Electricity Markets
FERC's Role in Protecting Consumers Gao ID: GAO-03-726R June 6, 2003The electricity industry is currently undergoing a restructuring, evolving from an industry characterized by monopoly utilities that provide consumers with electricity at regulated rates to a competitive industry in which prices are largely determined by supply and demand. The Federal Energy Regulatory Commission (FERC) has been engaged in this restructuring effort and is currently working, among other things, to foster competitive wholesale energy markets across the nation while protecting consumers against abuses of market power. At the retail level, about half the states have pursued restructuring their retail electricity markets in order to allow consumers such as residential, commercial, and industrial customers to choose their electricity suppliers. Proponents of electricity restructuring believe that it will ultimately provide consumers with lower electricity prices, more services, and technological innovation. However, opponents cite extremely high prices and market manipulation in California as evidence that, without more stringent oversight, restructuring may leave consumers vulnerable to higher prices, market manipulation, and less reliable service. In light of ongoing electricity restructuring efforts, Congress asked us to describe FERC's role in protecting electricity consumers.
FERC's role in protecting electricity consumers is to ensure that prices in the wholesale electricity market are just and reasonable. Traditionally, FERC has ensured rates are just and reasonable in the wholesale market by regulating them based on a utility's costs of service plus a regulated return on the utility's investment. However, with the advent of greater competition in the electricity industry, FERC believes the best ways to ensure wholesale prices are just and reasonable today is by (1) fostering competitive regional wholesale markets that have balanced market rules (i.e., rules that encourage efficient behavior and infrastructure development and deter abusive behavior), (2) continuously monitoring these markets for anticompetitive behavior, and (3) enforcing or correcting market rules as needed. As part of these efforts, FERC oversees the interstate transmission system to ensure it remains open without discrimination to all buyers and sellers of electricity. This oversight also works to protect consumers by ensuring companies that generate electricity will be able to transmit their power without disruptions or inefficiencies. FERC has limits on where and how it can protect consumers. For example, FERC does not oversee wholesale electricity sales and transmission in areas where it generally lacks jurisdiction, such as the areas served by federally owned utilities including the Tennessee Valley Authority and the Department of Energy's four federal Power Marketing Administrations, publicly owned (municipal) utilities, and most cooperative utilities. In addition, states, rather than FERC, have authority over the retail electricity rates paid by customers, the local distribution of electricity, and the construction and siting of power plants and transmission lines within their boundaries.
GAO-03-726R, Electricity Markets: FERC's Role in Protecting Consumers
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United States General Accounting Office:
Washington, DC 20548:
June 6, 2003:
Congressional Requesters:
Subject: Electricity Markets: FERC's Role in Protecting Consumers:
The electricity industry is currently undergoing a restructuring,
evolving from an industry characterized by monopoly utilities that
provide consumers with electricity at regulated rates to a competitive
industry in which prices are largely determined by supply and demand.
The Federal Energy Regulatory Commission (FERC) has been engaged in
this restructuring effort and is currently working, among other things,
to foster competitive wholesale energy markets across the nation while
protecting consumers against abuses of market power. At the retail
level, about half the states have pursued restructuring their retail
electricity markets in order to allow consumers such as residential,
commercial, and industrial customers to choose their electricity
suppliers. Proponents of electricity restructuring believe that it will
ultimately provide consumers with lower electricity prices, more
services, and technological innovation. However, opponents cite
extremely high prices and market manipulation in California as evidence
that, without more stringent oversight, restructuring may leave
consumers vulnerable to higher prices, market manipulation, and less
reliable service.
In light of ongoing electricity restructuring efforts, you asked us to
describe FERC's role in protecting electricity consumers. This report
does not evaluate FERC's success in serving this role, but does provide
examples of how FERC has acted previously to protect consumers. GAO
plans to issue a report in the summer 2003 on the progress FERC has
made so far in preparing itself to monitor competitive energy markets.
A complete list of the requesters appears at the end of this report.
Results in Brief:
FERC's role in protecting electricity consumers is to ensure that
prices in the wholesale electricity market are just and reasonable.
Traditionally, FERC has ensured rates are just and reasonable in the
wholesale market by regulating them based on a utility's costs of
service plus a regulated return on the utility's investment. However,
with the advent of greater competition in the electricity industry,
FERC believes the best ways to ensure wholesale prices are just and
reasonable today is by (1) fostering competitive regional wholesale
markets that have balanced market rules (i.e., rules that encourage
efficient behavior and infrastructure development and deter abusive
behavior), (2) continuously monitoring these markets for
anticompetitive behavior, and (3) enforcing or correcting market rules
as needed. As part of these efforts, FERC oversees the interstate
transmission system to ensure it remains open without discrimination to
all buyers and sellers of electricity. This oversight also works to
protect consumers by ensuring companies that generate electricity will
be able to transmit their power without disruptions or inefficiencies.
FERC has limits on where and how it can protect consumers. For example,
FERC does not oversee wholesale electricity sales and transmission in
areas where it generally lacks jurisdiction, such as the areas served
by federally owned utilities including the Tennessee Valley Authority
and the Department of Energy's four federal Power Marketing
Administrations, publicly owned (municipal) utilities, and most
cooperative utilities. In addition, states, rather than FERC, have
authority over the retail electricity rates paid by customers, the
local distribution of electricity, and the construction and siting of
power plants and transmission lines within their boundaries.
Background:
Established in 1977 as the successor to the Federal Power Commission
(FPC), FERC is the principal federal agency that regulates the
electricity industry. An independent agency, FERC obtains much of its
legal authority over electricity from three sources: the Federal Power
Act of 1935, which created the FPC and charged it with overseeing the
rates, terms, and conditions of wholesale sales and transmission of
electric energy in interstate commerce; the Public Utility Regulatory
Policies Act of 1978, which opened the door for competition in the U.S.
electricity supply market by allowing nonutility generators that met
criteria set by FERC to enter the wholesale market; and the Energy
Policy Act of 1992, which created a new class of electricity supplier-
-the exempt wholesale generator--and led to FERC Order No. 888, which
opened up the national transmission system to wholesale suppliers. In
fiscal year 2002, FERC had a budget of about $191 million and funding
for about 1,200 full-time staff.
The electricity industry is based on four distinct functions:
generation, transmission, distribution, and system operations. (See
fig. 1.) Once electricity is generated, 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]
[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. 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.
Since the early 1900s, electric utilities have been largely considered
natural monopolies because they have high fixed costs (the costs of
large-scale power plants, transmission lines, and distribution wires)
and can lower their production costs as they increase the volume of
electricity they generate. At that time, large, centralized power
plants were seen as the most efficient and inexpensive way to produce
and distribute electricity to retail customers. As a result, utilities
obtained exclusive service territories in exchange for the regulation
of their retail rates and terms of service by state public utility
commissions. Wholesale electricity generated and transmitted for the
interstate market came (and still resides) under FERC's jurisdiction.
Technological advances, such as the development of smaller, less costly
generation units, and the passage of the Public Utility Regulatory
Policies Act of 1978 created opportunities for companies other than
utilities to generate and sell electricity in the wholesale market. The
Energy Policy Act of 1992 gave FERC the authority, on a case-by-case
basis, to require utilities to provide nonutility generators with
access to the utility's interstate transmission lines. Subsequent FERC
orders advanced this principle, requiring most utilities to provide
nonutility generators access to their interstate transmission lines on
a nondiscriminatory basis. Several states have restructured their
intrastate market to allow retail customers to choose their electricity
provider while retaining their utility's traditional distribution
services. As we reported in December 2002, 24 states and the District
of Columbia had enacted legislation or issued regulations opening their
retail markets to competition.[Footnote 1] Of those, 17 states and the
District of Columbia were implementing programs that enable retail
customers to choose their electricity supplier.
FERC's Role is to Protect Consumers through the Wholesale Markets:
FERC's role with respect to protecting electricity customers is to
ensure that prices in the wholesale electricity market are just and
reasonable and to oversee the interstate transmission of
electricity.[Footnote 2] Traditionally, FERC approved its regulated
rates for wholesale electricity based on a utility's cost to generate
and transmit the power, plus a rate of return on investment. Opponents
of cost-based rate regulation contend that it is less efficient than
market pricing and results in, among other things, over investment in a
utility. In light of the advances in technology, the introduction of
nonutility power generators, and the nation's general shift in policy
over the past three decades away from government regulation and toward
markets, FERC now believes that the best way of achieving just and
reasonable rates is to:
* foster competitive regional wholesale markets that have balanced
market rules (i.e., rules that encourage efficient behavior and
infrastructure development and deter abusive behavior),
* continuously monitor these markets for anticompetitive behavior, and:
* enforce or correct market rules as needed.
Under this approach, FERC's first goal is to advance the development of
competitive wholesale markets by implementing clear and balanced market
rules and regulations on sales and transmission. According to FERC,
establishing balanced market rules up front encourages efficient
behavior and infrastructure development and deters abusive behavior in
the market. More specifically, following Order No. 888, FERC approved
the creation of independent system operators for New England, the Mid-
Atlantic states, New York, and California to operate wholesale energy
markets and transmission systems within their regions. Then, 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). RTOs are intended to bring the
nation's transmission systems under regional control in order to
increase access for all suppliers, improve management of system
congestion and reliability, and achieve fully competitive wholesale
power markets. Since issuing Order 2000, FERC has approved the creation
of two RTOs--the Midwest Independent Transmission System Operator, Inc.
(Midwest ISO) and the PJM Interconnection. Five others are in various
stages of the approval process--GridFlorida, GridSouth, RTO West,
WestConnect, and SeTrans[Footnote 3]. Additionally, in July 2002, FERC
issued a Notice of Proposed Rulemaking to establish a standard market
design for all jurisdictional electric transmission providers. In
FERC's view, the proposal will enable sellers to transact for
electricity more easily across transmission boundaries, thus
potentially bringing more sources of electricity to consumers and
allowing them to receive the benefits of lower-cost and more reliable
electricity supply. Since 1992, FERC has granted authority to more than
850 companies to charge market prices for their electricity, provided
that the companies comply with market rules and charge wholesale prices
that are just and reasonable.
Second, according to FERC, it will also monitor these markets and
thereby protect consumers by proactively identifying market violations
or mismanagement. In order to better monitor markets for
anticompetitive behavior, in August 2002, FERC established the Office
of Market Oversight and Investigations (OMOI). The role of this office
is to scrutinize wholesale energy markets in order to identify issues
before they develop into major problems and to monitor the market to
ensure that participants play by the rules. In addition, to help
monitor the markets, the Office of Market Oversight and Investigation
manages FERC's Enforcement Hotline, which is designed to provide
industry participants and the public a way to tell the commission their
concerns or complaints about behavior in electricity markets. In 2002,
the Hotline handled 584 calls.
Finally, to enforce or correct market rules, FERC, through OMOI, is
conducting investigations that are either self-initiated or result from
Hotline complaints or other referrals by industry participants.
According to FERC, as of May 1, 2003, OMOI's Divisions of Enforcement
and Operational Investigations were conducting 38 investigations
related to electricity matters such as generator practices, undue
discrimination, or market manipulation. Between June 2002 and midApril
2003, the division resolved or terminated 18 investigations. Several of
these investigations led to enforcement actions that either provided
payment of refunds, civil penalties, or investigation costs or provided
corrections to market rules to help ensure generation can adequately
meet increased demand.
Portions of the Wholesale Market are Not Subject to FERC Jurisdiction:
Some entities in the wholesale electricity market operate outside
FERC's statutory jurisdiction. These entities include the Tennessee
Valley Authority and the Department of Energy's four Power Marketing
Administrations.[Footnote 4] In addition, the Federal Power Act of 1935
excludes publicly owned utilities, such as municipal utilities, public
power districts, and irrigation districts, as well as most
cooperatively owned utilities from FERC's jurisdiction. Publicly owned
utilities are usually nonprofit and are regulated by the government
organization that owns them, while electric cooperatives are owned by
and provide service primarily to their members. Most cooperatives do
not sell electricity on the wholesale market or transmit electricity
interstate.
Figure 2: Jurisdictional Territories of FERC and Power Entities Not
Subject to FERC, 2002:
[See PDF for image]
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.
[End of figure]
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.
Portions of the map without shading indicate either that no electric
service is provided or the service area is very small.
As shown in figure 2, power entities generally operating outside FERC's
jurisdiction represent a significant share of the electricity market.
Together, they currently provide service for about 25 percent of the
nation's consumption of electricity and constitute an even larger
portion of the electricity market in some areas. For example, in
Nebraska, municipal utilities, cooperatives, and other suppliers not
explicitly subject to FERC's jurisdiction provide almost all of the
state's electricity. Many of the entities operating outside FERC's
jurisdiction reside in the Southeast, Midwest, and West. In addition,
municipal utilities, cooperatives, and federally-owned power entities
own about 30 percent of the nation's transmission system. Lines owned
by nonjurisdictional entities are prominent in the South and West.
States Regulate Retail Electricity Markets:
Although FERC has regulatory authority over most of the interstate
wholesale market in electricity, states have authority over the retail
electricity and distribution markets and thus regulate the retail rates
paid by residential, commercial, and many industrial
customers.[Footnote 5] In a majority of states, public utility
commissions set consumers' retail rates based on a utility's cost of
service plus a rate of return on investment. As we reported in December
2002, 24 states have enacted legislation or regulations to open their
retail electricity markets to competition. Seventeen of those states
and the District of Columbia have implemented programs enabling
residential, commercial, and industrial customers to choose their
electricity provider. However, of these 17 states, most have frozen
their retail electricity prices at levels equal to or less than the
retail cost-of-service rates that were in place at the outset of
competition.
In addition to setting rates in the retail electricity market, states
have the authority to approve the construction and siting of power
plants and transmission lines. To be built, these facilities usually
require the approval of the state's public utility commission as well
as the consent of other state and local government agencies on
environmental, zoning, and energy policy issues. Although transmission
lines increasingly serve regional needs and can cross state boundaries,
state and local governments make many of the decisions on whether and
where to site new lines and thus potentially have significant impact on
the transmission system's reliability and the amount of electricity it
can deliver to consumers.
Agency Comments:
We provided FERC with a draft of this report for its review and
comment. In general, FERC's Chairman agreed with our report and its
depiction of the commission's role in protecting electricity customers.
The Chairman suggested technical and editorial changes that we included
as appropriate.
Scope and Methodology:
To obtain information on the ways in which FERC can protect consumers,
we reviewed industry reports, academic literature, and discussed the
issue with officials from FERC's Office of Markets, Tariffs, and Rates
and Office of Market Oversight and Investigations. To obtain
information on FERC's jurisdiction, we reviewed applicable statutes and
federal rules. To identify areas of consumer protection and concerns,
we reviewed industry publications and interviewed officials with
consumer advocacy groups. In addition, we spoke to officials with the
National Association of Regulatory Utility Commissioners and the
Electricity Consumers Resource Council.
We performed our work between November 2002 and May 2003 in accordance
with generally accepted government auditing standards.
- - - --:
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until seven
days from the date of this letter. At that time, we will send copies to
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 about this report, please
contact me at (202) 512-3841. Key contributors to this report include
Dan Haas, Daren Sweeney, Randy Jones, Carol Kolarik, Jon Ludwigson,
Frank Rusco, Jonathan McMurray, and Barbara Timmerman.
Jim Wells
Director,
Natural Resources and Environment:
Signed by Jim Wells:
List of Congressional Requesters:
The Honorable Robert E. Andrews United States House of Representatives:
The Honorable Brian Baird United States House of Representatives:
The Honorable Tammy Baldwin United States House of Representatives:
The Honorable Shelley Berkley United States House of Representatives:
The Honorable John Conyers, Jr. United States House of Representatives:
The Honorable Peter DeFazio United States House of Representatives:
The Honorable Sam Farr United States House of Representatives:
The Honorable Bob Filner United States House of Representatives:
The Honorable Michael M. Honda United States House of Representatives:
The Honorable Dennis J. Kucinich United States House of
Representatives:
The Honorable Tom Lantos United States House of Representatives:
The Honorable Barbara Lee United States House of Representatives:
The Honorable Carolyn Maloney United States House of Representatives:
The Honorable Karen McCarthy United States House of Representatives:
The Honorable James P. McGovern United States House of Representatives:
The Honorable George Miller United States House of Representatives:
The Honorable Bill Pascrell, Jr. United States House of
Representatives:
The Honorable Bernard Sanders United States House of Representatives:
The Honorable Hilda L. Solis United States House of Representatives:
The Honorable Fortney Pete Stark United States House of
Representatives:
The Honorable Tom Udall United States House of Representatives:
The Honorable Maxine Waters United States House of Representatives:
The Honorable Robert Wexler United States House of Representatives:
[End of section]
Enclosure I: Comments from the Federal Energy Regulatory Commission:
FEDERAL ENERGY REGULATORY COMMISSION WASHINGTON. DC 20426:
OFFICE OF THE CHAIRMAN:
May 19, 2003:
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 your letter of May 9, 2003, enclosing your draft report,
Electricity Restructuring: FERC's Role in Protecting Electricity
Consumers. I congratulate you on your effort and appreciate the
opportunity to comment on this report.
I generally agree with the report and its description of the
Commission's role in protecting electricity customers. One point I
would like to emphasize is that the Commission is not only responsible
for enforcing and correcting market rules, but for facilitating the
development of balanced rules up front. Balanced rules encourage
efficient behavior and infrastructure development and deter abusive
behavior. I characterize our mission as including three equally
important components: balanced rules, sufficient infrastructure, and
vigilant enforcement.
In addition, I would like to suggest a few changes to your report to
elaborate on how the Commission protects electricity customers. First,
I suggest adding the following sentence on page 4 after the first
sentence in the last paragraph:
Following Order No. 888, FERC approved the creation of independent
system operators (ISOs) for New England, the Mid-Atlantic states, New
York and California to operate wholesale energy markets and
transmission systems within their regions.
In the second paragraph on page 5, 1 suggest changing the date the
Office of Market Oversight and Investigations was established to August
2002. In addition, in the same paragraph, I suggest revising the
description of the Enforcement Hotline as follows:
In addition, to help monitor the markets, the Office of Market
Oversight and Investigations manages FERC's Enforcement Hotline, which
is designed to provide industry participants and the public a way to
tell the Commission their concerns or complaints about behavior in
electricity markets.
I appreciate the work your staff put into this report and am hopeful it
will further understanding of the Commission's role in protecting
electricity customers. Thank you again for the opportunity to comment
on your report.
Best regards,
Pat Wood, III
Chairman
Signed by Pat Wood, III
[End of section]
FOOTNOTES
[1] U. S. General Accounting Office, Lessons Learned from Electricity
Restructuring: Transition to Competitive Markets Underway, but Full
Benefits Will Take Time and Effort to Achieve, GAO-03-271 (Washington,
D.C.: Dec. 17, 2002).
[2] Although FERC has authority to oversee the interstate transmission
system, the North American Electric Reliability Council (NERC) makes
sure the interconnections among transmission systems work reliably by
developing and monitoring standards of operation.
[3] As we reported in December 2002, Midwest ISO operates in Illinois,
Indiana, Iowa, Kentucky, Michigan, Minnesota, Missouri, Montana, North
Dakota, Ohio, South Dakota, Virginia, Wisconsin, and Manitoba (Canada).
PJM operates in Delaware, the District of Columbia, New Jersey,
Maryland, Ohio, Pennsylvania, Virginia, and West Virginia. GridFlorida
operates in Florida. GridSouth operates in North Carolina and South
Carolina. According to FERC, RTO West operates in Washington state,
Idaho, Montana, Oregon, Nevada, Wyoming, Utah, and a small part of
northern California. WestConnect operates in Arizona, Colorado, New
Mexico, and Utah. SeTrans operates in Alabama, Arkansas, Florida,
Georgia, Louisiana, Mississippi, South Carolina, and Texas.
[4] The Power Marketing Administrations are Bonneville, Western Area,
Southeastern, and Southwestern.
[5] Wholesale energy trades within a state--for example, when a
municipality purchases power from a generator in the same state--are
regulated by the state's public utility commission. In addition, FERC
has no jurisdiction over the wholesale market in Hawaii and Alaska
because, being geographically separated from the contiguous U.S., these
states have no interstate trade in electricity. Similarly, FERC has no
jurisdiction over wholesale electricity trades in much of Texas because
the state has few connections with the two major interstate grid
systems in the United States, the Eastern and Western Interconnect.
