October 2002

"Fall Fashion Preview: Standard Market Design"

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2002/11/27)
 

Fashion Scene

The fall fashion show this year in the Austin (TX) Power Boutique seems to have a retro bent. This was to be expected after the debacles in the past two seasons, when the free-form deregulation look, accompanied by high spike heels, proved just too extreme for customers. The runway collapse of the much-hyped California show, and the resultant crushing of such supermodels as Enron and Dynegy, just iced the cake. So this year, FERC is unveiling a new, more structured look in the form of its SMD line (that’s Standard Market Design, darlings, not "Silly Made-up Diagrams"), Docket No. RM01-12-000. This prêt-à-porter, one-size-fits-all approach is supposed to eliminate the unsightly regional power market seams, which last year’s RTO covered up but did not erase. By requiring uniform NAS (National Access System) and firm, full network transmission tariff stitching throughout, the new SMD line is intended to obsolete old standby transmission fashion styles, including the Native Load look (a favorite of priority-served local homebodies), and the bunchy Bundled Retail look previously available only outside of FERC jurisdiction for every state in the intrastate regulated trade.

Critics of the new SMD have raised several basic management complaints about the introduction of the new line, related to the way it is being forced on the market; its treatment of existing fashion styles; the extent of its fussy detail work and the possible impairment of wholesaling of goods by some of the bigger, more powerful dealers. To alert you to the possibility of mid-season corrections, a few words of more technical explanation on all this follow.

Features of the SMD Line

               Transmission Market Structure

FERC now proposes to delegate performance of transmission control, transition dispatch, resource adequacy planning to Independent Transmission Providers (ITPs), which will subsume RTOs, ISOs, ITCs – they will have strict independence standards. Essentially, ITPs are a mechanism to assure the demise of integrated utilities’ ownership of lines that offer preference to native load and to subsume bundled retail transmission under FERC rather than state jurisdiction. It is the ITPs that will be expected to file the new uniform NAS tariffs. (It is notably these reforms that already have led integrated utilities, notably in the South and Southwest, to take strong anti-SMD stands.)

                 Transmission Tariff Features

NAS is to replace the variety of structures of pro forma tariffs permitted under Order No. 888 with a standard form of universal transmission service. To serve grandfathered loads, transmission owners are now to take NAS from ITPs. Users, thereover, will have to revisit their existing arrangements for firm transmission service. A level playing field, therefore, will be created for all transmission customers. On a parallel track, the way in which FERC resolves the issues under the interconnection NOPR will collaterally affect the way in which NAS operates by defining fairly the terms of accessorization. (It is no wonder that, while applauding the spirit behind SMD, industrial and commercial users have expressed concerns regarding its implementation as well as destroying hard-won transmission access relationships.)

SMD contemplates a heavy emphasis on bilateral contracting, but also requires ITPs to provide day-ahead and real-time markets, and to assume responsibility for balancing and certain other ancillary services. Ultimately, whether zonal license plate or region-wide postage stamp rates will be charged at the transmitter’s option, it is transmission customers who ultimately will pay for transmission services by the ITPs on a locational marginal pricing (LMP) basis, i.e., users in load pockets will pay more for receipt of service and transmission cost no longer will be "socialized" (or rolled in) among all users. Pancaked rates will be precluded. (It is no wonder that regulators in low-cost production states are concerned that the removal of transmission barriers may have the collateral effect of leading to low-cost power exports to other states and the increase of power costs in their jurisdictions. Both they and legislators from their states have begun to express concern in that regard.)

Most basic of all, however, the introduction of SMD reflects a change in approach to the treatment of market-based rates (MBR), which essentially have been available to utility affiliates (as well as independents) whenever their parents have acceded to open access tariffs on their systems. SMD reflects FERC’s recognition that the exercise of market power (defined as "the ability to raise price above the competitive level") exists both in areas where either withholding physical power (physical withholding) or inflated bids (economic withholding) are options available to generators. (FERC’s prior efforts to ascertain the presence of market power that would preclude the award of MBR through the establishment of new, more stringent economic screens remain the subject of considerable controversy, and no final orders.)

Under SMD, FERC is seeking to deal with those circumstances where competitive market power is not present by propounding a combination of requirements for reliability must-run agreements for certain units, "safety net bid caps" on their rates under non-bilateral contracts, and mandatory ITP long-term regional generation resource adequacy analysis requirements (in recognition that spot market prices may not be indicative of market competitiveness). The possible use of automated market mitigation procedures similar to New York’s is approved. ITPs are to develop market mitigation procedures through independent market monitors, which apply to mitigation measures applicable to products traded under bilateral contracts outside the ITP’s spot markets. (It is not surprising that IPP merchant plant developer operators, and financial institutions that have invested in them, have begun to take note of this consequence of SMD and become nervous about these consequences for market-based rates.)

Fashion Forecast

We expect much additional controversy regarding the suitability of the SMD line, even though it’s at least superficially keeping with the overall "back to basics" theme of the season. We expect efforts to accessorize it so that it will be more broadly appealing to more customers. We don’t think that those who favor the even more retro Regulation Utility Suits (particularly popular in lighter weights in the South and hydroproofed numbers in the West) will be lured into this fashion. Catty critics have even begun calling it a "cry for help." All of this fashion debate may be moot, however, if rumblings that the Power Boutique’s holding company, Hawque USA, is bringing out a new line of camouflage fatigues turns out to be true.

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.