Has FERC Gone Far Enough in California?
The Federal Energy  Regulatory Commission isn't going far enough in its 
attempt to reform the  California wholesale electric market, according to a 
paper by three prominent  economists done for San Diego Gas and Electric. The 
paper by John D. Chandley,  Scott M. Harvey, and William W. Hogan argues that 
FERC should first end the  artificial separation that divides the California 
Power Exchange and the  California Independent System Operator, rather than 
worrying about the  governance of the two institutions.
"The change in governance may help," says  the paper - "Electricity Market 
Reform in California" - "but it is not likely to  be decisive in the near 
term. Explicit guidance from the commission regarding  the nature and 
trajectory of reforms will be essential if market reform is to be  
accomplished within an acceptable time frame." Hogan, of the Kennedy School 
of  Government, has been writing since 1995 in opposition to California's 
market  separation.
Also, argues the paper, freeing the California utilities to  engage in 
forward contracting is no panacea. "The expectation that merely  allowing 
utilities to participate in forward contracting necessarily would be  the 
solution to high prices is problematic and not supported by the commission's  
staff report," says the analysis, adding that "putting pressure on buyers to  
sign contracts in the present environment may make things worse." If the  
underlying problem in California is high cost and low capacity, requiring  
forward contracting could harm not only California but also the entire 
Western  U.S. electric system.
FERC's $150 so-called "soft cap" is a wild card that  has the three 
economists scratching their heads. "It does not appear in the  staff report 
and there is little critical analysis of their implications, other  than the 
discussion of Commissioner [Curt] Hebert." If the intent of the soft  cap is 
to move toward cost justification for bids above $150/MWh, then FERC is  
headed into an administrative morass "that would rival those under wellhead  
price controls in the natural gas industry."
If, on the other hand, the soft  cap is "truly soft" and would only require 
some paper work at FERC and the  possibility of a refund if the price is 
eventually deemed not just and  reasonable, "there might be little impact on 
consumer prices (particularly if  the principal sources of those high prices 
are high costs and regional capacity  shortages rather than the exercise of 
market power). Even so, the proposal might  serve to deter entry and new 
investments, thus combining the worst of both  worlds, high consumer prices 
and little or no new investment."
FERC's  proposed order in California also demonstrates confusion about just 
what  constitutes market power. The paper cites the proposed order's 
lawyerly,  obfuscatory conclusion that "while this record does not support 
findings of  specific exercises of market power, and while we are not able to 
reach definite  conclusions about the actions of individual sellers, there is 
clear evidence  that in California market structure and rules provide the 
opportunity for  sellers to exercise market power when supply is tight and 
can result in unjust  and unreasonable rates under the [Federal Power Act]." 
The economists note, "In  this regard, the debate is confused because we are 
dancing around the words  where the truth may be hard to face."
In the case of California, say the  economists, there is no evidence of 
market power. Even the practice of  generators avoiding the day-ahead market 
in favor of the real-time market "is a  response to bad market design and 
pricing incentives (including price caps), but  does not demonstrate the 
exercise of market power." Nor is bidding above  marginal cost necessarily an 
exercise of market power, they add. "The  distinction between direct marginal 
cost and opportunity cost is sometimes lost  in the discussion. Hence, a 
competitive bidder whose direct cost of generation  is $40 but who could sell 
the same energy outside California for $100 should bid  no less than $100. 
This would not be an exercise of market power."