Why wholesale market benefits are not always apparent in customer bills
Independently and transparently operated regional electricity markets can reduce wholesale electricity costs by improving efficiency and cost-effectively managing variable generation from renewable resources. In discussions about utilities joining these markets, some have questioned whether they benefit customers and renewables integration, pointing to higher retail rates in some market regions and asserting a lack of unbiased evidence supporting such benefits. This logic muddles a number of issues and creates an inappropriate comparison; there are regional differences other than organized markets that impact customer energy bills. Further, as shown by the independent studies discussed in this post, organized wholesale electricity markets produce savings, but the costs that utilities fold into their customers’ retail rates can offset market savings. Lastly, government data show that organized market regions have a greater percentage of wind and solar generation and capacity compared to non-market/ regions with comparable renewable resources.
Thus, there are at least two separate questions: (1) whether utilities should participate in organized wholesale electricity markets, even acknowledging that the markets can be improved; and (2) how to structure utility incentives to ensure they cost-effectively serve customers. Conflating these two questions may lead us to miss the benefits of such markets as well as the opportunity to focus on the real problems.
Regional Transmission Organization and Restructuring
To promote wholesale electricity competition, the Federal Energy Regulatory Commission (FERC) in Order 2000 encouraged Regional Transmission Organization (RTO) formation to “ensure that electricity consumers pay the lowest price possible for reliable service.” RTOs enhance competition by independently operating transmission systems over larger regions and organizing wholesale electricity markets to optimize the use of available transmission. Open-access transmission provides buyers and sellers similar access to the electric highways for power delivery and facilitates access to markets that can select the most cost-effective resources across broader geographies. And these markets can help balance variable wind and solar generation and customer demand differences across time zones and temperature ranges.
There are currently seven RTO-like entities in the United States, and all but the Electricity Reliability Council of Texas are overseen by FERC. RTO members include utilities that are vertically integrated or “restructured.” This is an important distinction because some criticisms aimed at RTOs are really issues that stem from incomplete restructuring that did not sufficiently mitigate market power concentration in incumbent utilities and their affiliates. To explain what this means requires some background. First, states have pursued restructuring to different degrees. Some have required their vertically integrated monopoly utilities to divest generation so that customer-serving utilities must procure generation from markets. Other states have further enhanced retail competition by allowing end-use customers to choose suppliers. However, most utilities that were required to restructure were allowed to sell their generation assets to subsidiaries instead of functionally divesting them. And in jurisdictions enabling retail choice, incumbents were allowed to become the default service provider. Thus, incomplete restructuring limited competition and its corresponding customer benefits, sometimes enabling utilities and their affiliates to capture the gains from trade that customers would have otherwise reaped.
Wholesale cost savings and other impacts on end-use customers’ retail bills
RTO savings come largely from more efficient use of existing resource fleets and a reduced need for additional resources. While the savings from avoided investments are projected to be an order of magnitude greater than the production cost savings from efficient use of existing assets, many academic studies have focused on the latter.
The most cited literature indicates that wholesale markets operated by RTOs have reduced production costs by increasing trade, as well as coordinating and driving efficiency improvements at power plants. Notably, several recent academic studies have quantified efficiency gains from wholesale electric energy trading, noting that while market power wielded by a few large companies was a concern, it was far outweighed by market efficiency benefits.
One study estimates that wholesale markets nationwide saved about $3 billion per year in production costs from 1999-2012. The savings accrued from greater use of lower-cost plants and increased trading among utilities. While market power wielded by a few large companies was a concern, it was far outweighed by market efficiency benefits.
Another study showed that nineteen Midwest utilities joining PJM Interconnection (for Pennsylvania Jersey Maryland) in 2004 produced efficiency gains of over $160 million annually, exceeding the one-time $40 million implementation cost. These Midwestern utilities had already been trading bilaterally with their eastern neighbors; after joining the RTO, the energy traded between them tripled, and production shifted to lower-cost facilities as the market identified new trading opportunities.
Lastly, a study of Texas’ transition from a bilateral market to a centralized auction found improved market efficiency that dominated any change in market power incentives. Following the transition, low-cost generators displaced higher-cost generators, leading to annual production cost savings of around $59 million.
Retail rate mechanisms can erode RTO cost savings in end-use customer bills
While organized markets can and should be improved, they have been generating savings, particularly as natural gas prices have trended downward. This has reduced the RTO cost component in end-use consumer bills. However, additional costs determined through state-jurisdictional processes have offset some of these savings. For example, despite wholesale costs declines, retail rates in regions with mostly vertically integrated utilities held steady where utilities have offset some or all of the savings with greater capital expenditures. Much of these investments are borne by customers as state-jurisdictional plant-in-service additions that earn a return for the company.
Where monopoly influences persist despite restructuring, for example because a vertically integrated utility did not fully divest its generation assets, marked-up power contracts and charges compensating for power plant losses have eroded customer savings. Ohio, for instance, allowed utilities to divest generation assets by selling them to a subsidiary, which meant that some customers saw rates increase despite falling wholesale costs.
In contrast, Texas has embraced competition by requiring utilities to fully divest generation assets, ensuring that market prices better reflect the value of electricity, and enabling customers to choose providers. Total bill data from Texas suggests that residential customers benefited from retail choice when compared to residential customers in non-restructured parts of the state. Such savings were attributed to declining service provider costs, reduced price mark-ups and declining wholesale market costs. However, recent extreme weather events in Texas indicate that some customers may not be equipped to respond to wholesale markets or understand the risks inherent in being exposed to market price spikes. Layering on protections during emergencies, like insurance, for those types of customers could help.
Unbiased academic studies show that there are efficiency gains from independently and transparently run organized markets, but additional costs levied at retail can diminish or offset these wholesale market savings. Such additional costs can stem from allowing regulated monopoly utilities to increase capital expenditures and divest generation to affiliated companies without adequately ensuring that their transactions are competitive. Thus, rather than forgoing organized markets and their benefits, decisions makers should ensure that retail reforms provide sufficient guardrails against market power; work toward enabling robust competition between suppliers; and align utility incentives with cost-efficiently serving their customers.
Image credit: ABCDstock