Lessons Learned From Electricity Restructuring
Transition to Competitive Markets Underway, but Full Benefits Will Take Time and Effort to Achieve Gao ID: GAO-03-271 December 17, 2002The electricity industry in the United States is undergoing major change, the outcomes of which will affect every consumer. The industry is restructuring from one where electricity prices are set by regulation to one in which competitive markets set the price. GAO was asked to report on the extent to which federal and state actions, to date, have achieved the goal of restructuring. GAO discusses lessons learned from efforts to date.
The goal of restructuring the electricity industry is to increase the amount of competition in wholesale and retail electricity markets, which is expected to lead to a range of benefits for electricity consumers. These benefits include lower prices and access to a wider array of retail services than were previously available. Increasing competition, however, requires that structural changes be made to the electricity industry, such as allowing a greater number of sellers and buyers of electricity to enter the market. The federal government has taken steps to bring about these changes by, among other things, promoting and opening access to regional wholesale markets and proposing to standardize a market design for these markets. In addition, about one-half of the states have taken steps to introduce competition in retail markets, including allowing customers to choose their own electricity supplier. It is not possible to determine the extent to which the goal of restructuring- the development of competitive markets- has been achieved to date. Our review of studies, our own analysis, and our evaluation of monitoring activities of electricity markets indicate a mixed picture of how much progress the industry has made in developing competitive markets and the extent to which expected benefits have been achieved. While some progress has been made in introducing competition, it has proven difficult to measure the benefits of restructuring, and where measurement has been possible, the extent to which expected benefits of restructuring have been achieved is unclear. Recently, with the formation of its new Office of Market Oversight and Investigations, the Federal Energy Regulatory Commission has taken positive steps to look more broadly at the performance of electricity markets. On the basis of our review, we identified five key issues and lessons learned that will require careful consideration as part of restructuring. The solutions to these lessons may prove contentious and addressing them will take time and effort. Unless addressed, the following four lessons will limit competition and thereby diminish the ability of electricity restructuring efforts to achieve their full expected benefits: (1) Different rules apply to the various regional electricity markets; (2) The Federal Energy Regulatory Commission has limited jurisdiction in wholesale markets; (3) Wholesale and retail electricity markets have developed separately; and (4) Generation and transmission siting decisions are subject to federal state, and local government jurisdiction. In addition, a fifth lesson points out the need for better monitoring of market performance to determine how well restructured markets are functioning and the extent to which these markets provide consumer benefits.
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Director: Team: Phone:GAO-03-271, Lessons Learned From Electricity Restructuring: Transition to Competitive Markets Underway, but Full Benefits Will Take Time and Effort to Achieve
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Report to Congressional Requesters:
United States General Accounting Office:
GAO:
December 2002:
LESSONS LEARNED FROM ELECTRICITY RESTRUCTURING:
Transition to Competitive Markets Underway, but Full Benefits Will Take
Time and Effort to Achieve:
GAO-03-271:
GAO Highlights:
Highlights of GAO-03-271, a report to the Chairmen, Subcommittees on
Government Efficiency, Financial Management and Intergovernmental
Relations and Energy Policy, Natural Resources and Regulatory Affairs,
House Committee on Government Reform.
LESSONS LEARNED FROM ELECTRICITY RESTRUCTURING
Transition to Competitive Markets Underway, but Full Benefits Will Take
Time and Effort to Achieve
Why GAO Did This Study:
The electricity industry in the United States is undergoing major
change,
the outcomes of which will affect every consumer. The industry is
restructuring from one where electricity prices are set by regulation
to
one in which competitive markets set the price. GAO was asked to
report
on the extent to which federal and state actions, to date, have
achieved
the goal of restructuring. GAO discusses lessons learned from
efforts to
date.
What GAO Found:
The goal of restructuring the electricity industry is to increase
the amount
of competition in wholesale and retail electricity markets, which
is expected
to lead to a range of benefits for electricity consumers. These
benefits
include lower prices and access to a wider array of retail services
than were
previously available. Increasing competition, however, requires
that
structural changes be made to the electricity industry, such as
allowing a
greater number of sellers and buyers of electricity to enter the
market. The
federal government has taken steps to bring about these changes
by, among other
things, promoting and opening access to regional wholesale
markets and proposing
to standardize a market design for these markets. In addition,
about one-half of
the states have taken steps to introduce competition in retail
markets, including
allowing customers to choose their own electricity supplier.
It is not possible
to determine the extent to which the goal of restructuring”the
development of
competitive markets”has been achieved to date. Our review of
studies, our own
analysis, and our evaluation of monitoring activities of
electricity markets
indicate a mixed picture of how much progress the industry has
made in developing
competitive markets and the extent to which expected benefits
have been achieved.
While some progress has been made in introducing competition,
it has proven difficult
to measure the benefits of restructuring, and where measurement
has been possible,
the extent to which expected benefits of restructuring have been
achieved is unclear.
Recently, with the formation of its new Office of Market Oversight
and Investigations,
the Federal Energy Regulatory Commission has taken positive steps
to look more broadly
at the performance of electricity markets. On the basis of our
review, we identified
five key issues and lessons learned that will require careful
consideration as part of
restructuring. The solutions to these lessons may prove
contentious and addressing
them will take time and effort. Unless addressed, the following
four lessons will limit
competition and thereby diminish the ability of electricity
restructuring efforts
to achieve their full expected benefits:
* Different rules apply to the various regional
electricity markets.
* The Federal Energy Regulatory Commission has
limited jurisdiction in wholesale
markets.
* Wholesale and retail electricity markets have
developed separately.
* Generation and transmission siting decisions are
subject to federal, state, and local
government jurisdiction.
In addition, a fifth lesson points out the need for better
monitoring of market performance
to determine how well restructured markets are functioning
and the extent to which these
markets provide consumer benefits.
What GAO Recommends:
To help Congress ensure that the fullest benefits are achieved
from electricity
restructuring, and to better understand what progress has been
made, GAO recommends
that the Federal Energy Regulatory Commission (FERC) (1)
determine how restructured markets
are performing across the country, and (2) report annually to
Congress and the states on
the status of these markets, including emerging issues and
impediments to reaching its goal.
In commenting on the draft report, FERC agreed with GAO‘s
findings, ’lessons learned,“ and
the recommendation for annual reporting. However, FERC said
GAO‘s recommendation to determine
how restructured markets are performing across the country is
problematic because of
the jurisdictional division between states and FERC. GAO
revised the recommendation to
clarify that it is not asking FERC to step outside of its
jurisdictional boundaries.
To view the full report, including the scope
and methodology, click on the link above.
For more information, contact Jim Wells at (202) 512-3841
or wellsj@gao.gov
Contents:
Letter:
Executive Summary:
Purpose:
Background:
Results in Brief:
Principal Findings:
Agency Comments:
Chapter 1: Introduction:
The Electricity Industry Is An Important and Complex Sector of the U.S.
Economy:
The Development of a National Electricity Network:
Federal and State Regulatory Framework Developed to Oversee the
Electricity Industry:
Changing Nature of the Electricity Industry Made Restructuring a
Possible and Attractive Option:
Restructuring Occurs in a Legislative and Regulatory Environment
Designed to Achieve Many Goals:
Objectives, Scope, and Methodology:
Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers:
To Meet the Goal of Increasing Competition Requires Structural Changes
to the Industry:
Increased Competition Is Expected to Lead to a Range of Benefits:
Restructuring Expected to Occur While Maintaining or Improving System
Reliability:
Conclusion:
Chapter 3: Federal and State Efforts Are Underway to Develop
Competitive
Markets:
Federal Efforts Have Promoted Competition and Opened Access to Regional
Wholesale Markets:
Some States Have Opened Retail Markets to New Sellers, While Others
Have Not Pursued Restructuring Efforts:
Conclusion:
Chapter 4: The Extent to Which the Goal of Competitive
Electricity Markets Has Been Achieved Is Uncertain:
Review of Studies Indicates a Mixed Picture of Competition and
Uncertainty Regarding Benefits:
GAO Evaluation Indicates Some Progress Made in Developing Competitive
Markets but Questions Remain:
Restructuring‘s Impact on Prices and Other Expected Benefits Remains
Unclear:
Conclusion:
Chapter 5: Lessons Learned from Electricity Restructuring and
Recommendations:
Experience with Restructuring to Date Provides Five Lessons Learned:
Conclusion:
Recommendations for Executive Action:
Agency Comments:
Appendix I: Scope and Methodology:
Appendix II: Related GAO Reports:
Appendix III: Comments from the Federal Energy Regulatory Commission:
Appendix IV: Bibliography of Selected Restructuring Studies:
Appendix V: GAO Contacts and Staff Acknowledgments:
Table:
Table 1: Status of RTOs Approved by FERC as of November 2002:
Figures:
Figure 1: Functions of the Electricity Industry:
Figure 2: The Three Major Interconnections in the Continental United
States:
Figure 3: Average Electricity Prices, 1960-1982:
Figure 4: Status of State Electricity Restructuring Activity as of
November 2002 and Average Prices as of 1992:
Figure 5: Generating Capacity Added, 1995 through July 2002:
Figure 6: Average Electricity Prices, 1960-2001:
Figure 7: Overall U.S. Capacity Factor, 1949-2001:
Figure 8: Areas Served by Entities Subject to FERC Jurisdiction, 2002:
Figure 9: Ownership of Large Transmission Lines by Entities Subject to
FERC Jurisdiction, 2002:
Abbreviations:
EPACT Energy Policy Act of 1992:
ERCOT Electric Reliability Council of Texas:
FERC Federal Energy Regulatory Commission:
ISO Independent system operator:
MW Megawatt:
OASIS Open Access Same-Time Information System:
PJM Pennsylvania, New Jersey, and Maryland independent system
operator:
PUHCA Public Utility Holding Company Act of 1935:
RTO Regional transmission organization:
United States General Accounting Office:
Washington, DC 20548:
December 17, 2002:
The Honorable Steve Horn, Chairman
Subcommittee on Government Efficiency, Financial Management
and Intergovernmental Relations
Committee on Government Reform
House of Representatives:
The Honorable Doug Ose, Chairman
Subcommittee on Energy Policy,
Natural Resources and Regulatory Affairs
Committee on Government Reform
House of Representatives:
As requested, we are reporting on efforts being taken to transition the
electricity industry from one in which monopoly utilities generate and
provide electricity to customers at regulated prices into one in which
private companies compete to sell electricity in a market-based system,
and the lessons learned from the experience to date. This report
contains recommendations to the Chairman, Federal Energy Regulatory
Commission (FERC), on (1) the need to develop a plan to collect and
evaluate data and information in order to monitor how electricity
restructuring is performing and to determine if the benefits of
restructuring are being achieved and (2) the need for FERC to report to
Congress and the states annually on, among other things, the progress
being made in developing competitive wholesale electricity markets.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from the date of this letter. At that time, we will send copies to
other appropriate congressional committees as well as to the Chairman,
FERC, and the Director, Office of Management and Budget. We will also
make copies available to others upon request. In addition, the report
will be available at no charge on the GAO Web site at http://
www.gao.gov.
If you or your staff have any questions concerning this report, please
call me at (202) 512-3841. Key contributors to this report are listed
in
appendix V.
Jim Wells
Director, Natural Resources
and Environment:
[End of section]
Executive Summary:
Purpose:
The electricity industry in the United States is undergoing major
changes, the outcomes of which will affect every consumer. The industry
is in the process of restructuring from one in which monopoly utilities
generated and provided electricity to consumers at regulated prices to
one in which numerous private companies are expected to compete to sell
electricity in wholesale and retail markets at prices determined by
supply and demand conditions. This restructuring effort, which began at
the wholesale level in 1992, has increasingly come under scrutiny as a
result of volatile prices, power shortages, and accusations of market
manipulation. For example, in 1998 the Midwest experienced a short-term
spike in electricity prices that resulted in the financial collapse of
some electricity trading companies and disruptions for some electricity
consumers. Further, in 2000, electricity markets in California
experienced a prolonged period of high prices and power shortages--even
blackouts, in some areas. GAO, academics, state government officials,
and others have found that market participants contributed to the
crisis through their efforts to raise prices. More recently, there have
been accusations of market manipulation, concerns over the accuracy of
financial reporting, widespread concern in the investment community
over credit-worthiness of some energy companies, and significant
declines in financial market valuation of several industry
participants.
A number of studies and investigations are underway to respond to these
concerns. FERC has launched several efforts to examine the operation of
wholesale electricity markets and investigate complaints of market
abuse and mismanagement. Similarly, states have undertaken examinations
of the status of their efforts to promote competition in retail markets
and undertaken investigations of complaints of market abuses. Congress
has held hearings to investigate accusations of market abuses and to
examine electricity markets in general. In addition, in each of the
past several years, Congress has examined proposed legislation aimed at
improving federal oversight of electricity markets and related matters.
As such, Congress will continue to play an important role in
restructuring the electricity industry.
In light of the importance of restructuring to consumers throughout the
United States, and to assist Congress in evaluating the state of
electricity restructuring, the Chairmen of the Subcommittee on
Government Efficiency, Financial Management, and Intergovernmental
Relations and the Subcommittee on Energy Policy, Natural Resources and
Regulatory Affairs, House Committee on Government Reform asked us to
determine (1) the goals of electricity market restructuring, (2) what
actions federal and state agencies have taken to restructure the
electricity industry, (3) to what extent these actions have achieved
the goals of restructuring, and (4) what lessons can be learned from
electricity restructuring efforts made to date.
Background:
Electricity is central to the lives and livelihoods of all Americans.
Annual expenditures on electricity amount to about $224 billion, and
electricity provides the power to produce billions more in revenue in
other industries. The electricity industry is based on four distinct
functions: generation, transmission, distribution, and system
operations. Once electricity is generated--whether by burning fossil
fuels, through nuclear fission, or by harnessing wind, solar, or hydro
energy--it is typically sent through high-capacity, high-voltage
transmission lines to electricity distributors in local regions. Once
there, electricity is transformed into a lower voltage and sent through
local distribution wires for use by industrial plants, commercial
businesses, and residential consumers. Because electric energy is
generated and consumed almost instantaneously, the operation of an
electric power system requires that a system operator constantly
coordinate the balance between the generation and consumption of power.
Absent such constant balancing, electrical systems would be highly
unreliable, with frequent and severe outages.
Historically, most utility companies built their own systems of power
plants and transmission and distribution lines to serve the needs of
consumers in their local areas. This arrangement occurred because
electricity service had long been considered a natural monopoly,
wherein it was believed to be most efficient for one company to serve
the entire needs of a local area. Over time, these individual company
systems were connected with adjacent companies‘ systems in order to
improve reliability and to facilitate trade across companies. In
addition to these utilities, federally owned utilities and power
marketing administrations (such as the Bonneville Power Administration,
the Tennessee Valley Authority, and the Western Area Power
Administration), publicly owned utilities (such as municipal
authorities and public power districts), and cooperatively owned
utilities also participated in these electricity systems. These
interconnected systems ultimately evolved into three major networks:
the Western Interconnect, the Eastern Interconnect, and the Texas
Interconnect. Because utilities operated as monopolies, wholesale and
retail electricity pricing was regulated by FERC and the states,
respectively. Under the Federal Power Act of 1935, FERC is charged with
overseeing the rates, terms, and conditions of wholesale sales and
transmission of electricity in interstate commerce. FERC does not
directly regulate federally owned, publicly owned, or cooperatively
owned utilities.[Footnote 1] States retained regulatory authority over
retail sales of electricity, electricity generation, construction of
transmission lines, and intrastate transmission and distribution.
Throughout the 1970s and 1980s, a number of events occurred in the
electricity industry--including rising electricity prices and advances
in generating technologies--that began to encourage a shift towards a
more competitive marketplace for wholesale power. In addition, many
economists and public policy analysts had long advocated the advantages
of competition over regulation and promoted the idea that competition
could drive down costs and prices by reducing inefficiencies, as well
as spur new technological innovations. Further, these advocates of
competition claimed that actions by legislators and regulators to
deregulate airlines, railroads, trucks, and barges had led to lower
prices, better service, and improved safety. These factors encouraged
legislators and regulators to examine the possibility of restructuring
the electricity industry.
Results in Brief:
Based on an extensive review of laws, federal regulations, and relevant
literature, the goal of restructuring the electricity industry is to
increase the amount of competition in wholesale and retail electricity
markets. Increasing the amount of competition requires structural
changes to the electricity industry, such as allowing a greater number
of sellers and buyers of electricity to enter the market. Competition
is expected to produce benefits for consumers, including lower prices
and access to a wider array of retail services, by increasing the
efficiency of wholesale electricity generation and by encouraging
innovations in retail electricity services. Such efficiency gains and
new services are expected to occur as a result of increased incentives
for electricity suppliers to provide better service at lower prices.
Over the past 10 years, the federal government has taken a series of
steps that have opened wholesale markets to competition, and nearly
half the states have taken various steps toward introducing competition
in retail markets. Federal efforts by FERC to promote competition have
opened access to regional wholesale electricity markets. More recently,
FERC has proposed to standardize a market design for all jurisdictional
electric transmission providers. Twenty-four states and the District of
Columbia have promoted competition in retail electricity markets in a
variety of ways, such as allowing customers to choose a retail
electricity supplier, while 26 states have not pursued restructuring
efforts and continue to require retail customers to purchase
electricity from the traditional utility operating in the customer‘s
geographic region. More recently, a number of states have delayed or
postponed their efforts to restructure.
It is not possible to fully determine the extent to which the
development of competitive markets--the goal of restructuring--has been
achieved to date. Our review of relevant studies indicates a mixed
assessment of how far along the industry is in developing competitive
markets and the extent to which expected benefits have been achieved.
Most studies found that some progress has been made in introducing
competition in wholesale electricity markets, but it has proven
difficult to measure the benefits of restructuring for retail
customers. Where measurement has been possible, there is disagreement
about the extent to which expected benefits of restructuring have been
achieved. Our own evaluation of the performance of restructuring was
also inconclusive. With respect to the goal of increasing competition,
restructuring efforts by the federal government and the states have
broadened electricity markets by making them more regional and allowing
new generation companies to participate. However, questions remain
regarding the competitiveness of these markets. In addition, the extent
to which restructuring has led to expected benefits is uncertain, in
part because restructuring is in the early stages of development.
In determining the goals of electricity restructuring, reviewing
actions the federal and state agencies have taken to restructure the
industry, and determining whether those actions have achieved the goal
of increased competition and the expected benefits of restructuring, we
have identified five lessons learned from experience to date that
relate to the structure of electricity markets and market oversight.
These lessons involve (1) the existence of different rules in
electricity systems, (2) FERC‘s limited jurisdiction in wholesale
markets, (3) the separate development of wholesale and retail
electricity markets, (4) federal, state, and local decisions on siting
new power plants and the transmission infrastructure, and (5) the
importance of better monitoring of restructuring. With regard to
monitoring, FERC has recently taken positive steps to look more broadly
at the performance of electricity markets through the formation of its
new Office of Market Oversight and Investigation. While these efforts
may improve the situation, GAO is making recommendations to FERC to
better monitor and report to Congress regarding the status of
restructuring efforts.
In commenting on the draft report, FERC agreed with GAO‘s findings,
’lessons learned,“ and the recommendation to report annually to
Congress and the states. However, FERC said GAO‘s recommendation to
determine how restructured markets are performing across the country
was more problematic because of the jurisdictional division between
states and FERC. In response, GAO has revised the recommendation to
clarify that GAO is not asking FERC to step outside its jurisdictional
boundaries.
Principal Findings:
Goal of Restructuring Is to Increase Competition in Order to Provide
Benefits to Consumers:
Based on an extensive review of laws, federal regulations, and relevant
literature, the goal of restructuring the electricity industry is to
increase the amount of competition in wholesale and retail electricity
markets. Increasing competition requires structural changes to the
electricity industry, such as increasing the number of buyers and
sellers of electricity, improving the availability and accuracy of
price information, and allowing private companies to enter into
competition with existing utilities freely and fairly. Economists and
other policy analysts expect competition to lead to a range of benefits
for consumers of electricity, including lower prices and access to a
wider array of retail services than have been previously available.
Based in part on success in other industries that have been
restructured, competition is expected to achieve these benefits through
improvements in the efficiency of wholesale electricity generation as
well as innovations in retail electricity services. Generally,
competition is expected to lead to greater efficiency and more
innovations by improving the incentives for electricity suppliers to
provide better and less expensive electricity service. Because of the
importance of the electricity industry to the lives of all Americans,
it is essential that any restructuring that does occur does not cause a
deterioration in the reliability of the electricity system.
Federal and Some State Efforts Underway to Develop Competitive Markets:
The federal government has taken a series of actions over the past
decade that have promoted competition in wholesale electricity markets.
The Energy Policy Act of 1992 (EPACT) (1) authorized FERC to require
utilities, on a case-by-case basis, to provide other wholesale buyers
and sellers access to their transmission lines and (2) created a new
class of generators to further compete with traditional utilities.
Beginning in 1996, FERC has issued a series of regulations to open up
the transmission system to competitive generators of electricity and to
promote the development of regional transmission organizations that can
operate the transmission system more efficiently and reliably than
traditional utilities. More recently, FERC has proposed mandating a
standard market design for all jurisdictional electric transmission
providers to allow sellers to transact easily across transmission
boundaries and to allow customers to receive the benefits of lower cost
and more reliable electricity supply.
To date, 24 states and the District of Columbia have enacted
legislation and/or issued regulatory orders to restructure their retail
electricity markets. Of these, 17 states and the District of Columbia
continue to be active in implementing retail access, thereby allowing
customers to choose their own electricity supplier. However, most of
these states have fixed retail electricity prices at (or below) the
regulated rate in place before the onset of retail competition and
continue to allow customers who do not select an alternative service
provider or whose competitive supplier has stopped offering service to
be served by their traditional utility. The remaining 26 states have
not enacted legislation and/or issued regulatory orders to implement
retail access, and they continue to require retail customers to
purchase electricity from their traditional utility at regulated rates.
The Extent to Which Markets Are Competitive Is Uncertain:
It is not currently possible to fully determine the extent to which the
goal of developing competitive markets has been achieved. Our review of
studies related to measuring the performance of restructuring indicates
a mixed assessment of how far along the industry is in developing
competitive markets and the extent to which expected benefits have been
achieved. While most studies found progress has been made in
introducing competition in wholesale electricity markets, results at
the retail level have been difficult to measure. Where measurement has
been possible, there is disagreement about the extent to which the
expected benefits of restructuring have been achieved. Our own
evaluation indicates that federal and state restructuring efforts have
broadened wholesale electricity markets by making them more regional
and allowing new generation companies to participate. For example,
several new regional markets have emerged where buyers and sellers bid
to buy and sell wholesale electricity. While it appears that markets
are broadening, we could not determine, based on existing studies or
our evaluation of available data, the extent to which the expected
benefits of increased competition have been achieved. For example,
while consumer prices have generally fallen since restructuring began-
-and more so in states that are restructuring than in nonrestructured
states--the falling prices continue a trend that began prior to
restructuring, making it difficult to determine the precise role
restructuring has played in causing the price reductions.
Lessons Learned from Electricity Restructuring:
We identified five lessons learned from experience to date regarding
the structure of electricity markets and the need to monitor market
performance. Collectively, these lessons demonstrate potential
limitations to developing a national competitive electricity market and
the expected benefits of restructuring, as well as the importance of
information in monitoring restructuring progress.
Different rules in electricity systems limit the ability to achieve
benefits from competition.
In its effort to promote competitive wholesale markets, FERC
historically has approved a wide range of specific rules that govern
the operation of individual transmission system operators and
centralized wholesale markets under FERC‘s jurisdiction. Today, these
different rules and operations in regional electricity systems and
wholesale markets make it more costly for participants in different
electricity markets to buy and sell from each other across electricity
systems. This, in turn, limits the degree of competition and the
expected benefits of restructuring.
FERC‘s limited jurisdiction in wholesale markets limits the ability to
achieve benefits from competition.
FERC does not have regulatory authority over all entities in wholesale
electricity markets, with large areas of the country operating
primarily outside the scope of FERC‘s authority. Therefore, FERC has
been unable to prescribe the same operating standards and access to
markets for these entities as it has with entities subject to its
jurisdiction. This situation limits the development of competitive
wholesale markets by limiting the degree to which market participants
can make electricity transactions across these jurisdictions. This, in
turn, limits the ability of restructuring efforts to achieve a truly
national competitive electricity system and ultimately limits the
expected benefits of restructuring.
Separate development of wholesale and retail electricity markets limits
the ability to achieve benefits from competition.
Federal and state actions to restructure wholesale and retail markets
have, for the most part, been undertaken separately. Federal actions
have focused on promoting wholesale competition by increasing the
direct interaction of buyers and sellers to determine price. However,
most state actions at the retail level--to freeze prices or continue
price regulation in areas not undertaking retail restructuring--have
had the effect of limiting the degree to which retail consumers respond
to changes in underlying wholesale prices. As a result, these actions
place limits on the extent to which fully competitive markets can
develop and, thus, will limit the expected benefits of restructuring.
Federal, state, and local decisions on siting new power plants and
transmission lines limit the ability to achieve benefits from
competition.
While restructuring has opened access to wholesale electricity markets,
new market entry--through building new generating or transmission
facilities--remains subject to federal, state, and local siting
decisions. For example, state decisions on how and when to site new
generation and transmission will, to a great extent, determine the
availability of and access to new electricity supplies and, therefore,
will affect the competitiveness of wholesale electricity markets. As a
result, state actions that serve to delay or prevent the addition of
new power plants or power lines have the effect of limiting market
entry and, consequently, may limit FERC‘s ability to achieve a national
market for competitive electricity and thus the expected benefits of
restructuring.
Better monitoring of market performance is needed to determine how well
restructured markets are performing and the extent to which expected
benefits of competition are achieved.
To date, monitoring of restructuring efforts has not been comprehensive
enough to fully assess how well restructured markets are performing nor
the extent to which expected benefits of competition have occurred.
Limitations in the authority to collect data and incomplete monitoring
efforts by regulatory and monitoring entities have precluded a
comprehensive effort to determine how far along the road to greater
competition we have come, and what remains to be done. To move forward,
it is essential that FERC and other regulatory bodies and market
monitors carefully watch for signs of problems and have the ability to
make needed adjustments, such as recognizing potential barriers to
needed investments in new generating or transmission facilities and
acting to address them in a timely fashion.
Recommendations:
To help ensure that the fullest benefits possible are achieved from
electricity restructuring, and to better understand what progress has
been made, GAO is recommending that the Chairman, FERC,
1. determine how restructured wholesale electricity markets are
performing by developing and implementing a plan to collect necessary
data and perform evaluative analysis. These data should be sufficient
to allow evaluation of the competitiveness of these markets (including,
but not limited to, the extent of market power, efficiency of the
industry, and ease of market entry) and the expected benefits to retail
consumers (such as lower retail prices and the availability of new
products). Where possible and appropriate, FERC should work in concert
with state and regional entities to take advantage of their knowledge,
expertise, and access to important data relevant to the impacts of
restructuring on consumers.
2. report annually to Congress and the states on the status of
restructuring efforts, identify emerging issues and impediments to
reaching FERC‘s goal of achieving national competitive wholesale
electricity markets, and make recommendations to Congress and the
states for changes that will improve the functioning of these markets.
Agency Comments:
We provided FERC with a draft of this report for review and comment.
FERC agreed with the report‘s principal findings and ’lessons learned.“
In addition, FERC agreed with GAO‘s recommendation that FERC should
report annually to Congress on the status of restructuring, noting that
it plans to do so in spring 2003. However, FERC said that GAO‘s
recommendation directing it to determine, in concert with the states
and regional entities, how both wholesale and retail markets are
performing is more problematic. FERC was concerned about this
recommendation because of the jurisdictional division between states
and FERC--states have jurisdiction over retail and FERC over wholesale
electricity markets. In addition, FERC stated that it does not have the
resources or expertise to evaluate retail markets.
In response to FERC‘s concern, we clarified that we are not
recommending that FERC step outside its jurisdictional boundaries or
attempt to assume responsibility for the status and effectiveness of
retail restructuring efforts. Further, we revised the language of our
recommendation to state that FERC should evaluate the impacts of
restructuring efforts in wholesale markets on retail electricity
consumers. With regard to the issue of resources and expertise, we
believe that FERC can supplement its own assets by drawing from many
sources, including other federal agencies, expert panels, state
agencies, and regional market monitoring entities.
FERC‘s written comments are presented in appendix III. Our evaluation
of FERC‘s written comments are contained at the end of chapter 5. In
addition, FERC provided us with some technical changes, which we
incorporated into the report as appropriate.
[End of section]
Chapter 1: Introduction:
The electricity industry is an important and complex sector of our
economy that is central to the lives of Americans. Historically, the
U.S. electricity industry developed into a structure of localized
monopoly utilities. Each of these monopoly utilities generated
electricity to serve consumers in its local area. Within this localized
structure, there was limited interaction among different utilities
across wide geographic regions. Because of the complex nature of the
electricity industry and its historical development, both federal and
state entities are involved in overseeing and regulating the industry.
Throughout the 1970s and 1980s, a number of events occurred in the
electricity industry that began to encourage a shift toward more
competitive electricity markets.
The Electricity Industry Is An Important and Complex Sector of the U.S.
Economy:
Electricity is central to the lives and livelihoods of all Americans.
Annual expenditures on electricity amount to about $224 billion, and
electricity is an important input to production in many industries. For
example, industrial customers--including companies engaged in
manufacturing and assembling products--rely on electricity to power
computers, tools, and machinery, as well as for lighting, heating, and
cooling their plants and buildings. Similarly, commercial customers--
including shopping malls, office buildings, individual stores, and
financial and stock markets--also depend heavily on electricity for
their day-to-day operations. In addition, residential customers rely on
electricity for heating and cooling, lighting, cooking, and cleaning.
Finally, with the expansion of Internet usage and the importance of
information technologies for commerce, electricity has assumed an even
greater role in the daily lives of Americans. As a result, the cost and
availability of electricity have implications for the entire economy.
The electricity industry is based on four distinct functions:
generation, transmission, distribution, and system operations. (See
figure 1.) Once electricity is generated--whether by burning fossil
fuels, through nuclear fission, or by harnessing wind, solar, or hydro
energy--it is sent through high-voltage, high-capacity transmission
lines to electricity distributors in local regions. Once there,
electricity is transformed into a lower voltage and sent through local
distribution wires for end-use by industrial plants, commercial
businesses, and residential consumers.
Figure 1: Functions of the Electricity Industry:
[See PDF for image]
Source: GAO.
[End of figure]
A unique feature of the electricity industry is that electricity is
consumed at almost the very instant that it is produced. As electricity
is produced, it leaves the generating plant, and travels at the speed
of light through transmission and distribution wires to the point of
use, where it is immediately consumed. In addition, electricity cannot
be easily or inexpensively stored and, as a result, must be produced in
near-exact quantities to those being consumed. Because electric energy
is generated and consumed almost instantaneously, the operation of an
electric power system requires that a system operator balance the
generation and consumption of power. The system operator monitors
generation and consumption from a centralized location using
computerized systems and sends minute-by-minute signals to generators
reflecting changes in the demand for electricity. The generators then
make the necessary changes in generation in order to maintain the
transmission system safely and reliably. Absent such continuous
balancing, electrical systems would be highly unreliable, with frequent
and severe outages.
The Development of a National Electricity Network:
Historically, the electric industry developed initially as a loosely
connected structure of individual monopoly utility companies, each
building power plants and transmission and distribution lines to serve
the exclusive needs of all the consumers in their local areas. Such
monopoly utility companies were typically owned by shareholders and
were referred to as investor-owned utilities. In addition to these
investor-owned utilities, several types of publicly owned utilities,
including rural cooperatives, municipal authorities, state
authorities, public power districts, and irrigation districts, also
began to sell electricity. About one-third of these publicly owned
utilities are owned collectively by their customers and generally
operate as not-for-profit entities. Further, nine federally owned
entities, including the Tennessee Valley Authority and the Bonneville
Power Administration, also generate and sell electricity--primarily to
cooperatives, municipalities, and other companies that resell it to
retail consumers.
Over time, the transmission and distribution systems owned by private,
public, and federal utilities became interconnected with one another in
order to improve reliability and to facilitate trade across companies.
These interconnected systems ultimately evolved into three major
networks: the Western Interconnect, the Eastern Interconnect, and the
Texas Interconnect. Figure 2 shows the division of the country into the
three major interconnected systems.
Figure 2: The Three Major Interconnections in the Continental United
States:
[See PDF for image]
Source: Energy Information Administration.
[End of figure]
Federal and State Regulatory Framework Developed to Oversee the
Electricity Industry:
Because the utilities operated as monopolies, wholesale and retail
electricity pricing was regulated by the federal government and the
states. The Public Utility Holding Company Act of 1935 (PUHCA) and the
Federal Power Act of 1935 established the basic framework for electric
utility regulation. PUHCA, which required federal regulation of these
companies, was enacted to eliminate unfair practices by large holding
companies that owned electricity and natural gas companies in several
states. The Federal Power Act created the Federal Power Commission--a
predecessor to FERC--and charged it with overseeing the rates, terms,
and conditions of wholesale sales and transmission of electric energy
in interstate commerce. FERC, established in 1977, approved interstate
wholesale rates based on the utilities‘ costs of production plus a fair
rate of return on the utilities‘ investment. States retained regulatory
authority over retail sales of electricity, electricity generation,
construction of transmission lines within their state‘s boundaries, and
intrastate transmission and distribution. Generally, states set retail
rates based on the utility‘s cost of production plus a rate of return.
In addition to federal and state regulation, some industry participants
have also self-regulated in part by their voluntary participation in
the North American Electric Reliability Council (NERC), an organization
of electricity industry entities that develops and maintains standards
for operating the electricity systems in the United States. The need
for such an organization to help coordinate operations of individual
utilities became apparent as the transmission and distribution systems
of the individual utilities became connected. Because small changes in
supply and demand in one network can affect neighboring networks, it is
necessary that all parties coordinate their operations. When
coordination fails, the reliability of the system is in jeopardy, as
was the case when blackouts occurred in the Northeast in 1965. NERC was
formed in response to these blackouts and continues to play a role in
facilitating coordination between different utilities‘ systems.
Changing Nature of the Electricity Industry Made Restructuring a
Possible and Attractive Option:
Throughout the 1970s and 1980s, a number of events occurred in the
electricity industry that began to encourage a shift towards more
competitive electricity markets. These events included rising
electricity prices charged by utilities, changes in the technology of
electricity generation, and a shift in regulatory thinking in the
United States and other countries around the world that had begun to
move toward the use of markets rather than governments to make
decisions about investments to meet many public needs.
Between 1970 and 1982, average residential and industrial electricity
prices increased by 37 percent and 124 percent respectively, after
adjusting for inflation. As seen in figure 3, this sharp increase
reversed a downward trend in prices over the previous decade.[Footnote
2] These price increases were in part the result of investment
decisions made by utilities and approved by state regulators to build
numerous large-scale, costly electric power plants. These plants were
built on the assumption that demand for electricity would increase
steadily in the future. However, demand did not rise as quickly as
anticipated, in part because of slower-than-expected economic growth.
Regulators allowed companies to recover the high costs of building
these new power plants through higher electricity rates.
Figure 3: Average Electricity Prices, 1960-1982:
[See PDF for image]
Source: GAO analysis of data provided by the Energy Information
Administration.
[End of figure]
In addition to rising electricity prices, significant technological
changes in both generation and transmission were occurring, which
improved the efficiency of natural gas-fired power plants. These
technological improvements made it possible to build smaller, more
efficient plants, capable of producing electricity at lower cost than
the prices charged by many of the existing utilities. In addition,
advances in transmission capabilities also allowed electricity to be
moved over longer distances, making it more readily available to a
wider range of customers. As a result, electricity customers,
particularly large industrial users, saw their electricity prices
rising, while advances in technology promised lower-priced power, and
they began to exert pressure on legislators and regulators to allow
them to gain access to electricity at lower prices. Restructuring the
industry to introduce competition was seen as a way to achieve this
aim.
More generally, the evolution of regulatory thinking in the United
States and other countries around the world shifted toward the use of
markets rather than governments to make decisions about investments to
meet many public needs. Economists and public policy analysts,
believing in the advantages of competition over regulation, promoted
the idea that markets could drive down costs and prices by reducing
inefficiencies and providing better incentives for companies to develop
new innovations. Legislators and regulators passed laws and implemented
rules that promoted competition across the U.S. economy. For example,
during the 1970s and 1980s Congress passed laws deregulating the
airline, railroad freight shipping, trucking, and barge shipping
industries. Over the same period, several other countries--including
New Zealand, Norway, Sweden, and the United Kingdom--restructured their
electricity industries to introduce competition. Citing successes from
other deregulation or restructuring efforts, many experts, industry
participants, and other interested parties began to call for
restructuring of the U.S. electricity industry.
Restructuring Occurs in a Legislative and Regulatory Environment
Designed to Achieve Many Goals:
Today, restructuring of the electricity industry is occurring within
the context of a myriad of federal and state laws and regulations
related to such issues as clean air, clean water, fish and wildlife
management, recreational uses of waterways and parks, irrigation, flood
control, and citizens‘ health and rights. Responsibility for
implementing and enforcing these laws and regulations is distributed
across a wide range of federal, state, and local agencies. The result
is a natural tension between achieving the goals of restructuring the
electricity industry and other existing laws and regulations.
Objectives, Scope, and Methodology:
The Chairmen of the Subcommittee on Government Efficiency, Financial
Management and Intergovernmental Relations and the Subcommittee on
Energy Policy, Natural Resources and Regulatory Affairs, House
Committee on Government Reform, asked us to determine (1) the goals of
electricity market restructuring, (2) what actions federal and state
agencies have taken to restructure the electricity industry, (3) to
what extent these actions have achieved the goals of restructuring, and
(4) what lessons have been learned from electricity restructuring
efforts made to date.
To answer these questions, we collected views of stakeholders and
industry experts, including market participants; trade associations;
and federal, state, and regional market monitors. We also reviewed
relevant studies of restructuring, including reports by market
monitors, trade associations, consumer interest groups, academics, and
consultants. In addition, we conducted our own evaluation of data
provided by the Energy Information Administration, FERC, and private
sources. We conducted our work from November 2001 through November 2002
in accordance with generally accepted government auditing standards.
For a more detailed description of our methodology, see appendix I.
[End of section]
Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers:
The goal of restructuring the electricity industry is to increase the
amount of competition in wholesale and retail electricity markets,
which is expected to lead to a range of benefits for electricity
consumers, including lower prices and access to a wider array of retail
services than were previously available. Increasing the amount of
competition requires structural changes within the electricity
industry, such as allowing a greater number of sellers and buyers of
electricity to enter the market. Competition is expected to produce
benefits for consumers by increasing the efficiency of wholesale
electricity generation and by encouraging innovations in retail
electricity services. Such efficiency gains are expected to occur as a
result of improved incentives for electricity suppliers to provide
better service at lower prices. Further, restructuring is expected to
occur while maintaining or enhancing the reliability of the electricity
system to consumers.
To Meet the Goal of Increasing Competition Requires Structural Changes
to the Industry:
Based on an extensive review of laws, federal regulations, other
relevant literature, and discussions with numerous industry experts,
there is a consensus that the goal of restructuring the electricity
industry is to increase the intensity of competition in wholesale and
retail electricity markets. Increasing competition requires that a
number of conditions be met, including (1) increases in the number of
buyers and sellers, (2) sufficient public information about electricity
prices to enable buyers and sellers to make informed decisions, and (3)
the ability of sellers to enter and exit markets in response to market
information. Meeting these conditions will require that the traditional
system of regulated local monopolies, which generated and provided
electricity to retail consumers at regulated prices, be replaced by a
market-based competitive system in which sellers and buyers interact to
determine the price of electricity.
Competition Requires an Increased Number of Buyers and Sellers.
More buyers and sellers of wholesale electricity are needed to ensure
that no single entity has the ability to influence the price of
electricity in its favor. Under the regulated environment that preceded
restructuring, utilities held local monopoly positions that encompassed
generation, transmission, and distribution of electricity to consumers
in each utility‘s area of control. While trading of wholesale
electricity between separate utilities occurred prior to restructuring,
this took place primarily between the existing monopoly utilities,
thereby limiting the number of participants in the wholesale markets.
Therefore, in order to increase the number of sellers, it is necessary
for the monopoly owners of transmission and distribution systems--the
wires that deliver electricity from generators to final customers--to
provide access to these systems to new market participants.
Specifically, new sellers of wholesale electricity will have to be able
to buy access to the transmission system at nondiscriminatory rates in
order to sell wholesale electricity to buyers.
In addition, greater numbers of retail sellers are also needed to offer
the many retail customers a choice of electricity provider and to
encourage competition among those providers. Under the regulated retail
environment, utilities were the sole suppliers of retail electricity to
final consumers. Even if numerous wholesale sellers emerge, without
changes in the structure of the retail side of the market, there will
be few buyers--each utility will still be the sole provider of
electricity to consumers in its area of control, and therefore the only
buyer of wholesale electricity. Therefore, in order to increase the
number of new buyers in the wholesale market, it may be necessary to
make changes in the retail structure to allow more buyers to compete
for electricity in the wholesale market. New buyers of wholesale
electricity could either be private companies that would buy wholesale
electricity and compete to sell it to retail consumers, or, in some
cases, final consumers themselves may be able to purchase directly from
wholesale suppliers. As in the wholesale market, retail competition
will require that new participants have nondiscriminatory access to
transmission and distribution systems. Changes in regulation will also
be needed to allow consumers to deal directly with wholesale sellers or
to allow competition among retail providers of electricity.
Adequate market information is needed.
In order for buyers and sellers of wholesale electricity to make
informed decisions, they must have access to sufficient information
about relevant prices, including prices of electricity at locations
near them and prices of transmission and other charges required to make
transactions. Well-functioning competition requires that no single
buyer or seller has better information about available prices of
electricity than any other market participant. If such an information
advantage exists, then those entities with superior information may be
able to take advantage of other participants, thereby leading to
undesirable outcomes, such as higher prices than would exist under
competitive conditions. In addition to price information, experts have
said that there must be adequate information about the volumes of
trades, and a general increase in the volume of electricity traded. In
most commodity markets, such information is readily and publicly
available. However, it is less prevalent in the electricity market, and
experts generally agree that structural changes are required to make
information more available. Specifically, experts point to a lack of
sufficient numbers of transactions in some electricity markets to
generate reliable information about prices and other market
information.[Footnote 3] In addition, there is concern that even in
markets with many transactions, price and other relevant market data
are not made publicly available. Academics and consumer advocates have
stated that a lack of public data limits the ability of nonstakeholders
to evaluate restructuring and has a detrimental effect on consumer
confidence in the restructuring process.
Freedom to enter and exit the electricity industry is needed.
One of the foundations of a competitive market is the ability of market
participants to freely enter and exit the electricity industry in
response to information about opportunities in that and other
industries. For example, if wholesale electricity prices in one region
are high compared to other regions--leading to higher than normal
profits for electricity sellers--this would indicate that new
investment in either generation or transmission capacity is warranted.
Similarly, if there were too much generation in a particular area,
leading to prices too low to support normal profits, companies may wish
to exit that area by shutting down power plants to avoid losing money.
Under competitive conditions, where all participants have the same
ability to enter or exit the industry, private companies can be
expected to make new investments or to withdraw from a region,
depending on market conditions. As a result, it is expected that
restructuring will lead to more consistent prices across regions than
under the previous regulated environment. More investment will be
attracted to high-price regions, thereby causing prices there to fall
relative to lower-price regions, while more trade between regions will
also have the effect of bringing regional prices closer together. For
potential participants to have freedom to enter and exit electricity
markets, they must be able to gain access to existing power lines and
associated facilities under terms that are consistent with their
competitors. Therefore, owners of power lines must be required to
provide access to new entrants at terms that do not discriminate
compared to existing market participants.
Increased Competition Is Expected to Lead to a Range of Benefits:
Increasing competition is expected to lead to benefits for consumers of
electricity. In particular, experts believe that competition in
wholesale markets will provide a way to reduce prices by improving the
efficiency of producing and delivering electricity. Proponents of
restructuring have stated that regulated companies and regulators made
poor investment decisions that raised the average cost of electricity
for consumers. These investments led to excess investment in
electricity generation capacity, in part because utilities and
regulators overestimated demand growth. Once this excess capacity was
built, electricity prices had to rise to cover the costs to the
utilities, even when generating units sat idle. In addition, economists
and other industry experts argued that monopoly utilities had poor
incentives to keep overall costs down because they were able to pass on
all approved costs to consumers in their regulated rates. The experts
also argued that regulation slowed the pace of technological
innovation, because even if new cheaper generating units could be
built, the regulators were still bound to allow the utilities to
recover their investment costs for older more expensive generating
units. Therefore, by introducing competition among wholesale suppliers
of electricity, experts expect new, lower-cost generating plants to be
built by nonutility companies, leading to greater efficiency in
producing electricity and ultimately causing prices to fall. As an
additional benefit, many newer generating plants are much less
polluting than the older existing plants. Therefore, investment in new
generating plants may facilitate improvements in air quality, if
electricity produced by these cleaner-burning generators displaces
electricity from older dirtier plants.
Restructuring of retail electricity markets is expected to (1) provide
a mechanism for transferring the lower costs achieved through wholesale
competition to consumers, (2) improve customer service, and (3) lead to
the introduction of new products and services. Under the old regulatory
environment, it was argued that monopoly utilities did not have
sufficient incentives to continually seek ways to provide better and
cheaper electricity and services to consumers. Introducing competition
among retail electricity suppliers is expected to allow retail
customers to choose a supplier on the basis of prices, products, and
service. As a result, retail suppliers will have an incentive to offer
electricity and services at prices consumers are willing to pay. Also,
in order to compete for customers, retail suppliers are expected to
develop and introduce new products and services.
Taken together, wholesale and retail competition could also provide a
mechanism by which the financial risks associated with building new
electricity generating plants can be transferred from consumers to
private companies and their shareholders. In the old regulatory
environment, utilities built the bulk of new generating plants after
first identifying an expected need for the new plants and after gaining
approval from state regulators. Once approved and built, the cost of
building and operating the new generators was passed on to consumers,
because the utilities were allowed to capture these costs in the prices
set by the regulators. Therefore, consumers bore the financial risk
associated with investments made by utilities. In a competitive
environment, owners of new generating capacity are not guaranteed
recovery of their costs; therefore, they bear the risks of their
decisions to build. In this environment, consumer prices are determined
more by current market conditions than by historical investment
decisions made by utilities and approved by regulators. For this
reason, it is argued, technological innovations that lead to lower
electricity costs will be adopted faster, leading to lower consumer
prices.
Restructuring Expected to Occur While Maintaining or Improving System
Reliability:
Because reliability of the electricity system is so important to the
economy, safety, and security of the country, it is essential that any
restructuring that occurs does so without adversely affecting
reliability. Historically, reliability has been maintained largely by
utilities owning enough generating capacity to serve even the highest
demand for electricity under conditions in which some of the capacity
may be inoperable. As a result, some power plants operated only a few
hours per year. Under restructuring, the total capacity required to
maintain reliability could be reduced for three reasons. First,
restructuring is expected to broaden electricity markets, which will
allow individual local areas to draw electricity from power plants
across a wider region, thereby reducing the amount of capacity the
local area must own to meet its demand. Because different localities
will have their highest demands at different times, idle power plants
in one locality could serve other localities experiencing high demand
and this reduces the total generating capacity necessary to maintain a
reliable supply. Second, under restructuring, some consumers will have
enhanced incentives to conserve power during peak demand periods when
electricity prices are high. Such incentives will reduce the total
consumption of electricity during the highest demand periods, thereby
reducing the total capacity required to maintain reliability. Third,
some consumers may enter contracts that allow the system operator to
shut off their power in times of electricity shortage to avoid more
general supply disruptions. In return, these consumers would be
compensated for the disruption.[Footnote 4]
Conclusion:
Developing competitive wholesale and retail electricity markets will
not be easy. Among other things, it will require the creation of an
environment that encourages new participants and the development of
adequate and reliable information in order for these participants to
make informed investment decisions, while maintaining reliability of
the electricity system. In addition, restructuring is occurring within
the context of other federal and state laws and regulations, including
those related to clean air, clean water, and endangered species.
Therefore, in developing competitive markets, it will take time to deal
with these issues in a way that instills confidence in both market
participants and consumers.
[End of section]
Chapter 3: Federal and State Efforts Are Underway to Develop
Competitive
Markets:
Federal efforts to promote competition have focused on promoting and
opening access to regional wholesale electricity markets, including
FERC‘s most recent proposal to create a standard market design for all
electric transmission providers. Twenty-four states and the District of
Columbia have enacted legislation and/or issued regulatory orders to
allow customers to choose their retail electricity supplier. The
remaining 26 states have not taken such actions and continue to require
retail customers to purchase electricity from their traditional
utility.
Federal Efforts Have Promoted Competition and Opened Access to Regional
Wholesale Markets:
The federal government has taken a series of actions over the past
decade that has promoted competition in wholesale electricity
markets.[Footnote 5] The Energy Policy Act of 1992 (EPACT) allowed some
nonutility companies to participate in wholesale markets without owning
their own transmission lines, an opportunity that was previously
limited.[Footnote 6] EPACT also authorized FERC to require utilities,
on a case-by-case basis, to provide other wholesale buyers and sellers
access to their transmission lines. By making it easier for nonutility
generators to enter the wholesale market for electricity, EPACT not
only expanded competition, but also facilitated the shift in how
electricity prices were set, since utilities could purchase electricity
from nonutility wholesale generators and pay market-based prices,
traditional cost-of-service prices, or a combination of both.
In April 1996, to remedy claims of undue discrimination in access to
the transmission system, FERC issued Orders 888 and 889, opening the
transmission systems of investor-owned utilities to all qualified
wholesale buyers and sellers of electricity. Commonly known as the
’open access rule,“ Order 888 required that transmission line owners
offer transmission services to other transmission users under
comparable terms and conditions that they provide for themselves. The
vertically integrated nature of utilities in the past had not allowed
independent electricity suppliers equal access to transmission systems.
In promulgating the regulation, FERC found that by limiting the extent
to which independent electricity suppliers could provide service to
electricity customers, growth of competitive electricity generation
markets had been hindered. Order 888 also required utilities to
separate their generation and transmission businesses--a process
referred to as unbundling--to prevent discriminatory practices in
providing transmission services, such as denying competitors equal
access to transmission lines. This unbundling was accomplished by
requiring utilities to separate their transmission service functions
from other business activities. Order 888 also encouraged utilities to
form independent system operators (ISO),[Footnote 7] to which they
could transfer operating control (but not ownership) of their
transmission facilities, thereby satisfying the unbundling requirement
contained in the order. Since Order 888 was issued, six ISOs have been
formed and are operating, each with its own set of operating
rules.[Footnote 8]
FERC also found that to effectively ensure nondiscriminatory access to
the transmission system, up-to-date information about transmission must
be unrestricted and public to all transmission users. To meet this
need, FERC issued Order 889, which required all privately owned
utilities to participate in the Open Access Same-Time Information
System (OASIS). OASIS is an interactive Internet-based database
containing information on available transmission capacity, capacity
reservations, and transmission prices. By providing timely access to
all qualified users regarding transmission market information, the goal
of OASIS was to facilitate the functioning of competitive electricity
markets.
After passage of Orders 888 and 889, FERC found evidence that the
traditional management of the transmission system was still inadequate
to support the open access and efficient and reliable operation needed
for the continued development of competitive electricity markets, and
that continued discrimination in the provision of transmission services
by vertically integrated utilities may also be impeding fully
competitive electricity markets. In December 1999, FERC issued Order
2000, which encouraged all privately owned utilities to voluntarily
place their transmission facilities under the control of a broader
market entity called a regional transmission organization (RTO). As a
result, ISOs created under Order 888 would be supplanted by larger
RTOs, which together would cover the entire nation. The rationale
behind FERC‘s approach to forming RTOs was that the nation‘s
transmission systems should be brought under regional control in order
to eliminate the remaining discriminatory practices in use, better meet
the increasing demands placed on the transmission system, improve
management of system congestion and reliability, and achieve fully
competitive wholesale power markets. Order 2000 did not specifically
require RTO participation; however, if a utility opts not to join an
RTO, it is required to explain why it is not doing so.
Since issuing Order 2000, FERC has approved one organization as an RTO
and conditionally approved three with the provision that to receive
full approval they take significant actions to further conform to RTO
requirements described in Order 2000. These organizations operate in 21
states and the District of Columbia, and in Manitoba, Canada. (See
table 1 for RTO approval decisions by FERC.):
Table 1: Status of RTOs Approved by FERC as of November 2002:
Organization: GridFlorida; Approval: [Empty]; Conditional approval[A]:
X; Area of operation[B]: Florida.
Organization: GridSouth; Approval: [Empty]; Conditional approval[A]:
X; Area of operation[B]: North Carolina, South Carolina.
Organization: Midwest ISO; Approval: X; Conditional approval[A]:
[Empty]; Area of operation[B]: Illinois, Indiana, Iowa, Kentucky,
Michigan, Minnesota, Missouri, Montana, North Dakota, Ohio, South
Dakota, Virginia, Wisconsin, and Manitoba (Canada).
Organization: PJM; Approval: [Empty]; Conditional approval[A]: X; Area
of operation[B]: Delaware, District of Columbia, New Jersey, Maryland,
Ohio, Pennsylvania, Virginia, West Virginia.
Source: FERC.
[A] Certain organizations that have received conditional FERC approval
are not yet operational as RTOs, in part because FERC has overlapping
jurisdiction with certain state regulatory authorities on the formation
of RTOs and because some states are still in the process of reviewing
RTO participation for their utilities.
[B] Includes all or parts of listed states.
[End of table]
Despite these efforts, FERC has acknowledged that significant
impediments remain to competitive wholesale markets. For example,
according to FERC, recent events such as the collapse of Enron and the
California electricity crisis reveal the need for clear, stable market
rules and overdue infrastructure investment in the U.S. wholesale
electricity industry. As a result, in July 2002, FERC issued a notice
of proposed rulemaking to provide a standard market design for all
electric transmission providers. FERC‘s fundamental goal in this
initiative is to create ’seamless“ wholesale electricity markets,
nationwide, that allow sellers to transact easily across transmission
boundaries and allow customers to receive the benefits of a lower-cost
and more reliable electricity supply. Accordingly, FERC‘s standard
market design proposal contains a wide range of rules to standardize
the structure and operation of wholesale electricity markets and
transmission services. Among other things, it (1) describes the rules
for how a portion of the nation‘s electricity will be exchanged in
organized markets, (2) defines a new transmission service, (3)
establishes a congestion management system to ensure that the
transmission system is managed effectively and that users recognize the
true value of their actions, (4) lays out new rules to assure that all
transmission owners and operators recover their costs, (5) establishes
new market power mitigation and monitoring requirements, and (6) sets
out long-term planning and resource adequacy requirements.
To date, the proposed standard market design rule has generated
significant comments from numerous organizations reflecting concerns
and reservations about the scope and details of the proposal. For
example, the Chairman, FERC, has noted that one of the most widely
voiced concerns about FERC‘s proposal is that it could cause low-cost
states‘ electricity prices to rise as competition allows sellers of
electric power in these states to sell to states with higher prices. In
addition, others have stated that the western U.S. market has unique
characteristics that may not readily lend itself to FERC‘s proposed
standard market design. In response to these and other comments and
concerns, FERC has extended the comment period to January 10, 2003, for
all interested parties to file comments on certain features of its
proposal. In addition, FERC has invited interested parties to comment
on more than 70 specific issues described in its proposal and has
convened a series of conferences to address its proposal. FERC
estimates that a final rule could be published during the summer of
2003.
Some States Have Opened Retail Markets to New Sellers, While Others
Have Not Pursued Restructuring Efforts:
To date, 24 states and the District of Columbia have enacted
legislation and/or issued regulatory orders to open their retail
markets to competition by implementing retail access, thereby allowing
customers to choose their own electricity suppliers.[Footnote 9] Of
these, 17 states and the District of Columbia continue to be active in
implementing retail access. [Footnote 10] Under retail access, the
local distribution utility continues to provide transmission and
distribution services. State restructuring legislation or regulatory
orders have either required or encouraged utilities to divest
generation assets, in part to encourage competition among generating
companies. In addition, in some states, metering and billing are
subject to competition, while in others these services are combined
with distribution services.
Most of the 17 states that have begun to open their retail markets to
competition have simultaneously frozen retail electricity prices at (or
below) the regulated rate in place before the onset of retail
competition. For example, in Michigan, the two largest utilities agreed
to provide a 5 percent rate reduction to all residential customers. The
reduction began in June 2001 and will extend through December 2003--
after which the utilities may still not increase rates until either
December 2013 or until the Michigan Public Service Commission
determines that certain conditions are met. In addition, most of these
states usually allow customers who choose not to select an alternative
service provider or whose competitive supplier has stopped offering
service to continue to be served by their local distribution utility.
The remaining seven states that have enacted legislation and/or issued
regulatory orders have either delayed or suspended implementation of
retail access. Six of these states--Arkansas, Montana, Nevada, New
Mexico, Oklahoma, and West Virginia--have delayed implementation of
retail access by, for example, choosing a new date to move forward. One
state, California, suspended its retail-access program in September
2001 after experiencing a prolonged period of high prices and power
shortages but has not repealed its overall plans to restructure.
The remaining 26 states have not enacted legislation or issued
regulatory orders to implement retail access, and they continue to
require retail customers to purchase electricity from their traditional
utility.[Footnote 11] Of these states, 8 continue to study the issue of
restructuring, while 18 have decided that electricity restructuring is
not in their best interest at this time and are not actively
considering it, according to a recent report by the National Regulatory
Research Institute. These states see little benefit from opening their
electric industries to competition anytime soon, since most of these
states have relatively low electric rates compared with the rest of the
nation. In contrast, states that have opened their retail electricity
markets to competition, such as Pennsylvania, New York, and most of New
England, have historically had higher than average U.S. retail
electricity prices. Figure 4 shows the status of state electricity
restructuring activity as of November 2002, as well as average retail
electricity prices in 1992, when widespread wholesale restructuring
began with the passage of EPACT.
Figure 4: Status of State Electricity Restructuring Activity as of
November 2002 and Average Prices as of 1992A:
[See PDF for image]
Source: Energy Information Agency.
[A] Average prices are in units of cents per kilowatthour, in 1992
dollars.
[B] States that took legislative and/or regulatory action have some
degree of shading. States not taking such actions are shown in white.
[End of figure]
Conclusion:
Despite FERC‘s efforts, significant impediments remain to the
development of competitive wholesale markets. FERC‘s efforts to develop
regional transmission organizations and standardize rules between them
are in the early stages of development, with a number of contentious
issues to still be resolved. Further, while nearly half of the states
moved forward to restructure their retail markets, some states--when
faced with the uncertainties that accompany restructuring--decided to
delay or suspend their efforts. Continuing to address these
restructuring issues will take considerable time and effort on the part
of FERC and the states.
[End of section]
Chapter 4: The Extent to Which the Goal of Competitive Electricity
Markets Has Been Achieved Is Uncertain:
It is not possible to determine fully the extent to which the
development of competitive markets--the goal of restructuring--has been
achieved to date. Our review of studies related to measuring the
performance of restructuring indicates a mixed assessment of how far
along the industry is in developing competitive markets and the extent
to which expected benefits have been achieved. While most studies found
progress has been made in introducing competition in wholesale
electricity markets, results at the retail level have been difficult to
measure, and, where measurement has been possible, there is
disagreement about the extent to which expected benefits of
restructuring have been achieved. Our own evaluation of the performance
of restructuring was also inconclusive. With respect to the goal of
increasing competition, restructuring efforts by the federal government
and the states have broadened electricity markets by making them more
regional and allowing new generation companies to participate. However,
we could not determine the extent to which expected consumer benefits
have been achieved, in part because restructuring is in its early
stages, but also because of a lack of data necessary to measure key
benefits.
Review of Studies Indicates a Mixed Picture of Competition and
Uncertainty Regarding Benefits:
In our review of more than 30 studies that examined the performance of
the electricity industry since restructuring began, we found general
agreement that some progress has been made in developing more
competitive wholesale electricity markets.[Footnote 12] For example,
the development of ISOs and the beginning of RTO formation is cited as
having caused greater numbers of sellers and buyers to have access to
electricity over wider geographic regions than was previously possible.
Some of these studies also conclude that this increase in competition
has led to lower prices for retail electricity customers. However,
other studies dispute the claim that retail electricity customers are
better off under restructuring and point to episodes of high prices,
including the crisis of 2000 and 2001 in California and the West, as
evidence that flaws in restructuring have led to undesirable outcomes.
A number of studies also pointed to continuing problems with the scope
of restructuring, including the fact that most retail electricity
customers are insulated from changes in wholesale prices. As such,
these customers typically pay a fixed price, regardless of changes in
the underlying cost of acquiring the electricity in wholesale markets.
Therefore, these customers do not respond to periods of high wholesale
prices by reducing their consumption of electricity as they might if
they had to pay those higher prices directly. As we recently reported,
there is general agreement among economists and other experts that the
absence of price-responsive customers may enable electricity sellers to
charge higher than competitive prices.[Footnote 13]
GAO Evaluation Indicates Some Progress Made in Developing Competitive
Markets but Questions Remain:
The combined efforts of the federal government and some states have
broadened electricity markets, expanding their scope in many cases from
a local to a regional focus. Along with this broadening of the markets
have come increases in the number of buyers and sellers entering the
wholesale electricity markets. Broader markets may also be improving
the availability and quality of electricity pricing information, but
there are indications, such as a lack of transparent electricity
transactions, that the industry is still lacking in this area. There
has also been a great deal of investment in new power plants,
indicating that entry into the industry has occurred.
Early restructuring efforts have led the electricity industry to
experience a significant change in the way power is sold across state
lines. Four ISOs--California, PJM, New York, and New England--currently
operate centralized power markets in which electricity suppliers and
buyers submit bids to sell and buy power. Sellers from across these
regions and states compete together in these centralized markets,
expanding the geographic scope of the markets. In addition to operating
power markets, the ISOs manage the generation and transmission of
electricity to maintain reliability of the system.
In addition to the introduction of more regional wholesale electricity
markets, private electricity trading hubs have emerged, expanding the
scope of markets even further and improving the ability of buyers and
sellers to manage risk. Specifically, these trading hubs provide a
market for buying and selling electricity, as well as for trading
electricity futures and various derivatives outside centralized
regional wholesale markets.[Footnote 14] Simply put, a trading hub is a
location on the power grid representing a delivery point where
ownership of electric power changes hands, although the actual trades
may take place in numerous locations. The emergence of trading hubs is
an important development in the process of developing competitive
electricity markets because hubs provide market participants a way to
trade a standardized increment of electricity. However, of the 10 major
hubs that have been developed to date, only a few account for the bulk
of power trading. Furthermore, there are indications that the future is
somewhat cloudy. For example, the New York Mercantile Exchange recently
announced that it was discontinuing trading of electricity futures,
citing a lack of trading volume. It remains unclear whether these types
of hubs will reemerge and become viable in the future electricity
industry environment.
Similarly, development of Internet-based trading systems, such as
EnronOnline, Dynegydirect, and Intercontinental Exchange, has further
changed the ways in which electric power is sold. Such systems provide
an additional market for both physical energy (electricity and natural
gas products) and energy derivatives to be bought and sold. Experts say
that in other commodity markets the existence of multiple markets has
resulted in improvements in the quality and availability of price
information. Recently, in the electricity industry, there have been
accusations that large market participants who had superior market
information manipulated these systems, and some companies such as Enron
have stopped such Internet-based trading.
Increases in the number of wholesale electricity sellers--one of the
key structural changes required to implement competition--has
accompanied the opening of regional wholesale electricity markets,
trading hubs, and Internet-based trading systems. The introduction of
ISOs and RTOs has allowed more market participants to compete
effectively and allowed all the suppliers in the region to compete in a
broader marketplace. In addition, since 1992 FERC has granted authority
to 850 companies to charge ’market-based“ rates, which enables them to
participate in competitive wholesale markets. FERC‘s approval to charge
market-based rates enables these companies to participate as sellers in
the various wholesale markets that have emerged. If these companies are
not granted authority to charge market-based rates they can only sell
power in interstate wholesale markets at regulated rates, based on
their costs, which must also be approved by FERC.
In addition to an increase in the number of wholesale sellers, some
states are witnessing an increase in the number of retail sellers who
are competing with utilities to sell electricity to consumers. For
example, one study, conducted by the National Regulatory Research
Institute, found that in the 18 states that have operated restructured
retail markets, there were 75 companies competing with these states‘
utilities to sell electricity to retail customers. These companies must
either buy their electricity from the wholesale markets or generate it
themselves, and when they buy electricity from the wholesale market,
this increases the number of wholesale buyers as well, another key
structural change needed to implement competition. In providing
technical comments on a draft of this report, FERC stated that most
states that have implemented retail competition fear that too few new
retailers have entered the market to support effective retail
competition.
There have also been improvements in the availability and reliability
of price and other market information--another requirement of
competitive markets. Increased numbers of transactions, whether
executed through institutions such as ISOs or RTOs, through private
trading hubs, or through other types of transactions, provide a
critical means of developing price information and making it available.
While the development of broader electricity markets has contributed to
the availability and quality of price data, there are indications that
the electricity industry is still in the early stages of development in
this area. For example, in a recent FERC conference on market
monitoring, several conference participants stated that there is still
not enough trading in many markets across the country to ensure
confidence that the prices observed in those markets are accurately
representative of the prices at which electricity is generally trading
there. In addition, recent concerns by FERC and others that some market
participants may have misreported price information used in various
publications have raised questions about the reliability of publicly
available information.
Another indication of the emergence of competition is that new
suppliers are able to enter the market. In recent years, there has been
a large increase in the amount of new generating capacity that has been
built. Specifically, from 1995 through July 2002 there has been about
175,000 megawatts (MW) of new generating capacity built in the United
States, with most of this capacity added since 1998.[Footnote 15] These
new generating plants added about 23 percent to the total generating
capacity that existed in 1995. In addition, nonutility companies own
most of the new generating capacity built in recent years, which has
served to increase in the number and capabilities of these new types of
electricity sellers in wholesale markets. Specifically, nonutilities
accounted for about 148,000 MWs of generating capacity, or about 85
percent of the 175,000 MWs added from 1995 through July 2002. Investor-
owned utilities (IOUs) accounted for the remaining 15 percent. Figure 5
shows the new investments in generating capacity from 1995 through July
2002.
Figure 5: Generating Capacity Added, 1995 through July 2002:
[See PDF for image]
Source: GAO analysis of PowerDAT data provided by Platt‘s/RDI.
[A] 2002 reflects data through July.
[End of figure]
The growth rate of generating capacity over these years has been far
higher than the average growth rate of demand, meaning that new
generating plants will likely displace some generation from existing
facilities. This is especially likely because most of the new
generating units burn natural gas and employ technology that is
currently less costly per unit of electricity generated than many older
generating plants, making the former more economically competitive and
able to sell power profitably at lower prices. Any displacement of
older plants powered by fossil fuel by power plants that burn natural
gas would have a positive effect on air quality because, in addition to
running at lower cost, the newer plants create far fewer emissions per
unit of electricity generated than the older plants. However, over the
past year, a large number of proposed power plants have been canceled,
in part as a result of poor market conditions, including tighter credit
requirements from banks and investors, slower economic activity, and
the financial difficulties of several large energy companies.
Restructuring‘s Impact on Prices and Other Expected Benefits Remains
Unclear:
Available data and information do not allow a determination of the
extent to which restructuring efforts to date have led to the expected
benefits for consumers of lower electricity prices and a wider array of
services. While electricity prices have generally fallen since
restructuring began in the 1990s, it is not clear how much of the
decline was attributable to, or simply coincided with, restructuring
efforts. Further, periods of higher prices have also occurred in some
places and during some periods of time. Similarly, new electricity
products have emerged, both in restructuring and nonrestructured
states, making it difficult to conclude that these new products are the
direct result of restructuring efforts. In addition, while operating
efficiency for power plants appears to have increased since
restructuring began, this is a continuation of a trend that began prior
to restructuring, and it is therefore not clear how much of the
improvement can be attributed to, or is simply coincident with,
restructuring.
Throughout the 1990s--the period during which restructuring began at
the national level and expanded to individual states--average retail
prices for electricity fell, after adjusting for inflation.
Specifically, from 1990 through 1999, average retail prices for
residential customers fell by about 14 percent, and prices for
industrial customers fell by about 23 percent. However, in 2000, retail
prices for industrial customers rose, and, in 2001, prices rose for
both industrial and residential customers. Over the entire period from
1990 through 2001, retail residential and industrial prices fell by
about 13 and 15 percent, respectively. As shown in figure 6, the
decrease in prices throughout the 1990s continues a trend that began in
1983.
Figure 6: Average Electricity Prices, 1960-2001:
[See PDF for image]
Source: GAO analysis of data provided by the Energy Information
Administration.
[End of figure]
To try to determine the effect of restructuring efforts on retail
prices, we examined these price changes in the context of state
restructuring status, distinguishing between (1) states that
implemented restructuring plans, (2) states that made restructuring
plans but delayed their implementation, and (3) states that did not
develop restructuring plans.[Footnote 16] In addition, we focused on
the years from 1997 through 2001, which encompass the period during
which individual states began restructuring their retail markets. In so
doing, we found that those states that implemented some restructuring
efforts generally experienced decreases in residential retail prices
while prices generally increased in states that did not implement
restructuring during the same period. For example, over the entire 4-
year period, average residential prices fell by about 4 percent in
states that implemented restructuring, but rose by 4 percent in states
that delayed and by 3 percent in states that made no restructuring
plans. Over the same 4-year period, overall retail prices for
industrial customers generally rose, but we found that the price
increases were generally smaller for states that implemented some
restructuring efforts compared to states that either delayed or made no
restructuring plans. Specifically, we found that on average,
restructuring states witnessed almost no change in average retail
industrial prices over the entire four year period from 1997 through
2001, while states that delayed their restructuring plans or did
nothing had 24 and 5 percent price increases, respectively. As
discussed previously in this report, residential retail prices rose in
2001, and industrial retail prices rose in both 2000 and 2001.[Footnote
17]
While restructuring may have contributed to the overall reduction in
retail prices in the 1990s, and may account in part for the greater
decreases in restructuring states in the period from 1997 through 2001,
there are other factors that could have affected prices. For these and
other reasons, we were unable to determine the effect of restructuring
on retail prices. For example, this period also witnessed reductions in
the prices of natural gas, coal, and other fuels used to generate
electricity, as well as the introduction of cost-saving technologies at
new and existing power plants, all of which may have led to price
reductions. We also found that states that restructured generally
reduced and froze retail prices at the time they restructured in the
expectation that restructuring would lead to lower prices overall and
to ensure that their retail customers benefited immediately. Therefore,
the greater price reductions observed in these restructured states may
reflect state regulator‘s expectations, rather than what restructuring
actually achieved.
Expert opinion is also mixed on the impact of restructuring on retail
prices. Some experts attribute lower retail prices in part to
restructuring and increased competition in wholesale and retail
markets, while others, citing periods of higher prices, point to flawed
restructuring as the cause, claiming that the electricity industry
cannot be made to behave competitively. Still others have stated that
flaws in restructuring efforts, including frozen retail rates that made
it difficult for new sellers to compete with existing utilities, have
reduced what impact restructuring could have had on lowering retail
prices. Finally, because electricity frequently crosses state borders
as generators in one state sell to buyers in another, prices in any
single state will often affect prices in adjacent states. This further
complicates the picture, making it difficult to sort out the effect of
restructuring on overall retail electricity prices.
Another expected benefit of restructuring, new electricity products,
has become available in recent years, but new products have occurred in
both restructured and nonrestructured states. These products include
green power (electricity produced by renewable resources), electricity
sold at a price that varies according to time of use or market
conditions, and energy service contracts that provide additional
services to consumers, such as energy audits or energy efficiency
improvements. For example, in several states, green power has emerged
as a product for which consumers are willing to pay more. One recent
study found that in 18 states that had actively pursued retail
restructuring, companies were offering their customers 49 different
ways to buy electricity generated by renewable sources. New products
are also emerging in nonrestructured states. For example, in Colorado-
-a state that has not restructured--the local monopoly utility has also
offered to sell electricity generated by renewable sources to its
customers. Because new products have emerged in both restructured and
nonrestructured states, and because there is no central source of data
on the development of new products, we were unable to determine what
effect restructuring has had on the development of these products.
While it appears that there have been efficiency gains in the operation
of electricity generating plants, another expected benefit of
restructuring, we find that it is not possible to determine whether
restructuring caused or simply coincided with these gains. In promoting
restructuring, experts believed it would improve efficiency by, among
other things, reducing the amount of excess generating capacity
required to maintain a reliable electricity system. Throughout the
1990s, power plants did experience increases in their intensity of use-
-reducing excess capacity during these years. However, this was a
continuation of a trend that began in 1983, prior to restructuring. In
addition, the upward trend in intensity of power plant use was reversed
in 2000 and 2001. Some experts attribute part of the overall efficiency
gains to restructuring, stating that increased competition improves
incentives for using existing power plants more intensively. They also
attribute the fall in intensity of power plant use in 2000 and 2001 in
part to the large number of new plants that began operation during
those years and to the fact that overall demand grew more slowly than
expected. Overall, due to data limitations, we were unable to determine
the impact of restructuring on the efficiency of power plant
operations. Figure 7 shows the average capacity factor for power plants
from 1949 through 2001. The capacity factor for generating plants shown
in the figure measures the proportion of total generating capacity that
is actually produced during each year.
Figure 7: Overall U.S. Capacity Factor, 1949-2001:
[See PDF for image]
Source: GAO analysis of data provided by the Energy Information
Administration.
[End of figure]
Conclusion:
Competitive electricity markets are clearly in the early stages of
development. While restructuring efforts have broadened electricity
markets and increased the number of market participants (both buyers
and sellers), the extent to which expected benefits have been achieved
is uncertain. Because the development of competitive markets and the
expected benefits from competition are central to restructuring
efforts, understanding how far along the road to greater competition we
have come and what remains to be done in moving forward is important.
[End of section]
Chapter 5: Lessons Learned from Electricity Restructuring and
Recommendations:
In determining the goals of electricity restructuring, reviewing
actions that federal and state agencies have taken to restructure the
industry, and determining whether those actions have achieved the goal
of increased competition and the expected benefits of restructuring, we
have identified key lessons learned from experience to date that relate
to the structure of electricity markets and market oversight. The
lessons presented here point out potential limitations to the extent of
competition in electricity markets and to the expected benefits of
restructuring. In addition, we discuss the need for improved monitoring
of restructured electricity markets.
Experience with Restructuring to Date Provides Five Lessons Learned:
Different rules in electricity systems limit the ability to achieve
benefits from competition:
In its effort to promote competitive wholesale markets, FERC has
historically approved a wide range of specific rules that govern the
operation of individual transmission system operators and centralized
wholesale markets under its jurisdiction. FERC has acknowledged the
lack of a single set of rules for transmission access or wholesale
market operations. Furthermore, FERC has stated that the absence of
consistent rules has permitted (1) rules that can be used to
discriminate and lead to increased transmission costs and system
reliability problems and
(2) various design flaws in wholesale markets and transmission services
that have created operational problems within and between wholesale
markets. For example, a variety of inconsistent rules governing the
operation of power plants in PJM, New York ISO, and ISO New England
have made it more costly for participants in these electricity markets
to buy and sell from each other. Overall, the presence of different
rules and operations limits the extent of possible competition between
these markets. Limiting the extent of competition between wholesale
markets will, in turn, limit the expected benefits from restructuring.
Recently, FERC‘s proposed standard market design rulemaking was
developed largely to address the variations in rules and operating
procedures for the wholesale markets and transmission services. Through
its proposal, FERC plans to bring a level of standardization to market
rules and procedures that will remedy these problems and provide a
level playing field for all entities that seek to participate in
wholesale electricity markets.
FERC‘s limited jurisdiction in wholesale markets limits the ability to
achieve benefits from competition:
FERC does not have regulatory authority over all entities in wholesale
electricity markets. Specifically, FERC does not have jurisdiction over
power sales by federally owned entities (e.g., the Bonneville Power
Administration, the Tennessee Valley Authority, and the Western Area
Power Administration), publicly owned utilities, or most cooperatively
owned utilities. For example, the electricity needs of Nebraska are
entirely served by municipal, cooperative, and other suppliers not
explicitly subject to FERC oversight. As a result, a patchwork of rules
has developed governing both restructured and nonrestructured
jurisdictions, with large areas of the country operating primarily
outside the scope of FERC‘s authority.
While many of these nonjurisdictional entities are smaller than many
investor-owned utilities, taken together they serve large areas of the
country and provide service to about 25 percent of the nation‘s demand
for electricity. As shown in figure 8, the areas served by entities not
under FERC jurisdiction cover a wide area, especially in the Southeast,
Midwest, and West.
Figure 8: Areas Served by Entities Subject to FERC Jurisdiction, 2002:
[See PDF for image]
Source: GAO analysis of PowerMap data provided by Platt‘s/RDI.
[End of figure]
Notes:
Areas served by entities generally not subject to FERC jurisdiction
include areas served by publicly owned entities such as municipal
utilities, cooperative utilities, and others.
Data on service territories include some overlaps, indicating that some
areas are served by both entities subject to FERC jurisdiction and
entities not generally subject to FERC jurisdiction, particularly some
areas in Pennsylvania, Michigan, Wisconsin, and Iowa. Data reflected
above depict those areas of overlap as not generally subject to FERC
jurisdiction.
Unshaded portions of the map indicate either that no electric service
is provided or the service area is very small.
In addition to covering wide areas of the country, these
nonjurisdictional entities also own about 30 percent of the
transmission lines nationwide. FERC has only limited jurisdiction over
the transmission services of such entities. As shown in figure 9, the
lines owned by nonjurisdictional entities are prominent in the West and
South, including lines owned by federal entities such as the Bonneville
Power Administration, the Western Area Power Administration, and the
Tennessee Valley Authority. Many of the lines owned by these
nonjurisdictional entities are high-voltage transmission lines,
capable of carrying large volumes of electricity over long distances.
These types of lines may offer opportunities to facilitate transactions
between regions.
Figure 9: Ownership of Large Transmission Lines by Entities Subject to
FERC Jurisdiction, 2002:
[See PDF for image]
Source: GAO analysis of PowerMap data provided by Platt‘s/RDI.
Notes:
Data for transmission lines reflect primary ownership--some lines may
have multiple owners.
Federal entities include the Bonneville Power Administration, the
Tennessee Valley Authority, the Western Area Power Administration and
others.
High voltage transmission lines are generally capable of moving higher
volumes of electricity over greater distances with fewer losses, than
lower voltage lines.
[End of figure]
As a result of the lack of jurisdiction across wide regions of the
country and over significant transmission lines connecting some areas
of the country, FERC has not been able to prescribe the same standards
of open access to the transmission system. This situation, by limiting
the degree to which market participants can make electricity
transactions across these jurisdictions, will limit the ability of
restructuring efforts to achieve a truly national competitive
electricity system and, ultimately, will reduce the potential benefits
expected from restructuring.
FERC‘s proposed standard market design rulemaking does not address the
issue of its jurisdiction and authority regarding federally owned
entities, cooperatives, and municipalities. Nonetheless, there have
been several legislative proposals in the 107th Congress to address
FERC‘s limited jurisdiction, though none has been enacted.
Separate development of wholesale and retail electricity markets limits
the ability to achieve benefits from competition:
Federal and state governments each have regulatory authority for
overseeing the electricity industry--federal over wholesale and state
over retail markets. As a result, the actions taken to restructure
wholesale and retail markets have, for the most part, been undertaken
separately. For example, to promote competition in wholesale markets,
FERC has taken actions to allow prices to be established by direct
interaction between buyers and sellers. However, most state actions at
the retail level have in fact served to freeze retail prices, thereby
limiting the degree to which buyers can respond to changes in
underlying wholesale prices. Specifically, states have imposed frozen
retail prices in restructured markets or continued to regulate prices
in areas not undertaking retail restructuring, both of which limit the
ability of consumers to respond to changes in wholesale prices. There
is general agreement among industry experts that the absence of a
significant demand response has a negative impact on the functioning of
wholesale electricity markets, causing prices to be higher and more
volatile and facilitating the exercise of market power by electricity
sellers. As a result, these state actions place limits on the extent to
which competitive markets can develop and, thus, reduce the potential
benefits expected from restructuring.
Because FERC does not generally have authority over retail electricity
markets, FERC‘s standard market design proposed rulemaking does not
directly address the issue of making electricity consumers responsive
to prices. However, the proposed rulemaking does reference and comment
on the value and need for a better link between supply (wholesale) and
demand (retail) to help create improved supply planning and a more
efficient competitive environment. Further, according to FERC, the
proposed rulemaking would require market operators to receive demand
reduction bids if states allow retail customers to make such bids.
Federal, state, and local decisions on siting new power plants and
transmission lines limit the ability to achieve benefits from
competition:
Federal, state and local entities all have authority over key decisions
that affect new investment in generation and transmission facilities.
Decisions made by private investors on how and when to site new
generation facilities will influence the availability of new
electricity supplies. Further, although transmission increasingly
serves regional needs, state and local governments make many of the
decisions on whether and where to site new lines. Therefore, the
investments necessary to maintain adequate supplies of electricity and
a reliable electricity system are critically dependent on how federal,
state, and local regulatory bodies exercise their authority over these
new investments. For example, adding a transmission line that crosses
several state boundaries and passes through federal lands requires
multiple permits and approval processes involving numerous regulatory
entities charged with, among other things, environmental protection and
land use planning issues. Similarly, investments in new generating
facilities, while typically involving a single state, generally require
approval from multiple regulatory entities to address state and local
environmental, zoning, and energy policy issues.
While recognizing the importance of the regulatory approval process,
many market participants have stated that the lack of a unified and
consistent regulatory environment across states creates a potential
barrier to investment that leads to uneven and, in some cases,
insufficient investment in new generating or transmission facilities.
For example, as we have previously reported, states‘ power plant siting
decisions affect companies‘ perceived risk of entering a given market,
which may, in turn, result in more or less investment.[Footnote 18] As
restructuring creates markets that are more regional in scope, less
than needed investment in new plants in one state may have implications
for neighboring states--resulting in the need for additional plants to
be built in adjacent states or contributing to higher market prices. As
a result, state actions that serve to delay or prevent additions of new
power plants or power lines could limit FERC‘s ability to achieve a
national market for competitive electricity and, thus, limit the
expected benefits of restructuring.
FERC‘s standard market design proposal does not directly address the
siting processes for electricity power plants or for transmission
lines. However, the standard market design proposal does encourage
regional cooperation and state and federal collaboration on generation
and transmission system planning.
Better monitoring of market performance is needed to determine how well
restructured markets are performing and the extent to which expected
benefits of competition have occurred:
FERC, the states, and other market monitors are not fully monitoring
the overall performance of all wholesale and retail markets nor
collecting sufficient data to do so. As a result, cross-regional
comparison of the performance of markets is generally not possible.
FERC has recently proposed changes to the design of electricity
markets, which include plans to improve monitoring efforts.
Until recently, FERC has not actively monitored market performance in a
general sense. As reported earlier this year, FERC‘s previous efforts
to directly oversee the market have been incomplete or
ineffective.[Footnote 19] Specifically, FERC staff told us that in the
past their monitoring efforts were largely undertaken on a case-by-case
basis in response to specific problems. For example, FERC has been
actively investigating several complaints of market manipulation and
violations of market rules over the past year, many stemming from the
western U.S. electricity crisis that began in 2000. Further, FERC has
limited authority to compel market participants to provide proprietary
data needed for more comprehensive monitoring. For example, FERC has
identified difficulties in getting data on individual power plant
operations that it needs in order to evaluate the functioning of the
transmission system. Senior FERC officials told us that, in general,
FERC‘s authority to collect data from market participants is predicated
on developing a specific legal argument that the data support a
specific investigation, rather than for more general monitoring of
market performance. In some cases, according to FERC, this is due to
the requirements of the Paperwork Reduction Act.
State efforts to monitor the electricity industry have declined since
the mid-1990s. According to experts, the ability of state public
utility commissions to monitor restructured electricity markets is
limited because oversight has shifted from the states to FERC. They
further stated that state commission access to data from market
participants is more limited under restructuring than under the
previous regulated environment in which they had authority over setting
electricity rates for the utilities in their states and, therefore,
access to most of the relevant industry data. In addition, a survey of
public utility commissions, currently in process by the National
Regulatory Research Institute, indicates that only 23 of the 40 states
that responded had a formal standard on electricity reliability and
service quality.
As required by FERC, all ISOs or RTOs currently operating wholesale
electricity markets have market-monitoring units that evaluate the
conduct of their participants and some measures of market performance.
However, the primary focus of the monitors has been to identify and
mitigate the exercise of market power by electricity sellers, rather
than measuring how well their overall design is working or whether
these markets are delivering benefits to consumers. Market monitors we
spoke with said that their efforts to evaluate market power have
generally focused on comparing estimates of the costs of producing
electricity to the prices received from the market. In most specific
cases of day-to-day monitoring, monitors share their results in
nonpublic reports with the management of the ISO and sometimes with
FERC. In addition, the market monitors develop periodic reports, which
evaluate the performance of their markets and are often made public.
However, the authority and scope of each of these market monitors to
collect data from market participants is limited by the boundaries of
their individual markets. As a result, investigations undertaken by
these entities are inherently limited because some key information may
not be reviewed if it involves transactions with entities located
outside the monitors‘ jurisdiction or involves transactions about which
the monitor has no detailed information. In addition, because several
of the market monitors rely on different methods to evaluate market
power, there is a lack of uniformity in what data are collected, how
they are analyzed, and what is reported, making cross-market
comparisons difficult.
Recently, with the formation of FERC‘s new Office of Market Oversight
and Investigations, FERC has begun to look more broadly at the
performance of electricity markets and is in the process of studying
what measures of market performance to evaluate on a regular basis. As
part of this effort, the Office of Market Oversight and Investigations
has begun to produce weekly reports on market conditions for the
commissioners and staff, although at this point the reports offer only
limited coverage. In addition, FERC‘s efforts to implement its proposed
standard market design may improve market monitoring by standardizing
the markets and improving the ability to make cross-market comparisons.
As part of its proposed standard market design, FERC intends for each
region to set up market monitoring units that would report to FERC
regularly. FERC would also require that some of the data collected by
the regional market monitors follow comparable protocols to facilitate
cross-market comparisons. Using these reports and data received from
the market monitors and other sources, FERC intends to regularly
monitor electricity markets and take corrective actions in the event
that problems emerge in wholesale electricity markets.
While FERC‘s recent efforts may improve the situation, key issues
remain unresolved, and, unless addressed, will prevent full and
consistent monitoring of restructured markets from going forward. Among
the issues identified by recent participants in a FERC sponsored
conference on market monitoring are (1) the lack of consistency in what
data are collected and what evaluations are made, which makes cross-
market comparisons difficult; (2) the unavailability of data needed by
the public and researchers to evaluate restructuring; (3) the
unavailability of key data to market monitors, such as information
about bilateral trades between buyers and sellers outside the ISO-run
markets; and (4) concern and reluctance on the part of market
participants that the proprietary data they provide to market monitors
may be revealed in such a way that it impedes their ability to compete
effectively. As a result, no entity can currently conduct a
comprehensive evaluation of restructuring across different states and
electricity markets to determine how restructuring is doing with
respect to overall performance and the delivery of consumer benefits.
Conclusion:
Because the transition to greater competition will take considerable
time, it is possible that bad outcomes for consumers, such as rising
retail prices in the aftermath of the electricity crisis in the western
United States from summer 2000 to spring 2001, could occur again. It is
essential, therefore, that FERC and other regulatory bodies or
independent monitors carefully watch for signs of problems and be able
to make needed adjustments in a timely fashion. Further, better
monitoring of electricity markets would also help to ensure that the
goal of increasing competition in electricity markets and the expected
benefits associated with this greater competition are achieved. Without
a concerted effort to improve monitoring of wholesale markets and their
impact on consumers, FERC will lack key information needed to make
informed regulatory decisions and to report to Congress about the
status and progress of restructuring.
Recommendations for Executive Action:
To help Congress ensure that the fullest benefits possible are achieved
from electricity restructuring, and to better understand what progress
has been made, GAO is recommending that the Chairman, FERC,
determine how restructured wholesale electricity markets are performing
by developing and implementing a plan to collect necessary data and
perform evaluative analysis. These data should be sufficient to allow
evaluation of the competitiveness of these markets (including, but not
limited to, the extent of market power, efficiency of the industry, and
ease of market entry) and the expected benefits to retail consumers
(such as lower retail prices and the availability of new products).
Where possible and appropriate, FERC should work in concert with state
and regional entities to take advantage of their knowledge, expertise,
and access to important data relevant to the impacts of restructuring
on consumers.
report annually to Congress and the states on the status of
restructuring efforts, identify emerging issues and impediments to
reaching FERC‘s goal of achieving national competitive wholesale
electricity markets, and make appropriate recommendations to Congress
and the states for changes to improve the functioning of these markets.
Agency Comments:
In its written comments, FERC agreed with our report‘s ’lessons
learned“ and principal findings. In addition, FERC agreed with our
second recommendation that FERC should report annually to Congress on
the status of restructuring, noting that it plans to do so in spring
2003. However, FERC said that our recommendation directing it to
determine, in concert with the states and regional entities, how both
wholesale and retail markets are performing is more problematic. While
FERC agreed that it should evaluate and report on wholesale markets
under its jurisdiction, it stated two reasons for its concern about
evaluating retail markets in concert with state entities. First,
because retail markets are under state jurisdiction, while FERC
oversees wholesale markets, FERC is sensitive to this division of
jurisdiction and is hesitant to monitor the status and effectiveness of
retail competition unless Congress specifically directs it to do so.
Secondly, FERC states that it does not currently have the expertise or
resources to evaluate the multiplicity of retail markets.
We are sensitive to the separation of jurisdiction over retail and
wholesale electricity markets. For this reason, we are not recommending
that FERC step outside its jurisdictional boundaries or attempt to
assume responsibility for the status and effectiveness of retail
restructuring efforts. However, we believe that in order for FERC to
fully evaluate and understand the effectiveness of its actions to
implement competition in wholesale markets, it must examine the status
of restructuring in wholesale markets as well as the impact of this
restructuring on consumers of electricity. FERC‘s Order 888, issued
April 24, 1996, points out that FERC‘s actions are ’—designed to remove
impediments to competition in the wholesale bulk power marketplace and
to bring more efficient, lower cost power to the nation‘s electricity
consumers.“ Because lower electricity prices to consumers are an
expected benefit from more competitive wholesale markets, we believe it
is reasonable that FERC, Congress, and the states should know if lower
prices are occurring as the basis for possible future policy actions.
With regard to the issue of resources and expertise, we believe that
FERC can supplement its own assets by drawing from many sources to
assist it in evaluating retail impacts. Among these sources are (1)
other federal agencies--including the Energy Information
Administration--and private companies that collect data on consumer
electricity prices and other related information; (2) market monitoring
units of regional or state independent system operators or other
entities that operate wholesale electricity markets; (3) expert panels,
such as the panels recently brought together to assist FERC with its
market monitoring plans in FERC‘s proposed standard market design; and
(4) state agencies that have historically tracked consumer issues as
part of their oversight over retail electricity markets--as we
previously reported, there is precedent for FERC obtaining input on its
studies from state public utility commissions.[Footnote 20] We also
believe that FERC is in a unique position to be able to make a
nationwide assessment of restructuring because, as the primary federal
agency responsible for overseeing wholesale electricity markets, it is
the only entity that currently has access to key information from all
its jurisdictional markets and market participants. In addition, in the
process of formulating its proposed standard market design, FERC has
consulted with state and regional entities, in part to formulate plans
to monitor the performance of markets under the standard design. We
believe that such coordination between FERC, the states, and regional
entities is necessary and should extend to evaluating the impacts of
wholesale restructuring on consumers.
In order to make it clear that we are not asking FERC to overstep its
jurisdictional boundaries, we have revised the language of our
recommendation to state that we recommend FERC evaluate the impacts of
restructuring efforts in the wholesale markets on retail electricity
consumers. However, because of the importance of state and regional
involvement in restructuring of the electricity industry more
generally, we continue to encourage FERC, where possible and
appropriate, to work in concert with state and regional entities to
develop this analysis.
In a related comment, FERC also noted that while the report
distinguishes between wholesale and retail markets, it does not
recognize or clearly articulate the significant differences between the
two markets and the impacts of and motivations for competition at each
level.
We agree that there are significant differences between retail and
wholesale markets, but we believe the report appropriately reflects
these differences and therefore we made no change in response to this
comment. More importantly, retail and wholesale markets are closely
linked through the actions of buyers and sellers; for this reason, an
evaluation of one of these markets without considering its effect on
the other market is incomplete and could be misleading. For example,
federal actions to restructure wholesale electricity markets are
expected to ultimately reduce electricity prices for retail consumers
through improvements in efficiency brought on by restructuring. It is
equally true that actions at the retail level have an impact on the
functioning of competitive wholesale markets. For example, as we
previously reported, there is wide agreement among industry experts and
academics that the absence of consumer response to sharply higher
prices in western wholesale electricity markets was a contributing
factor to the financial and:
energy crisis in the West during 2000 and 2001.[Footnote 21] These
examples illustrate the need for FERC to make a periodic nationwide
assessment of restructuring that includes an evaluation of the impacts
of wholesale restructuring on expected retail consumer benefits.
[End of section]
Appendix I: Scope and Methodology:
To address the objectives overall, we interviewed and obtained
documentation from a wide range of stakeholders to the issue including
federal and state government officials, industry officials, academic
experts, and various other special interest groups and organizations.
We interviewed officials at FERC, the Department of Energy‘s Energy
Information Agency, the Congressional Research Service, the Maryland
Energy Administration, the California Energy Commission, the Western
Interstate Energy Board, and the National Association of Regulatory
Utility Commissioners. Of particular note, we interviewed
representatives from the existing ISOs in the United States to
understand the structure and performance of their markets. These ISOs
include California ISO, ISO New England, Midwest ISO, New York ISO, PJM
ISO, and the Electric Reliability Council of Texas. We also talked with
representatives of organizations that are in the process of creating
ISOs to run their wholesale electricity markets, including Regional
Transmission Operator West and the Southeastern Transmission System. We
also interviewed noted economists. In addition, we talked to the Edison
Electric Institute, the Electric Power Supply Association, the National
Energy Marketers Association, the Electricity Consumers Resource
Council, and the Consumer Energy Council of America, and Public
Citizen. We also spoke with representatives from a number of research
organizations, including EPRI, the National Regulatory Research
Institute, the Tellus Institute, Resources for the Future, and the
Regulatory Assistance Project.
In addition to gathering the views of experts and stakeholders, we
reviewed numerous appropriate documents from outside sources, including
academic books and articles on restructuring and reports from the
Energy Information Administration, the North American Electric
Reliability Council, the Congressional Research Service, the
Congressional Budget Office, various ISOs, and electricity industry
experts. Furthermore, we reviewed prior GAO work on the electricity
industry.
To better understand the basis for and nature of electricity
restructuring in the world community, specifically, we interviewed
selected representatives and reviewed readily available reports and
information on the restructuring experiences of several foreign
countries, including the Great Britain, Norway, Sweden, Australia, and
New Zealand.
To develop an understanding of the goals and guiding principles of
restructuring, we conducted legislative and regulatory searches as well
as an extensive literature search, supplemented by interviews with
government and industry officials, experts, ISO officials, and other
stakeholders. We reviewed information on federal legislation, FERC
orders, FERC proceedings and other documents related to restructuring,
and court orders related to FERC regulations. This included reviews of
FERC‘s notice of proposed rulemaking on standard market design, staff
research papers, congressional testimony by FERC Chairman Pat Wood, and
speeches by other FERC officials.
To identify actions that federal and state agencies have taken to
restructure the electricity industry, we reviewed documents related to
federal and state restructuring laws and regulations. We also
interviewed numerous officials from federal and state regulatory
agencies and the staff of all the ISOs.
To determine to what extent federal and state actions achieved the
goals of restructuring, we reviewed numerous studies of restructuring;
collected views of experts and market participants and interviewed
officials from FERC, state regulatory agencies, and trade groups, as
well as the staff of the ISOs. In addition, we collected publicly
available data, including wholesale and retail electricity prices,
generating capacity, electricity consumption, investment in new
generating plants, and information about the transmission system. We
evaluated this data to try to determine whether statistical methods
could be used to estimate the extent to which restructuring has
achieved expected consumer benefits. However, we found that the
publicly available data were generally insufficient to allow such
statistical methods to be used in light of the transitional nature of
restructuring. For example, we were unable to collect comprehensive
data on the operations of electricity generating plants, and these data
are necessary to determine how the efficiency of operations may vary
according to the restructuring status of the states in which these
generating plants are situated. Because we had to rely, instead, on
more aggregated and less comprehensive data, we were unable to
determine whether generating plants in restructured markets operate
more efficiently than do plants in regions that are still regulated
traditionally.
We conducted our work from November 2001 through November 2002 in
accordance with generally accepted government auditing standards.
[End of section]
Appendix II: Related GAO Reports:
Restructured Electricity Markets: California Market Design Enabled
Exercise of Market Power. GAO-02-828. Washington, D.C.: June 21, 2002.
Energy Markets: Concerted Actions Needed by FERC to Confront Challenges
That Impede Effective Oversight. GAO-02-656. Washington, D.C.: June 14,
2002.
Air Pollution: Emissions from Older Electricity Generating Units. GAO-
02-709. Washington, D.C.: June 12, 2002.
Tennessee Valley Authority: Information on Benchmarking and Electricity
Rates. GAO-02-636. Washington, D.C.: May 30, 2002.
Restructured Electricity Markets: Three States‘ Experiences in Adding
Generating Capacity. GAO-02-427. Washington, D.C.: May 24, 2002.
Air Quality: TVA Plans to Reduce Air Emissions Further, but Could Do
More to Reduce Power Demand. GAO-02-301. Washington, D.C.: March 8,
2002:
Energy Markets: Results of Studies Assessing High Electricity Prices in
California. GAO-01-857. Washington, D.C.: June 29, 2001.
California Electricity Market: Outlook for Summer 2001. GAO-01-870R.
Washington, D.C.: June 29, 2001.
California Electricity Market Options for 2001: Military Generation and
Private Backup Possibilities. GAO-01-865R. Washington, D.C.: June 29,
2001.
Federal Power: The Evolution of Preference in Marketing Federal Power.
GAO-01-373. Washington, D.C.: February 8, 2001.
Power Marketing Administrations: Their Ratesetting Practices Compared
With Those of Nonfederal Utilities. GAO/AIMD-00-114. Washington, D.C.:
March 30, 2000.
Federal Power: The Role of the Power Marketing Administrations in a
Restructured Electricity Industry. GAO/T-RCED/AIMD-99-229. Washington,
D.C.: June 24, 1999.
Federal Power: Regional Effects of Changes in PMAs‘ Rates. GAO/RCED-99-
15. Washington, D.C.: November 16, 1998.
Federal Power: Options for Selected Power Marketing Administrations‘
Role in a Changing Electricity Industry. GAO/RCED-98-43. Washington,
D.C.: March 6, 1998.
Federal Power: Issues Related to the Divestiture of Federal Hydropower
Resources. GAO/RCED-97-48. Washington, D.C.: March 31, 1997.
Power Marketing Administrations: Cost Recovery, Financing, and
Comparison to Nonfederal Utilities. GAO-AIMD-96-145. Washington, D.C.:
September 19, 1996.
[End of section]
Appendix III: Comments from the Federal Energy Regulatory Commission:
FEDERAL ENERGY REGULATORY COMMISSION WASHINGTON, DC 20426:
December 5, 2002:
OFFICE OF THE CHAIRMAN:
Mr. Jim Wells:
Director, Natural Resources and Environment United States General
Accounting Office Room 2T23:
441 G Street, NW Washington, DC 20548:
Dear Mr. Wells:
Thank you for the opportunity to comment on your report, Lessons
Learned from Electricity Restructuring: Transition to Competitive
Markets Underway, But Full Benefits Will Take Time and Effort To
Achieve. I congratulate you on your effort and appreciate the
opportunity to comment on this report.
I agree with the report‘s identified ’Lessons Learned“ and ’Principal
Findings.“ I also agree with the report‘s second recommendation that
the Commission should report annually to the Congress and the states on
the status of wholesale markets, including emerging issues and
impediments to reaching its goal. This is something we are already
planning to do.
However, the report‘s first recommendation that the Commission should
determine in concert with states and regional entities how both
restructured retail and wholesale markets are performing across the
country is more problematic. Retail and wholesale markets are very
different and the Commission does not currently have the expertise or
resources to effectively evaluate the multiplicity of retail markets.
I note the report‘s finding that separate development of wholesale and
retail electricity markets limits the ability to achieve benefits from
competition. I agree; however, there are deep seated, historical
reasons underlying the separation of wholesale and retail markets. I do
not see the Commission currently being in a position to bridge this
gap. States have jurisdiction over retail markets and control the
choice of whether to move to retail competition.
While the report distinguishes between wholesale and retail markets, it
does not recognize and clearly articulate the significant differences
between the two markets and the impacts of and motivations for
competition at each level. Competitive wholesale markets provide
economic efficiency, liquidity, price transparency and risk hedging
through forward, bilateral, day ahead and real-time markets for
generators, wholesale traders and retail suppliers. Competitive retail
markets can provide lower prices over time, enhanced services, flexible
billing and individual customer choice of suppliers and retail energy
products. The key linkage between wholesale and retail markets is that
healthy wholesale competition is a necessary precondition for healthy
retail service with or without retail competition. FERC‘s statutory
mandate is to oversee wholesale electricity markets and it has promoted
competition and restructuring in wholesale markets. States may or may
not adopt retail restructuring. The FTC‘s September 2001 report
Competition and Consumer Protection Perspectives on Electric Power
Regulatory Reform: Focus on Retail Competition offers a good
description of the issues faced in retail and wholesale competition
(see pages 6-12).
The Commission is taking a number of steps to make competition work in
wholesale electricity markets, consistent with the mandates of the FPA.
We appreciate the report‘s recognition that the Commission‘s efforts in
Standard Market Design are going in the right direction. The Commission
has undertaken other important initiatives such as standard
interconnection agreements that will also benefit competitive markets.
As your report indicates, the Commission has already taken positive
steps to look more broadly at the performance of electricity markets
with the formation of its new Office of Market Oversight and
Investigations (OMOI), which began operations in August 2002. The
Office reports directly to me and is charged with being ’the cop on the
beat,“ overseeing and assessing the operations of wholesale electricity
and natural gas markets and enforcing Commission rules and regulations.
As part of its mission, OMOI analyzes market data, measures market
performance, recommends market improvements and prepares reports
detailing the status of the electricity and natural gas markets. There
are a number of initiatives well underway to ensure the Commission has
the needed data and methodologies in place to evaluate wholesale market
performance. OMOI staff reports to the Commission every two to three
weeks in closed session on the status of gas and electricity markets,
including investigations and enforcement activities.
In reference to the report‘s second recommendation, FERC plans to
report annually to Congress on the status of wholesale electricity and
natural gas markets. In the past, we have prepared a State of the
Markets Report and have scheduled the next report for Spring 2003. This
report will provide a comprehensive look at natural gas and
electricity wholesale markets, identifying where improvements have
been achieved and targeting areas of concern, which may require
infrastructure or rule changes. This report will be made available to
the states and the public. OMOI staff is also preparing semi-annual
assessments of relevant energy markets as we enter the heating and
cooling
seasons.
While there is widespread agreement that competitive wholesale markets
are appropriate public policy and a clear mandate for the federal
government, there is less agreement that retail access is needed.
Implementation of retail access has slowed in the past two years, and
is clearly a state jurisdictional issue. If it is Congress‘ will that
we do so, this agency will be happy to work with states to monitor the
status and effectiveness of retail competition. Regardless of retail
action, we will continue working closely with the states to implement
competition in wholesale markets, attempting to minimize conflicts and
maximize the benefits for all customers.
Thank you again for the opportunity to comment on your report. I
appreciate GAO‘s attention and assistance to the Commission to oversee
and investigate wholesale electricity markets and hope it will further
the goal of well-functioning electricity markets for all customers.
Best Regards,
P Wood, III:
Chairman:
Signed by P. Wood, III
[End of section]
Appendix IV: Bibliography of Selected Restructuring Studies:
Alexander, Barbara R. ’Part One: An Analysis of Residential Energy
Markets in Georgia, Massachusetts, Ohio, New York and Texas.“ National
Center for Appropriate Technology, August 2002.
Borenstein, Severin, and James Bushnell. ’Electricity Restructuring:
Deregulation or Reregulation?“ (unpublished). February 2000.
Borenstein, Severin. ’The Trouble with Electricity Markets (and some
solutions)“ (unpublished). January, 2001.
Brennan, Timothy J. ’The California Electricity Experience 2000-01:
Education or Diversion?“ Resources for the Future, October 2001.
Brown, Matthew H. ’Part Two: An Analysis of Opt-Out Aggregation in
Massachusetts and Ohio.“ National Center for Appropriate Technology,
August 2002.
California Independent System Operator. ’Background Paper: Comparison
of Capacity Obligations and Markets.“ Draft prepared by Power
Economics, Inc., March 15, 2002.
Citizens for Pennsylvania‘s Future. ’Electricity Competition: The Story
Behind the Headlines A 50-state Report.“ Harrisburg, PA: August 2002.
Congressional Budget Office. ’Causes and Lessons of the California
Electricity Crisis.“ Washington D.C.: September 2001.
Cooper, Mark N. ’All Pain, No Gain: Restructuring and Deregulation in
the Interstate Electricity Market.“ Consumer Federation of America,
Washington, D.C.: September 2002.
Cooper, Mark N. ’U.S. Capitalism and the Public Interest: Restoring the
Balance in Electricity and Telecommunications.“ Consumer Federation of
America. Washington, D.C.: August 2002.
Deregulation of Network Industries: What‘s Next. Peltzman, Sam and
Clifford Winston, editors. AEI-Brookings Joint Center For Regulatory
Studies. 2000.
Electricity Advisory Board. ’Competitive Wholesale Electricity
Generation: A Report of the Benefits, Regulatory Uncertainty, and
Remedies to Encourage Full Realization Across All Markets.“ Electric
Resources, Capitalization Concerns Subcommittee. September 2002.
Electricity Advisory Board. ’Transmission Grid Solutions Report,“
Subcommittee on Transmission Grid Solutions. September 2002.
Electricity Consumers Resource Council. ’Preventing Market Failures on
the Road to Competition: Analysis and Recommendations of Electricity
Consumers Resource Council, a Special Report.“ Washington, D.C.: May
2001.
Federal Trade Commission. ’Competition and Consumer Protection
Perspectives on Electric Power Regulatory Reform: Focus on Retail
Competition.“ Washington, D.C.: September 2001.
Harvard Electricity Policy Group. ’Reshaping the Electricity Industry:
A Public Policy Debate.“ Harvard University, June 2001.
Heffner, Grayson C., and Charles A. Goldman. ’Demand Responsive
Programs--An Emerging Resource for Competitive Markets?“ Environmental
Energy Technologies Division of Lawrence Berkeley National Laboratory,
August 2001.
Hirst, Eric. ’Barriers to Price-Responsive Demand in Wholesale
Electricity Markets.“ Prepared for Edison Electric Institute, June
2002.
Hirst, Eric. ’The California Electricity Crisis Lessons for Other
States“ (unpublished). July 10, 2001.
Hirst, Eric. ’The Financial and Physical Insurance Benefits of Price-
Responsive Demand.“ February 2002.
Hogan, William W. ’Electricity Market Restructuring: Reforms of
Reforms.“ Paper presented at annual conference of Center for Research
in Regulated Industries, Rutgers University: May 23-25, 2001.
Hogan, William W. ’Regional Transmission Organizations: Millennium
Order on Designing Market Institutions for Electric Network Systems“
(unpublished). May 2000.
Hunt, Sally. Making Competition Work in Electricity. New York: John
Wiley & Sons, 2002.
Joskow, Paul L. ’Lessons Learned from Electricity Liberalization in the
UK and U.S.“ Presentation at Conference Towards a European Market of
Electricity at the SSPA-Italian Advanced School of Public
Administration, Rome, Italy. June 24, 2002.
King, Chris S. ’The Economics of Real-Time and Time-of-Use Pricing for
Residential Customers.“ American Energy Institute, June 2001.
Lee, Stephen T. ’Lessons Learned from the California Power Crisis.“
EPRI, Palo Alto, CA. November 1, 2001.
Mattoon, Richard. ’The Electricity System at the Crossroads-Policy
Choices and Pitfalls.“ Economic Perspective, 1Q/2002.
Moore, Adrian T. and Lynne Kiesling. ’Powering Up California: Policy
Alternatives for the California Energy Crisis.“ Policy Study No. 280,
Reason Public Policy Institute, Los Angeles, CA: February 2001.
Morey, Matthew J. ’Ensuring Sufficient Generating Capacity, During the
Transition to Competitive Electricity Markets.“ Prepared for Edison
Electric Institute, Washington, D.C.: November 2001.
Moss, Diana. ’Promoting Competition in the U.S. Electricity Industry:
Policy Issues and Recommendations.“ The American Antitrust Institute,
Washington, D.C.: December 18, 2001.
Pricing in Competitive Electricity Markets. Faruqui, Ahmad and Kelly
Eakin, editors. Kluwer Academic Publishers. 2000.
Rose, Kenneth and Venkata Bujimalla. ’2002 Performance Review of
Electric Power Markets.“ National Regulatory Research Institute,
Columbus, OH.: August 30, 2002.
Rowe, John W., Peter Thornton, and Janet Bieniak Szcypinski.
’Competition Without Chaos.“ Joint Center for Regulatory Studies,
Working Paper 01-07, June 2001.
State Corporation Commission (of Virginia). ’Part III-Recommendations
to Facilitate Effective Competition in the Commonwealth.“ August 2002.
Stoft, Steven. Power System Economics: Designing Markets for
Electricity. IEEE/Wiley, 2002.
Sweeney, James, L. ’The California Electricity Crisis: Lessons for the
Future.“ The Bridge, Volume 32, Number 2. Summer 2002.
Weston, Frederick, and Jim Lazar. ’Framing Paper #3: Metering and
Retail Pricing.“ Produced for New England Demand Response Initiative by
The Regulatory Assistance Project, May 1, 2002.
Wolak, Frank A. ’Designing a Competitive Electricity Market that
Benefits Consumers“ (unpublished). October 15, 2001.
Wolfram, Catherine D. ’Electricity Markets: Should the Rest of the
World Adopt the UK Reforms?“ (unpublished) September 1999.
[End of section]
Appendix V GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Jim Wells (202) 512-3841
Dan Haas (202) 512-9828:
Acknowledgments:
In addition to the individuals named above, Mike Gilbert, Jason
Holliday, Rich Iager, Randy Jones, Jon Ludwigson, Jonathan McMurray,
Frank Rusco, and Barbara Timmerman made key contributions to this
report. Important contributions were also made by Kim Wheeler-Raheb,
and Venkareddy Chennareddy.
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FOOTNOTES
[1] Federally owned electricity-producing entities, such as the
Tennessee Valley Authority and the Bonneville Power Administration, are
subject to Department of Energy and congressional oversight. Because
publicly owned utilities, such as municipal systems, are owned by the
people they serve, they are generally overseen by the city council or
elected/appointed members of an operating board. Similarly, since
cooperatives are also owned by the people they serve, they are
generally overseen by a board of directors, or the equivalent, elected
by the customers/owners. In their comments to a draft of this report,
FERC pointed out that additional oversight of cooperatives may be
provided by the Rural Utilities Service or by FERC.
[2] Prices are reported in cents per kilowatt-hour. A watt is a unit of
electrical power. A kilowatt is 1,000 watts. One kilowatt used for one
hour equals 1 kilowatt-hour.
[3] For electricity markets to be efficient and for market participants
to have confidence in the prices, there must be sufficient liquidity,
meaning that there must be many trades taking place between
knowledgeable buyers and sellers.
[4] Such contracts can and do also exist under the old regulated
environment, but the incentives for such contracts are greater when
electricity prices reflect the current levels of supply and demand, as
would be the case under full restructuring, than when prices are
generally fixed across most periods, as has generally been the case in
the regulated environment.
[5] Restructuring is not currently planned to introduce competition to
the transmission or distribution of electricity.
[6] Prior to EPACT, this ability was limited to a small group of
companies that generally produced electricity through cogeneration
processes and/or the use of renewable energy.
[7] An ISO is an entity encouraged by FERC to manage the transmission
system as the electric industry in the United States is restructured.
An ISO is to control the power system or grid without special interest,
and is to own no generation, transmission, or load. Therefore, the ISO
is intended to run the system fairly, for the benefit of all market
participants.
[8] These ISOs are California ISO; ISO New England; Midwest ISO; New
York ISO; Pennsylvania, New Jersey, and Maryland Interconnect (PJM);
and Electric Reliability Council of Texas (ERCOT) ISO. ERCOT
established an ISO in 1996 to satisfy the requirements of the Public
Utility Commission of Texas for deregulating the wholesale electricity
market in the state. The wholesale market in the ERCOT region is
basically isolated from other U.S. markets because its transmission
system has only minor interconnections to other U.S. transmission
systems. FERC has limited jurisdiction over the region because the
ERCOT market is essentially intrastate.
[9] These states are Arizona, Arkansas, California, Connecticut,
Delaware, Illinois, Maine, Maryland, Massachusetts, Michigan, Montana,
Nevada, New Hampshire, New Jersey, New Mexico, New York, Ohio,
Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas, Virginia, and West
Virginia.
[10] These states are Arizona, Connecticut, Delaware, Illinois, Maine,
Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York,
Ohio, Oregon, Pennsylvania, Rhode Island, Texas, and Virginia. Note:
Retail access in these states is either currently available or will
soon be available; each state‘s retail access schedule varies according
to its legislative mandates or regulatory orders. In Oregon, for
example, no customers are currently participating in the state‘s retail
access program, but the law allows nonresidential customers access.
[11] These states are Alabama, Alaska, Colorado, Florida, Georgia,
Hawaii, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Minnesota,
Mississippi, Missouri, Nebraska, North Carolina, North Dakota, South
Carolina, South Dakota, Tennessee, Utah, Vermont, Washington,
Wisconsin, and Wyoming.
[12] A bibliography of studies can be found in appendix IV.
[13] U.S. General Accounting Office, Restructured Electricity Markets:
California Market Design Enabled Exercise of Market Power, GAO-02-828
(Washington, D.C.: June 21, 2002).
[14] Derivatives are financial products--for example, options, futures,
and other contracts--the value of which is derived from underlying
instruments, such as company stocks, electricity and natural gas
commodities, or other financial instruments.
[15] A megawatt is a measure of electric power equal to 1,000,000
watts. One megawatt of generating capacity can serve the needs of about
750 homes.
[16] For the purpose of this analysis, we modified the Energy
Information Administration‘s classification of states‘ restructuring
status as of November 2002 by grouping California, which is currently
listed as ’suspended,“ with the 17 ’active“ states. We did this because
California had an active retail access program from April 1998 until
September 2001. Using this modified classification, 18 states and the
District of Columbia have implemented restructuring plans, 6 states
made restructuring plans but delayed their implementation, and 26
states did not develop restructuring plans. All prices have been
adjusted for inflation and are expressed in terms of 2001 dollars. In
addition, the average prices we report are a simple average across
states, as opposed to an average weighted by the volumes of electricity
consumed in each state.
[17] The data used in figure 6 differ from those used in the
calculations of prices from 1997 through 2001. The data used to
generate the figure include prices from utilities, as well as energy
service providers selling to retail customers, while the data used to
calculate changes from 1997 through 2001 only reflect utility prices--
state-by-state data for energy service providers were not available.
[18] U.S. General Accounting Office, Restructured Electricity Markets:
Three States‘ Experiences in Adding Generating Capacity, GAO-02-427
(Washington, D.C.: May 24, 2002).
[19] U.S. General Accounting Office, Energy Markets: Concerted Actions
Needed for FERC to Confront Challenges that Impede Effective Oversight,
GAO-02-656 (Washington, D.C.: June 14, 2002).
[20] U.S. General Accounting Office, Energy Markets: Concerted Actions
Needed for FERC to Confront Challenges that Impede Effective Oversight,
GAO-02-656 (Washington, D.C.: June 14, 2002). See page 43 for reference
to obtaining input from state public utility commissions for FERC
studies.
[21] U.S. General Accounting Office, Restructured Electricity Markets:
California Market Design Enabled Exercise of Market Power, GAO-02-828
(Washington, D.C.: June 21, 2002).
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