energy Regulatory Commission (FERC) regulates the prices of interstate electricity transmission, access to interstate transmission services, and wholesale sales in interstate commerce. FERC regulates prices to wholesalers, not to end-users.

The wholesale market is quite an active market and is growing in importance. It has three main components:

• Sales among large, vertically integrated investor-owned utilities, which sell power to one another to minimize costs or improve reliability

• Sales from the integrated utilities to distributors, such as municipalities and rural cooperatives that mainly operate distribution systems and in general must buy their power from others

• Sales from independent power producers (IPPs) to either investor-owned utilities or small distributors.

More important, interstate transmission service is under FERC's jurisdiction, and FERC's transmission jurisdiction is an important part of the electricity industry's transition to competition. It is widely believed that the generation sector of that industry can be competitive, and FERC is moving to make that sector as competitive as possible. The historic problem is that the transmission business has been, and is still, a natural monopoly. To deliver electricity, one needs access to the wires, and in any region there is usually only one owner and operator of those wires. The utilities that

own the regional transmission systems also own substantial generation assets. While competing generators are ready to enter the market, the transmission owners have not been very willing to give their competitors access to those wires.

That barrier to entry has resulted in widely varying prices for electricity across the country, because people cannot buy and sell to each other freely, as they can in most other markets. One cannot simply put electricity on a truck and send it down a highway to which everyone has access. The resulting disparity in prices nationwide is very large. Prices range from about 14 cents per kilowatt hour on Long Island to about 4 cents per kilowatt hour in the Pacific Northwest. That evidence does not suggest the existence of a well-functioning market.

To help bring about more uniform prices, FERC is working with others in the regulatory community to open generation to competition. On April 24, 1996, the Federal Energy Regulatory Commission issued two major orders, Orders 888 and 889, which we think will speed the progress of the electric utility industry toward a competitive structure. Specifically, Orders 888 and 889:

• Ordered all public utilities to provide non-discriminatory open transmission access

• Adopted comparability standards and functional unbundling to help guard against discrimination

• Provided for stranded cost recovery

• Announced procedures for sharing transmission system information

• Required a wholesale marketing Code of Conduct

• Proposed to adopt a Capacity Reservation Tariff

• Established a schedule for implementation.

FERC Orders 888 and 889 deal with several major aspects of access to transmission. The first is equal access at nondiscriminatory prices. FERC Order 888 requires all public utilities to file tariffs providing nondiscriminatory access to all wholesale users. (Retail or end-users are still under the purview of the states).

Second is access to transmission information. Transmission systems are very information-intensive businesses. The impact and feasibility of new transmission service depends critically on a host of highly technical data. Transmission owners in the past have had monopolies on that information. They have found it easy to refuse service on the grounds that there was no capacity available. No one had the information needed to challenge these claims. FERC Order 889 takes a step toward making this information available by requiring each transmission owner to make available an Open Access Same-time Information System (OASIS), an electronic bulletin board that will be available on the Internet.

The concept of comparability is the underpinning of FERC's rule. You can look at a utility as engaging in three functions—generation, transmission, and distribution. It sells itself transmission service, in a sense, to market the services of its generating assets. A public utility transmission owner must provide transmission service to all other market participants on terms comparable to those under which it provides service to itself. We call this the golden rule: treat others the way you treat yourself.

One of the major issues of comparability that FERC addresses in its rule is the requirement that a utility must provide all the transmission services it can provide—not just the services that it actually provides to itself. The Commission wanted to avoid technical arguments over whether a utility in fact provides itself the type of service that is requested by a customer. Under the new rule, any kind of transmission service the utility is capable of providing must be provided to others.

Another issue addressed in Order 888 is eligibility. All wholesale customers are eligible for transmission service under a FERC tariff. Foreign utilities are included, provided they are willing to reciprocate by giving U.S. producers access to their markets on the same terms. Certain retail customers who gain access to the interstate market with the permission of their local utilities or through their state commission's retail access programs are also eligible.

The fact that most of the major transmission owners are also vertically integrated into the generation sector makes enforcing comparability tricky. How can FERC enforce the concept of comparability? The Commission adopted two principal means. One is called "functional unbundling." The other is the OASIS.

Functional unbundling. The basic idea of functional unbundling is that, for all wholesale power transactions it makes, the utility must receive transmission service under its own tariffs. The utility must break down its transactions into a power service and a transmission service and then secure transmission service "from itself" under the same terms and with the same priority as all other market players. It cannot go to the head of the line in terms of service availability, and it cannot provide itself special price deals. To accomplish this, the utility must have a wholesale marketing function and a transmission function that are separate and deal with each other at arm's length.

In addition, the utility must gain access to information about the transmission system in the same way as everyone else, which is on the electronic bulletin board called OASIS. Privileged or inside transmission information can no longer be passed between the transmission operation part of the utility and the wholesale marketing part of the utility.

Functional unbundling is a way of separating a utility's marketing and transmission functions to ensure fairness. It is regarded as a minimal form of functional separation. FERC has rejected, for now, a stricter separation of functions, known as "operational unbundling." Operational unbundling would involve a formal separation of the transmission and generation functions. Many of the comments on the proposal that resulted in Orders 888 and 889 argued that functional unbundling would not work because utilities would be able to work around the functional separation and would be in privileged positions. FERC intends to give functional unbundling a chance to work before considering stronger measures. FERC has also rejected proposals for requiring corporate restructuring, or divestiture, i.e., spinning off generating assets from transmission assets.

One way of accomplishing the same aims as operational unbundling would be to establish independent system operators and give them control of transmission facilities. That idea is being discussed in a number of

regions in the country. It would guarantee comparability by placing decisions about investment, access, and maintenance in the hands of an independent third party. FERC has not required it, but is encouraging the industry to explore the concept. FERC has set out principles for utilities to think about when they are considering the independent system operator concept. The objective of the principles is mainly to guarantee that the entity is truly independent and that it will truly operate the system, rather than being simply an information gatherer or administrator of tariffs.

OASIS. The requirement for the OASIS, or electronic bulletin board, is the second means of enforcing comparability. Each utility must post information about its total transfer capability and the available transfer capability on the system for the next hour, the next day, the next week, the next month, and so on. The object is to make information available to everybody.

In addition, all requests for transmission service and all responses to service requests must be made through the OASIS. Keeping the information out in the open will limit opportunities for preferential behavior. The OASIS will use the Internet and must be implemented in October 1996.

Order 888 requires that all public utilities file tariffs that offer two basic transmission services—network and point-to-point. Order 888 sets out a pro forma tariff, containing minimum terms for good transmission access. All utilities must file tariffs with these minimum terms. If they wish to stray from those terms, their terms must be better for customers.

One condition of taking service under the pro forma tariff is "bilateral reciprocity." This condition is meant to address the problem that not all transmission owners are jurisdictional to the FERC; for example, publicly owned and foreign owned transmission systems are not. The bilateral reciprocity condition is an attempt to bring these owners into the open access world. Any transmission owner who takes service under a FERC tariff must promise to reciprocate, that is, to make available to the utility from whom they are getting service comparable transmission service.

FERC has also addressed the very sticky issue of stranded costs in its rule, but only for wholesale contracts. Under Order 888, utilities will be entitled to extracontractual consideration and given the opportunity to recover up to 100 percent of any costs stranded as a result of a customer leaving the system for another supplier. From FERC's point of view, the regulatory compact entered into by utilities and their regulators obliged utilities to serve customers. In carrying out that obligation, the utilities needed to build enough facilities to satisfy present and projected future load. Because they made investments in facilities for that purpose, utilities reasonably expected to recover the costs of those investments.

But the world has changed. Competition is going to take much of that market away. As a matter of equity, FERC believes utilities are due some consideration on their stranded assets. They made investments in good faith, and they are entitled to collect the revenues to which they had a reasonable expectation.

However, utilities will not be able to collect every dollar they want to collect. They will need to show FERC that these investments were made on the basis of a reasonable expectation that the customers were going to stay on their systems beyond the contract period. In addition, utilities have a duty to mitigate any stranded costs by selling some assets, selling some power, or letting customers take control of their power and try to get the best price for it.

The pro forma tariffs must be filed within 60 days of the issuance of the rule, that is, by July 9, 1996. Individual utilities must file these pro forma tariffs and take service under them (unbundling and sharing information as required). Immediately afterwards, utilities may ask for changes to the pro forma tariffs, as long as the changes are improvements from the customers' point of view or reflect regional practices. Large power pools must file their pro forma tariffs by the end of 1996. FERC has given them extra time to file because they have embedded arrangements and contracts and understandings with one another which need to be worked out.

The Commission has also proposed eliminating the network service now provided for in the pro forma tariffs and replacing the current tariffs with a new capacity reservation tariff. This type of tariff would require service to be provided on the basis of capacity rights to inject and withdraw specific amounts of power from specific points of receipt and delivery. Organizing transmission service this way should result in better planning and facilitate a resale market. A technical conference will be held and comments received on this proposal in the fall of 1996.