April 2000

Sheikawatts vs. Negawatts

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2000/05)

Plots repeat themselves first as tragedy and then as farce. First the tragedy. Oil prices rise, and Washington flees to short term, parochial fixes. The possibility of structural change is ignored for the palliative of short term promises (even absurd ones like gas tax revocation). Root causes are ignored and intersectional rivalries are politically exploited. It is, one hopes, a blip on the landscape, although it has the seeds of a secular American tragedy. It seems make believe free markets with strong suppliers and fragmented consumers can have very real world consequences for prices and economics.

Now the farce. The prospect of summer’s power spike is upon us early this year. But there is no "big battery" to rival the Strategic Petroleum Reserve, whose spigot can be opened if the thermometer gets too hot. Somehow the projected emergent inventory of new generating facilities has not emerged as projected. (Or it has, but those with power in electricity supply markets like those in oil markets seek profit maximization in it, with market equilibrium a later, derivative and poorer relation.)

While PJM, New England and California all face analogous circumstances, focal point for the problem in the nation - possibly with election overtones - is the Midwest (the ECAR Region). The prediction of a tight summer comes not just from the pundits, but from the wholesale power markets themselves. Enron Power Marketing already has pulled its offers for July/August into Cinergy markets, and has not made any offers since then. Future market prices continue to hit highs – the expectation is that capacity margins and peaks will be the same as last summer.

What to do? Three theories have been articulated recently, but they all stem from the same root. Chairman Hoecker of FERC has raised the possibility of "bold" action – a national system of reliability based on private contract presumably instead of based on a law setting standards and enforcements. (Perhaps that is a way of saying, since Congress won’t or can’t legislate, FERC will have to try to bite the bullet itself. In other words moderation in the face of non-reliability (or just unattractive price spikes) is no vice.....break out the NRA purple eagle for power.

That approach seems to suit the mood of a coalition of Midwestern retail and wholesale consumers, who have petitioned the presidential candidates to provide relief based on the mandatory creation of a super regional transmission organization, not based on voluntary utility participation, as is the punches pulled FERC RTO proposal.

Suits the views of the big marketers too, who are petitioning FERC to combine the three Northeastern ISOs into one RTO. Some such players, like Dynegy would also like an Interregional Transmission System Coordinator to overlay the regional RTOs.

So for their own reasons, each of the big players have chosen to think that reliability governance will alleviate foreseeable spike crises. Perhaps it is time to reread the hearings following last year’s crises, which attributed at least some of the price developments to strategies of market players or simply to the way immature markets work. But no matter, the FERC Chairman has told us our only option is to push ahead (ed note: like lemmings) with the "reinvention" of markets.

It is interesting that while there has been emphasis on improved transmission, through reliability arrangements, there has been no suggestion that conservation – in the form of mandatory load reshaping – might be the optimal response to excessive peak use. Shades of our enlightened national approach to the pending oil crisis: or, as it might be termed, SUV-diplomacy. This is particularly striking, given that Elcon recently pointed out to its members, that this was an optimal way to actually profit from deregulation. Similarly PJM has sought to improve reliability and avert a spike by initiating a demand side bidding program, whereby industrial customers get paid to cut back use. Local citizens groups suggest that things would be even brighter if suppliers came up with incentive programs for small business and residential users to get offline. Striking to observe, particularly in that conservation/demand management was one of the few effective strategies during the last oil crisis.

So here is a puzzle: if it is justified to meet the upcoming spike with a non-statutory solution as FERC suggests; and if the market-based way is the American way to do it; why not go "negawatt" and put profits in the hands of those who directly alleviate the crisis than and reward those in control of production for skillful market gamesmanship selling "sheikawatts" on a transmission constrained grid. You don’t need the moral equivalent of war or the economic equivalent of Adam Smith to reach that conclusion.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.