ELECTRICITY RESTRUCTURINGWHAT’S GONE RIGHT?WHAT S GONE RIGHT?

WHAT’S GONE WRONG?WHY DO WE CARE?WHY DO WE CARE?

Paul L. JoskowAlfred P. Sloan Foundation

andMITMIT

October 1, 2008,

The views expressed in this presentation are my own and do not represent the viewsof the Alfred P. Sloan Foundation or MIT

SOME BASIC FACTS ABOUT ELECTRICITY SECTORELECTRICITY SECTOR

• Accounts for 42% of primary U.S. energy % p y gyconsumption

• Accounts for 35% of U.S. fossil fuel consumption• Accounts for 40% of U.S. CO2 emissions and

this share projected to grow in BAUU l t t l Oil t d f• Uses almost no petroleum: Oil accounted for 17% of generation in 1973 and only 1.5% today

• Relies primarily on North America for fuel• Relies primarily on North America for fuel• Consumption projected to grow faster than total

energy consumptiongy p

Distribution lines

66-115 kV lines

Distribution subs

Transmission subs

Transmission lines230-500 kV

Networkswitchyard

GeneratorStep-up

Generator

ConsumersVertical Integration + Monopoly + COS Regulation

NetworkGenerating

UnitsTransmission

Network Distribution

NetworkOperationsandDispatch

Other Control Areas

Wholesale Market

U.S. Investor-Owned Electric Utility Holding Companiesas of January 2004

PSD

PSD

AVA

ENE

SPI

AVA

SPI

NOR

MDU MDU

XEL OTTR

MDUNGG

CVNU UTL

EMA

MAP

EAS

EAS

WECEAS

SPICZN

OTTR

OTTRALE

XELWPS

UPENWEC

WPS

LNT

GMP

UGI

NORIDASPI

SPI IDA

IDA

SPI

IDA

SRP

SPI

SPI

SPI

SPI

NOR MDU

BKHCMS

DTE

AEP

AEP

AEPDPL

AYE

AYEPPL

PPL

AYE

AYE PEG

NMKNMK

EAS

NGG

NGG

CHG

ED

NU

UIL

NGG

NUNGG

NST

NU UTL

EXC

DQE

FE

FE

FE

FE

FEFE

AYE

AYE

AEP

XEL

LNTBRKBRK

BRK

XELXEL

WEC

WEC

MGE

DYNDYN

EXC

NI

AEE

LNT

LNT

LNT

PCG

EIX

SRP

SPI

UNS

XEL

ILA

PNM

GXP

EDE

WR

AEP

AEP

EDE

AEE DYN

D

PGNDUK

AESVVC

AEP AEP

DAEP

AYECIN

POM

CEG

POMEXC

AEE

AYE

AYE

XEL

GXP

CIN

AEEAEE

PWG

PWG

PWG

EON

EON

AEPEON

PGN

EON

ILA

ILA

ILA

ILA

SRE

PNW

PNW

UNS

PNW

PNM

PNM

TNP

AEPTNPETR

AEP

ETR

ETR

AEP

AEP

OGE

AEPAEP

OGE

ETR

SO

SO

SO

SCG PGN

XEL

TXU TXU

DUK

SCG

Alaska

MAPP

WSCCMAIN ECAR MAAC

NPCC

NERC Regions of North America

EE

TNP

AEP

AEPETR

HOU

TNP

CNL

CNLETR ETR

SO

FPU

TEFPL

CNP PGN

CNL

+ 2 000+ municipal and

The service boundaries on this map are a general representation of individual utility regions and do not necessarily depict the exact legal boundaries of the regions. Information on this map is believed to be accurate but is not guaranteed.© 2004 PA Knowledge Ltd. Unauthorized duplication or dissemination

prohibited.

HE

Hawaii

SERC

SPP

ERCOT

FRCC

+ 2,000+ municipal and800 rural coops

Source: NERC

THE GOOD OLD DAYS OF REGULATED MONOPOLYREGULATED MONOPOLY

• Construction cost overruns and poor generating plant ti foperating performance

• Inefficient retail pricing• Wide price variations within regionsp g• Costly fragmentation and wide variations in performance• Productivity and innovation lags• Growing adverse environmental impacts• Growing adverse environmental impacts• But it worked from the “big picture” perspective and was

particularly good at mobilizing capital• Only energy or infrastructure sector that has escaped• Only energy or infrastructure sector that has escaped

mandatory national “liberalization” reforms• Partially reformed 1935 industrial organization and

regulatory framework for a 21st century technology andregulatory framework for a 21st century technology and policy challenges, especially GHG mitigation

REFORM GOALSREFORM GOALS• Efficient and reliable supplies of electricity to pp y

support valuable services and economic growth• Efficient prices that provide good signals for wise

use of electricity and sufficient revenues touse of electricity and sufficient revenues to support efficient operation of and investment in the supply systemE d t k it d li bilit• Energy and network security and reliability

• Key platform for meeting GHG mitigation goals• Stimulate innovation on the supply and demand• Stimulate innovation on the supply and demand

sides• Do better than just “work”

VISION FOR COMPREHENSIVE REFORMCOMPETITIVE WHOLESALE RETAIL MARKETSCOMPETITIVE WHOLESALE + RETAIL MARKETS

GENCO GENCO GENCO GENCO GENCO GENCO

MARKETERMARKETER

NETWORKOPERATOR

ORGANIZED SPOT MARKETS FOR ENERGY AND

OPERATING RESERVES

TRANSMISSIONOWNER + OPERATOR

DISTCODISTCODISTCO ESPESP DISTCODISTCOESP

RETAIL CONSUMERS

ISO/RTOs in the United States 2006

ISO NEMISO ISO NENYISO

PJM

MISO

SPPCAISO

ERCOT

CAISO

Source: State of the Markets Report 2004, FERC Office of Market Oversight andInvestigations (2005, page 53).

Source: FERC 2006 State of the Markets Report

STATUS OF RETAIL COMPETITIONAND RESTRUCTURING REFORMSAND RESTRUCTURING REFORMS

2007

AVERAGE PRE-REFORM INDUSTRIAL PRICES19961996

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

Plants operated by IOUs in restructuring states experienced the greatest improvement in nonfuel

e to

198

1p g p

operating expenses (similar results for employment)

0

0.1

0.2

wth

Rel

ativ

e

0 3

-0.2

-0.1

pens

e G

row

-0.5

-0.4

-0.3

Non

fuel

Exp

-0.6

N

MUNI PlantsIOU: Non-restructured StatesIOU: Restructured States

Frabrizio, Rose and Wolfram (AER, 2007)

Capacity factors increased for nuclear plants facing restructuring activity g g y

(Zhang, 2007)

Courtesy of Nancy Rose

Quantities traded: Day-ahead net t Mid t E texports, Midwest East

White and Mansur (2008)

CHALLENGESCHALLENGES• Markets must produce adequate revenues to stimulate p q

efficient investment– Capacity obligations– Scarcity pricingy p g

• Better integrate demand side into short-term wholesale markets

• Improve efficiencies of interregional trades of power• Improve efficiencies of interregional trades of power• Retail competition and retail procurement• Investment in transmission facilities, especially inter-p y

regional transmission facilities• Living with a mixed system with no comprehensive

national electricity policy frameworknational electricity policy framework

IDEALIZED WHOLESALE ELECTRICITY MARKETWITH DEMAND RESPONSE

D3Price

D1

D2 D4

MC

P3

MC

P2P1

P2

QuantityKmax

MCDemandPrice

Infra-marginal rentshelp to pay for capital costs

Pc

QuantityKmax

MC

PriceScarcity rationed by Demand and system

t ’ d

R

Pcoperator’s procedures

R

Additional “scarcity rents” help pay capital costsAdditional “scarcity rents” help pay capital costs of all units and are especially important for “reserves” that run infrequently

Dp

Capacity constraint

Kmax Quantity

ISO New England (2008)

ISO New England (2008)

PJM (2008)

SCARCITY RENTS PRODUCED DURINGOP 4 CONDITIONS ($1000 Price Cap)OP-4 CONDITIONS ($1000 Price Cap)

($/Mw-Year)YEAR ENERGY OPERATING OP-4 HOURS/

MC=50 MC=100 RESERVES (Price Cap Hit)

2002 $ 5,070 $ 4,153 $ 4,723 21 (3)

2001 $15 818 $14 147 $11 411 41 (15)2001 $15,818 $14,147 $11,411 41 (15)

2000 $ 6,528 $ 4,241 $ 4,894 25 (5)

1999 $18,874 $14,741 $19,839 98 (1)

Mean $ 11,573 $ 9,574 $10,217 46 (6)

Peaker Fixed-Cost Target: $ $70,000 - $95,000/Mw-year

PJM (2008)

●

Market price without OOM

Source: ISO NE

ISO New England (2008)

ISO New England (2008)

ISO New England (2008)

NY ISO (2008)

RETAIL COMPETITION IN MASSACHUSETTSMASSACHUSETTS

Retail Choice Began March 1998Retail Choice Began March 1998Regulated Basic Charge ended ~ April 2005Replaced with default wholesale market procurement

Customer Type % of Load Served by ESPS

February May May2004 2005 20082004 2005 2008

Residential 2.6 6.1 11.7Small Commercial 10.8 19.3 33.9Medium C&I 17.0 22.2 49.8Large C&I 48.3 63.3 87.3

TOTAL 22.6 34.0 53.0TOTAL 22.6 34.0 53.0

EFFECTS OF REGULATED BASIC SERVICEBASIC SERVICE

RETAIL CHOICE IN TEXASRETAIL CHOICE IN TEXASResidential Megawatt-hours switched to Competitive g p

REP

60.00%70.00%

10.00%20.00%30.00%40.00%50.00%

0.00%

Jan-0

2Ju

l-02

Jan-0

3Ju

l-03

Jan-0

4Ju

l-04

Jan-0

5Ju

l-05

Jan-0

6Ju

l-06

Jan-0

7Ju

l-07

TXU ED Centerpoint AEP CentralAEP North TNMP Total

RETAIL CHOICE IN TEXASRETAIL CHOICE IN TEXAS

Non-AREP Share of Secondary Voltage Megawatt-hours

40 00%

60.00%

80.00%

100.00%

0.00%

20.00%

40.00%

Jan-0

2Apr-

02Ju

l-02

Oct-02

Jan-0

3Apr-

03Ju

l-03

Oct-03

Jan-0

4Apr-

04Ju

l-04

Oct-04

Jan-0

5Apr-

05Ju

l-05

Oct-05

Jan-0

6Apr-

06Ju

l-06

Oct-06

Jan-0

7Apr-

07Ju

l-07

Oct-07

J A O J A O J A O J A O J A O J A O

TXU ED Centerpoint AEP CentralAEP North TNMP Total

MAJOR CONGESTED INTERFACES

Source: Platts

CLIMATE CHANGE CHALLENGESCHALLENGES

• The electric power sector must play anThe electric power sector must play an important role in GHG mitigation– Energy efficiencygy y– Nuclear Power– CCS– Renewable energy

• But the industry is in an unstable “partial y preform” equilibrium with “regulated,” “deregulated,” and “mixed” states

CLIMATE CHANGE CHALLENGESCHALLENGES

• Assume a cap and trade program with primarily free ll ti i iti llallocation initially

• Assume supplementary renewable energy portfolio standards

• Issues– Mobilizing adequate capital in deregulated states– Controlling construction costs and getting good operating

performance in reg lated statesperformance in regulated states– Getting the price of CO2 into retail prices in regulated states to

stimulate conservation and energy efficiency– Transmission investment to reach most favorable locations forTransmission investment to reach most favorable locations for

large scale wind and solar initiatives– Squabbling over differences in effects between regulated and

deregulated states delaying actionPlethora of individual state programs reducing efficiency of a– Plethora of individual state programs reducing efficiency of a national program with international linkage