November 14, 2002

Can FERC's Proposed Structure Adapt to the Unknown

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Fifteen years ago Vernon Smith wrote of electricity markets:

"Replacing the entrenched regulatory regime, after eighty-odd years, with a competitive regime will require regulators to be forward looking, politically bold, and cognizant of the disciplinary value of competition."

Today the Federal Energy Regulatory Commission, and many of the state regulatory commissions, can look back with considerable pride at what they have accomplished. Deregulation of electric power generation has proceeded, perhaps not as quickly as in some other industries, and not without some missteps, but with a deliberate and sustained pace. Competition is now deeply entrenched in the nation's power generation system, and it has made that system more efficient, more adaptable, more resilient, and more reliable. Much of this progress has been driven by technological innovation and also by economic developments outside the industry, but to a considerable extent it is the product of hard work and innovative thinking within the regulatory commissions themselves, at both the federal and state levels.

FERC's current Standard Market Design (SMD) proposal is a bold-although not final-step in the evolution of electricity markets. It recognizes that, in power generation, competition is now the primary guarantor of "just and reasonable" rates. It seeks to protect and promote that competition by proscribing anticompetitive practices, especially those that take the form of "undue discrimination" by vertically integrated transmission operators. It seeks to expand the scope of competition by erasing the "seams" between different geographic jurisdictions, as well as smoothing some of the seams between wholesale and retail markets. And it seeks to unmask the price signals for transmission investment that will alleviate the troublesome bottlenecks in the existing infrastructure.

These goals are laudable, and some of the features of the proposed SMD are welcome. In our view, however, the current proposal also suffers from several serious flaws, that make us unable to support the current proposal.