State of competition in US wholesale power markets

The Honorable Joseph T. Kelliher, Chairman of the Federal Energy Regulatory Commission, argues that regulation and competition can co-exist.

The fundamental duty of the Federal Energy Regulatory Commission (FERC) in the area of electric regulation is to “guard the consumer from exploitation by non-competitive electric power companies”. That is our core responsibility. FERC has discretion in how to discharge that duty, however.  Over the past 25 years, the agency has relied on two principal means to guard the consumer and assure just and reasonable wholesale power prices. One is direct regulation. The other is promoting competition.

FERC’s policy is not and has never been deregulation. Deregulation is the absence of regulation, and wholesale power sales have never been completely unregulated. The agency has never relied solely on competition to assure just and reasonable rates, and has never withdrawn from regulation of wholesale power sales. The nature of FERC regulation has changed over time, of course. While FERC used to control the exercise of market power by setting cost-based rates for individual sellers, the agency now analyzes the market power of individual sellers and sets rules of general applicability that are enforced through the enforcement powers recently granted to FERC by Congress.

Some persist in the view that regulation and competition cannot coexist. They argue that the country must go down one path or the other. Personally, I reject that notion. Nearly 40 years ago, the great economist Alfred Kahn observed that: “The two principal institutions of control in private enterprise economy are competition and direct regulation. Rarely do we rely on either of these exclusively: no competition markets are totally unregulated, and no public utilities are free of some aspects of rivalry. The proper object of search, in each instance, is the best possible mixture of the two.” I agree with Dr Kahn. In my view, the central challenge facing FERC today is finding the best possible mixture between regulation and competition of wholesale power markets.

Some doubtless believe that FERC has not yet found the best possible mixture. But none should doubt FERC’s resolve to do so. That is driving a lot of what FERC is now doing. It led us to adopt the first fundamental reforms to our transmission open access rule in a decade. It led us to steadily reform our market based rate program, which prevents exercise of generation market power.  It led us to reform transmission pricing to spur increased investment in the grid – the interstate highway system for wholesale power sales. It led us to strengthen our enforcement program. It led us to explore how to assure adequate electricity supply through continued entry by new generation.

The United States does not have a national wholesale power market. Our wholesale markets are regional in nature, and there are significant differences among the regional markets. Some of these differences relate to market structure. The wholesale markets in the Midwest, Northeast and California have regional transmission organizations with organized markets. In the West and South, wholesale competition takes the form of bilateral sales, without a centralized market. In my view, both basic forms of wholesale markets are likely to remain for some time. 

There are challenges to competitive wholesale power markets, both the organized markets and the bilateral markets. The competitive challenges vary among the market structures, and the solutions also vary, but I believe we can achieve effective competition in both the organized and bilateral wholesale market structures. FERC, as it considers reforms to make wholesale markets more competitive, must bear in mind those differences in market structures. We should consider reforms that are both national in scope, as well as changes that improve one particular market structure.

While competitive markets face challenges, we should acknowledge that competition in wholesale power markets is national policy. The Energy Policy Act of 2005 embraced wholesale competition as national policy for this country. It represented the third major federal law enacted in the last 25 years to embrace wholesale competition. To my mind, the question before FERC is not whether competition is the correct national policy. That question has been asked and answered three times by Congress.

I not only recognize that competition is national policy, I strongly believe it is the correct policy. Under traditional rate regulation, consumers bear all risk. Competition shifts risks away from consumers to market participants. For example, consumers bore the burden of the cost of the nuclear overbuild in the 1970s and 1980s. By contrast, investors bore the burden of excess generation built in recent years. Competition provides greater incentives for generators to reduce costs, introduce new technology, improve efficiency, enhance operating performance and improve service reliability. My view is that effective competition in wholesale power markets – when combined with sound regulation – can best assure just and reasonable prices, which benefit wholesale customers and ultimately benefit retail consumers. The best possible mixture between competition and regulation can believe the greatest benefits to consumers. 

If we accept that FERC has a duty to guard the consumer, and that competition is national policy, our duty is clear. It is to make existing wholesale markets more competitive. That is the focus of our efforts today. In February 2007, we initiated a comprehensive review of the state of U.S. wholesale power markets. The purpose of this review is to not only identify the challenges facing competitive wholesale markets but also identify and assess solutions. We have begun that process, and I will expect action in due course.

Competition has existed in wholesale power markets for many decades, but it has steadily become a more important feature of electricity markets in the last 25 years. At the outset of our competition review, we heard from some of the principal architects of our wholesale power competition policy. One issue we explored in our competition review was the origins of competition policy: why did the country commit itself to competition in the first place? Ironically, the origins of competition policy lie in the perceived failure of traditional rate regulation. As one of the panelists at our February conference stated: “The good old days were not nearly as good as some people seem to believe.” 

Much of the current dissatisfaction with competitive electricity markets is a direct response to the fact that natural gas prices are high and high gas prices are resulting in high electricity prices, since natural gas is a principal primary fuel for electricity generation. The reality is that high natural gas prices also produce higher electricity costs under traditional rate regulation, since rate regulation assures recovery of prudently incurred costs such as fuel costs. 

There are challenges facing wholesale power markets. FERC has significant authority, but there are limits to our regulatory authority. In some areas, states have more authority than FERC. That means FERC must work closely with our state colleagues to solve these problems. One of the lessons of the California and Western power crisis of 2000-2001 is a recognition that federal and state regulators work at cross purposes, we both fail and consumers suffer the consequences. I also do not necessarily think that all challenges facing competitive markets can be resolved by regulators. Some challenges may be best resolved by the industry itself.

FERC is a reform agency, and we are prepared to adopt reforms to make wholesale markets more competitive and assure effective regulation.