Federal Electricity Regulation and Alternative Energy: The Good, the Bad and the Ugly

1. Federal Electricity Regulation andAlternative Energy:The Good, the Bad and the Ugly Presented byScott M. Harvey Prepared forAmerican Bar AssociationSection of Environment, Energy and Resources Teleconference December 14, 2005

2. The author is or has been a consultant on electricity market design and transmission pricing, market power or generation valuation for Allegheny Energy Global Markets; American Electric Power; American National Power; California ISO; Calpine Corporation; Centerpoint Energy; Commonwealth Edison; Constellation Power Source; Coral Power; Dynegy; Edison Electric Institute; General Electric Capital; GPU; GPU Power Net Pty Ltd; GWF Energy; Independent Energy Producers Association; ISO New England; Midwest ISO; Morgan Stanley Capital Group; New England Power; New York Energy Association; New York ISO; New York Power Pool; Ontario IMO; PJM Supporting Companies; Reliant Energy; San Diego Gas & Electric; Sempra Energy; Mirant/Southern Energy; Texas Genco; Texas Utilities; Transpower of New Zealand Ltd; Westbook Power; Williams Energy Group; and Wisconsin Electric Power Company. • The views presented here are not necessarily attributable to any of those mentioned, and any errors are solely the responsibility of the author. 1

3. The Good • Between 1998 and 2005, RTO-coordinated day-ahead and real-time power markets based on locational marginal pricing were implemented in regions accounting for a large proportion of the U.S. population and economy. • These changes have provided renewable and distributed energy generation with unrestricted, non-discriminatory access to spot markets. • Locational marginal pricing in real-time provides a natural opportunity for distributed generation to compete with centralized generation at the margin. • Financial transmission rights, day-ahead schedules and real-time dispatch provide an ideal transmission reservation system for intermittent generation, which will not want to use the same amount of transmission over the day and year.

4. The Bad • Energy market price caps in RTO-coordinated spot markets have been set at lower and lower levels and meaningful shortage pricing has been implemented only in New York. • Distributed generation will not be economic on a widespread basis if spot prices only reach $92, even in a Stage 1, 2 or 3 emergency. • Capacity markets in New York, PJM and New England are intended to provide a revenue stream that compensates for below-market energy prices during shortages but the capacity markets in PJM and New England have been largely dysfunctional. • Even with “better” capacity markets, it is unclear whether capacity market rules will be neutral, favor or disfavor renewable energy and distributed generation.

5. The Bad • There are still substantial regions in the United States (Southeast, Southwest, Rockies, Pacific Northwest) in which there is no real-time spot market and only traditional firm (use-it-or-lose-it) transmission service. • In these regions, the traditional vertically integrated utility (investor-owned or public) provides the only market for renewable and distributed energy generation.

6. The Ugly • In much of the same region in which RTO-coordinated spot markets have been implemented, the states have also implemented retail competition. • This has been good for renewable generators that have been able to realize a premium for marketing “green” energy. • Retail competition has also resulted in no entity having a long-term load-serving obligation in most of this region, undermining long-term power contracting. • Until recently, FERC has focused on the congestion hedging requirements of retail access providers whose horizon is six months to two years, rather than on providing mechanisms for LSEs to acquire long-term financial transmission rights capable of hedging future congestion charges on power from major renewable generation projects.

7. The Ugly • This short-term contracting focus applies to all generation sources, not just renewables, but the lack of long-term markets for financial transmission rights is more likely to adversely impact contracting for renewable generation. • Gas-fired generation can, and should, be built close to load because it is cheaper to transport gas than power, so long-term congestion hedges are not always essential to supporting long-term contracts for gas-fired generation. • Wind, biomass and geothermal generation, on the other hand, must be built where the resources exist and are likely to be located remotely from load, so availability of long-term congestion hedges is potentially important to long-term contracting.

8. The Future • Issues important to renewable energy and distributed generation will be resolved at FERC and in RTO stakeholder processes in the coming year. • Will shortage pricing be introduced into spot power markets or are capacity markets the future? • Will California, Texas and the Southwest Power Pool implement RTO-coordinated markets based on locational marginal pricing over the next two to three years? • Will there be a shift toward financial transmission right auction systems that support the sale of long-term rights?

9. SCOTT M. HARVEY (617) 761-0106 sharvey@lecg.com LECG Energy Website: www.lecg.com/Practices/Energy/Research Papers & Testimony