By: Peter Fox-Penner The Brattle Group 1133 20th Street, NW Suite 800 Washington, DC 202.955.5050

1. FIXING AMERICA’S ELECTRIC MARKETS:FIVE MAJOR CHALLENGESPresented atNational Governors’ AssociationCenter For Best PracticesExecutive Policy Forum on EnergyIs Electricity Restructuring in Jeopardy?April 5, 2001 By: Peter Fox-Penner The Brattle Group 1133 20th Street, NW Suite 800 Washington, DC 202.955.5050 202.955.5059 (fax) www.brattle.com Visuals Only - Not a complete Record of discussion

2. Average Monthly Spot Prices in Competitive Bulk Power Markets PJM Market New England New Zealand CAPX SP15 Calif-Oregon Boarder Spot Price Mid-Columbia Spot Price

3. Retail Price of Electricity Sold by Electric Utilities, 1960-1999 • Retail price increases rival those experienced in 1973-82- -highest ever.

4. How Did We Get Here? • Circa 1990: • UK set up first major competitive market • 1992: • EPACT establishes first FERC authority to compel wheeling - limited. • Wholesale markets feature bilateral trades between utilities. • 1994: • California issues the Blue Book. • Retail choice suddenly becomes fashionable. • Still no federal bulk power open access! • 1996: • FERC issues Order 888 - - open access mandated via tariffs. • First states retail choice laws were in New Hampshire, Rhode Island and California. • By 1998: • First retail markets open. • Order 888 wholesale open access tariffs recognized as too weak.

5. How Did We Get Here? • Summer 1999: • Midwestern price spikes • Increases in TLR • Debate rages at FERC over how to improve market • ISO vs. Transco debates leads to RTO • Early 2000: • Order 2000 semi-directs all jurisdictional utilities to form RTOs. • Long-Term Bottom Line: • Competitive bulk power markets only three years old and began with many flaws. • Many key market needs only now getting addressed; timing uncertain. • Overlaying retail competition onto nascent bulk power markets was and is risky.

6. Five Major Challenges • Transmission Adequacy and Reliability • Market Power • Price-Responsive Demand • Better integration with gas market policies • Sound public interest and environmental policies • No long-term shortage of power plants or ability to generate. “Supply shortage” is not a structural, long-term problem.

7. Transmission Adequacy and Reliability • Transmission adequacy affects reliability and economics. Better reliability policies are a critical legislative need. • MW-miles of transmission per MW of peak demand has fallen 16.2% nation-wide between 1989 and 1998. • More than a decade ago, NGA found that annual added transmission capacity dropped 23% between 1970-1974 (3800 miles a year) to the 1975-1984 period (2900 miles a year). • Since then, annual additions have declined “to essentially zero between 1994 and 1998.” (Hirst 2000) • Impacts of these transmission constraints are being felt in many markets: • New York City, California, and parts of PJM, the Midwest, and New England. • Our transmission system resembles our air traffic control system: • Too little capacity for the amount of throughput. • Airports haven’t built any new runways in 20 years and we’ve built no new lines since 1994.

8. Least-Cost Infrastructure Siting: A Proposal • Serious talk on Capitol Hill about FERC eminent domain authority for new lines. • Need for a focused, time-limited regional deliberative line siting process. • The process should include: • Engineering alternatives. • Input from all segments of the industry. • Input from local communities affected by the proposed additions. • A substantial examination of cost-effective alternatives to new lines, including distributed generation, energy efficiency at the state and local level, renewable energy, technological fixes to existing transmission corridors, and the economic costs and benefits of expanding the grid. • If through this process, no other reasonable and timely alternatives exist, then the line is approved with eminent domain authority to implement it. • Model: Interstate River Basin Commissions.

9. Market Power • Market Power is another word for the incentive we give entrepreneurs to invest and invent. • Object is not total elimination, but there are limits to the amount of market power sellers should have and how they acquire it. • In their present form, antitrust enforcement is a difficult way to police the electric power markets. • FERC has not developed it own market power standards. It used a method to grant market based rates that was wholly inadequate up to now. • FERC many face enormous pressure to impose price caps this summer or temporarily suspend MBR for all sellers and require them to refile for MBR. If so, each option has pro’s and con’s, and a temporary return to cost-based rates should not be ruled out.

10. Price-Responsive Demand, Natural Gas and Public Protection • Most importantly, these areas cannot be neglected the way they have been in the “first era” of deregulation. • Electric markets WILL NOT WORK PROPERLY until electric demand becomes responsive to price in the short term. • Requires time-of-use meters and “smart building” technology. • Will take several years of concerted effort. • Federal and State governments should spur market adoption. • Re-examine our gas and electric market policies to make sure that the two sectors integrate properly. • Important to keep environmental protection, energy efficiency, R&D, and low-income policies strong.

11. Conclusion • Taming the lions of transmission adequacy, market power, price-responsive demand integrated gas policies, and continued public protection will be a long-term challenge. • These needs are critical regardless of the near-term pace of retail choice. • Supply adequacy, reasonable prices, and expanded competitive markets will return when we address these key challenges.