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Raging at the Machine…

I was passing time waiting for a flight out of San Francisco and I ran across a LinkedIn article by a very bright friend of mine – Ron McNamara – on incentives and market outcomes. Ron used to oversee Markets in MISO, and before that, he worked for AEP. The gist of the piece is that if you have a financial interest in an organized electricity market, then you should also be invested in that market’s architecture and rules. In markets for equities, credit, or “normal” commodities there is a clear ownership structure and relatively light regulatory oversight. The imperative is to make sure nobody can game the market, but the outcomes are between willing buyers and sellers. Not so for electricity. Consider for a minute; who “owns” the CAISO? Who “owns” SPP or PJM or MISO?

Anyone who knows me is aware of my conviction that ISOs and RTOs – imperfect though they are – are a vast improvement over the old paradigm of vertically integrated utilities. They allow for non-discriminatory operation of the transmission grid, and economically efficient dispatch of resources. What confounds me is that we would never tolerate a commodity market for corn, oil, or natural gas that does not have a clear relationship to the participants with skin in the game. Why should electricity be unique? Why couldn’t the organized markets be companies that were mutually owned by the member companies? That’s how the New York Stock Exchange and other markets were founded. Just a thought to ponder before going into something more immediately relevant.

Old School: Learning to Negotiate

A long time ago, I was part of a merry band of market practitioners who went around the country negotiating an ISO market design that we all believed was going to sweep across the lower 48 states. It was the late 1990s and FERC Order 888 had spurred on the formation of ISO-New England, the New York ISO, PJM, MISO, and SPP. We were present for the restructuring of ERCOT into a network market. CAISO, although also FERC jurisdictional, was a more insular affair. As usual, California tightly controlled the process, and since I was working for an unregulated affiliate of PG&E, I was not entirely welcome in the discussions.

My memory of that time is crystalized, not only by the relationships built, but also by the earnest and reasoned discussions undertaken by nearly all the parties. There was sincere effort to develop rules that would be fair and that would allow proper market structure to achieve efficient economic outcomes. As my boss at the time, Sarah Barpoulis, said “don’t negotiate the rules according to how our corporate interests. If the market structure is right and fair, it will work for us.” This sentiment seemed to permeate almost all the discussion we had from IOUs, Public Power, Independent Power, Cooperatives. Even the meetings of “Desert Star” in Arizona, New Mexico, and Nevada were in that spirit. Same with “Indigo” as we collectively worked to set up a market in the Pacific Northwest.

That all changed around 2000-01. Was it the Western Power Crisis or was it the post-September 11 change in zeitgeist where we collectively went from a confident to a defensive nation? I don’t know, but even conversations in well established markets like PJM turned from collegial and inclusive to ring-fencing and talking one’s “book”.

Consequently, when I recently sat in on a discussion by various California power market participants on ways to suggest reforms in one particular product area, I was pleasantly surprised to witness an honest exchange of ideas, a willingness to listen to an opposing view, and genuine efforts to reach reasonable accommodation. It was almost as if I was in the “way back machine” and I could hear discussions of market efficiency, how to collectively seek solutions, and ways to convince the regulator. I was in San Francisco and this diverse group of our industry was really talking and negotiating. Very cool. Very… “retro”.

If you’ve ever been denied a loan, come see me!

When PG&E filed for bankruptcy, it underscored for me that commanding a utility to procure renewable energy via “renewable portfolio standards” (RPS) is an example of failed policymaking. This policy circumvents the construct of the market. Rather, it policy by feel good legislation.  Furthermore, the success of such a policy regime is predicated on the regulated utilities being credit worthy and costs being procured through non-by passable rates. You know, captive customers.

I’m not a “denier” in the climate debate. I view the procurement of renewable energy as a good thing even if one weren’t convinced by climate science. Think of market-based mechanisms like cap-and-trade as a good “risk management” tool. One engages in “risk management” even if one is not convinced something will happen. If it might happen, managing the risk is prudent. But here is the problem: It is much easier and more convenient to hide the costs inside a utility charge rather than as a separate cost that bid into a transparent market. For this reason, among others, policy makers in California and elsewhere don’t trust markets to capture those costs and pass them along as they intend.

I suspect that part of the reason for “rage” by climate deniers is the seeming arrogance of the policy makers and the “messianic” parts of the environmental movement to command a solution that doesn’t allow for any deviation. But I digress from my point… easy credit.

Well, the US has been enjoying historically low interest rates for over a decade. This situation means that credit terms are easy. If you want to lend money and get a return, make it easier for those with dodgy credit to borrow. This is a factor throughout the entire economy and whenever anyone senses that someone like the Federal Reserve is going to take the “punch bowl” away, the howls of the equity markets and even some politicians are loud and anguished.  It would be foolish to deny that some projects in our electric markets got built because of regulatory demands and easy credit. But everyone is addicted.

How will this hurt the markets, and ultimately the electric consumer? While it is hard to say, we can be certain that anything untested by the discipline of the market will be found either to be “too expensive” at some point, or superfluous. Think of resources built to such an extent that they can’t be used because of lack of transmission… oh, yeah, that is happening. Would these projects have been added if terms – either by regulatory fiat or easy money – weren’t so easy? Possibly not. Was this situation the result of the thoughtful and collaborative work of industry stakeholders?  Certainly not.

The passing of an era?

Those of us in the West know FERC Commissioner LaFleur quite well and knew she was departing even before it became official that she will leave after the Commission’s July meeting. Despite having the misfortune of being a New England Patriots fan, she has been very involved in the West and is highly regarded. More importantly, Commissioner LaFleur has been an informed, interested, and involved federal public servant who has tried to keep Westerners from thinking FERC was a four-letter word.

Given all the rumors we hear of staff defections and discord between Commissioners, does Cheryl’s departure represent the passing of an era? An era in which FERC was not political but rather an agency we could count upon to issue orders based on the record before them. FERC – both staff and Commissioners – has enjoyed a reputation of being hardworking, dedicated, and talented. Now one hears whispers that the discord that has become so much part of Washington in recent years had finally reached 888 1st Street, NE. We shall see.

A great deal depends on who is nominated to fill the seat made vacant by Commissioner McIntyre’s death, and the one by Cheryl’s departure. If we are to get to one or more markets to manage resources in the West, we may need a FERC that is at the same time thoughtful, involved and appropriately deferential. That will mean we may need FERC to be at its best.