ELECTION 2001: THE CALM BEFORE THE STORM
Reapportionment... A new governor... The 2002 election... What's in the future for Pennsylvania politics?

Presentations by Senator Jeffrey Piccola, Senate Majority Whip; Representative Michael Veon, House Minority Whip; Professor G. Terry Madonna, Millersville University

Luncheon Program - December 3, 2001 - 11:30 a.m.
Harrisburg Hilton and Towers
Regular Admission - $25.00/PennFuture Members - $15.00
Event followed by an Open House with refreshments in our Harrisburg Office from 4:30 - 7 p.m.
R.S.V.P. by Nov. 28 or call 1-800-321-7775. You can also register online under "Events" at www.pennfuture.org or reply to this email.
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November 26, 2001
Vol. 3, No. 22

Governing a Northeast RTO

When the Federal Energy Regulatory Commission (FERC) ruled that the three Northeastern ISOs - the Pennsylvania-New Jersey-Maryland Independent System Operator (PJM), the New England ISO (NEISO), and the New York ISO (NYISO) - should become a Regional Transmission Organization (RTO), some hoped that these birds of a feather would flock together. After all, PJM, NEISO, and NYISO are examples for the country, teaching that RTOs are an essential condition for the creation of competitive wholesale markets. The three ISOs also individually oversee very small markets that are vulnerable to market power, have higher than necessary transaction costs, and other problems precisely because of the scope of their individual markets. Indeed, even once all three markets are merged, the combined market will account for less than 15 percent of the nation's generation. All these factors would drive rational participants focused on creating genuinely competitive markets toward merger. At least one would think so.

Yet so far, an intensive mediation process reveals that nobody is checking parochial interests at the negotiating-room door. In terms of the new RTO board and membership, participants are haggling about whether 3+3+3=1 independent board or whether 5+3+2 does. Such equations will never balance, no matter how hard one tries. The greater good is getting lost in turf battles and worse. If this myopic behavior continues, the result will be that all regions and all states lose, because they cannot see beyond their own noses.

Consequently, the ball is squarely back in FERC's court to direct the development of a successful RTO. It now faces some key decisions as it attempts to make good on the promise of the merger: to improve market efficiency, diminish market power concerns, improve interconnection rules for renewable energy resources, and reduce costs to consumers. For demand response and renewable energy advocates the stakes are especially high. Indeed the expansion of PJM into the Allegheny Energy control area was crucial to resolving interconnection issues that allowed development of the Mill Run, Pennsylvania 15-MW wind farm and enables future wind development in West Virginia that will in January 2002 be significantly within PJM.

The ability of the Northeast RTO to make effective decisions and follow through on those decisions will determine its eventual success or failure. But the debate over RTO governance begins and ends with the fact that FERC directed that PJM be the platform for the new organization, utilizing the "best practices" from NYISO and NEISO. PJM has the greatest experience and most successful track record of the three ISOs and is about the same size as NYISO and NEISO combined. At the same time, NYISO and NEISO have performed well and have addressed some issues more successfully than PJM. The recent PJM report to the Pennsylvania Public Utility Commission confirming that PJM's thoroughly discredited ICAP market was indeed manipulated by a "single market participant" which exercised undue market power in early 2001 is a timely reminder that PJM does not walk on water.

Unfortunately, rather than tackling implementation issues solely on their merits, debates have retained the persistent undercurrent of ISO, regional, stakeholder and corporate turf wars or self-interests.

Only FERC can get the process moving swiftly in the right direction by directing that the new RTO be an independent entity with superior board experience and clear decision-making authority responsive to genuine stakeholder input. There is no place for perpetuation of existing ISO self-interests, self-serving stakeholder vetoes, or regional power brokering.

Four principles are critical in the formation of any governance structure: board experience and independence, effective input of all stakeholders, sufficient board decision-making authority, and sufficient monitoring of market power.

An Independent and Experienced Board

Happily, the three proposals which emerged from the mediation process require members of the board to be independent from any of the market participants, precluding working for any of the companies doing business in the Northeast RTO markets, owning stock in member companies, or participating on any affiliated boards.

In contrast to this good news is the bad news that the three proposals focus too heavily on giving each existing ISO proper representation on the new RTO board, and what the proper representation would be. This regional focus undercuts independence and treats the RTO board like the United States Senate where each Senator comes from a state and argues for its interests. Loyalty to the home ISO becomes the real requirement in such cases, not independence.

Independence for the new RTO board membership should also mean independence from the institutional interests of the existing PJM, NYISO, and NEISO. Even if the existing ISOs retain operation for an extended period, it would be for practical, technical reasons, not because the ISOs themselves are a necessary constituency. To take a seat on the Northeast RTO board, all new RTO board members should resign any existing ISO board positions. The only fiduciary responsibility these board officers should have is to the new organization.

The new RTO board should include the most qualified individuals, without undue emphasis on whether or not they previously served on a particular ISO board. It makes sense that some, but perhaps not all, of the individuals on the new RTO board will have previously served on ISO boards. Such experience is invaluable. Yet it appears that some parties are stuck in the rut that ISO experience must bring ISO baggage. If the fiduciary duty of RTO board members is clearly to the RTO instead of to a prior ISO, it will be easier to get beyond ISO power issues. To encourage the movement of the most qualified ISO board members to the new RTO board, the "transition" board also should be or become the initial "permanent" Northeast RTO board.

Rather than on representation, selection of RTO board members should focus primarily on the breadth of issues that will be facing the new RTO. A well-rounded set of board experience and skills is essential to addressing such important issues as demand response, interconnection of generators, cost recovery mechanisms, system planning, and reliability.

The new RTO board should have members with regulatory, financial, environmental, consumer and reliability backgrounds. Besides providing voices genuinely without the baggage of prior ISO affiliation, the initial RTO board should probably, for example, include someone with substantial experience in merging organizations. The search process for new board members should be done in an open manner with input from all stakeholders to ensure adequate expertise in the diversity of issues that will face the new RTO.

Stakeholder Input

Meaningful stakeholder input is crucial because the RTO will be fundamentally charged with serving the public interest in an industry that is at the heart of our economy, security, and environment. Moreover, no board or management team can adequately predict all of the impacts brought on by rule changes without close coordination with market participants. The RTO will ultimately survive only if it maintains its credibility and the confidence of the public.

The three existing ISOs have made a substantial transition from a narrow conception of stakeholders as "transmission owners" to encompass "market participants" and even to include public representatives. PJM has recently expanded the types of parties that can participate in the process by facilitating the ability of State Consumer Advocates to join and be voting members. Other ISOs have gone even further by specifying specific categories for environmental agencies and individual consumers (and minimizing the costs of joining.) Of course, many stakeholder processes require so much time and expense that it is difficult or even impossible for such stakeholders to meaningfully participate.

But while opportunities for genuine and appropriate stakeholder input are essential, stakeholder processes cannot become an excuse or a means to avoid problem solving. There is a fine line between genuine stakeholder input and de facto special interest veto power. Over the past four years, PJM relied heavily on its membership to make improvements to market rules and has the best (though still flawed) wholesale energy market in the country. Yet it is equally clear that stakeholder input can impede positive changes, such as eliminating the ICAP requirements or implementing demand-response proposals.

These concerns are balanced by having stakeholder opportunities for input built into RTO problem solving, without allowing stakeholder processes to have a life of their own or the pretense of being the board. Stakeholders should not only be able to comment on proposed changes but also should constantly look for ways to improve the market and be able to communicate these suggestions to the RTO board. In turn, the board should take these suggestions seriously. This healthy relationship is hard to reduce to rules and rules alone cannot create it. Ultimately only a combination of rules, incentives, and personal leadership can make it happen.

Decision-Making Authority

Ultimately, the RTO board should be able to file changes with FERC on all market rule changes and reliability changes, with stakeholder input but without specific stakeholder approval. The RTO board must have the ability to file under the more broadly defined Section 205 of the FPA.

One example of the effective use of this type of intervention came earlier this spring. After months of negotiation on an economic demand-response program, several PJM market participants chose to block passage. The PJM board reviewed the results of the various votes on the demand-response programs, determined that the programs were justified and important, and filed the proposed rule changes, which FERC approved.

Since individual ISO boards will likely remain during a transition phase, all FERC filings should be made through the RTO board, which would have final decision-making authority.

Market Monitoring

Effective, independent market monitoring is essential to identifying market power problems and fixing them. But an effective market monitoring presence also requires close observation from inside the RTO. PJM's Market Monitoring Unit (MMU) works for and reports to PJM.

As more parties attempt to merge and contractually control more assets, monitoring market power will become more important. The market would be better served if the MMU were more independent of PJM, perhaps reporting directly to FERC and the board. The MMU must have both the ability to identify market flaws and the authority to make corrections in a timely manner, without being subjected to a committee process that could delay or avoid effective responses.

Next Steps

Since the mediation process, FERC has been working to incorporate state regulatory agencies into the development of the RTO. But as with other stakeholders, too many states are allowing parochial interests to interfere.

To keep the process moving, an independent search firm should review existing board members and potential new candidates to determine what would make for an effective RTO board which meets the criteria outlined above. FERC should then direct the new RTO Board to start the long process of creating a fully functional and effective RTO. The first task of the RTO board is to commission an implementation team and set out the overall direction.

Second, FERC should establish an inclusive stakeholder process that can effectively communicate to the board.

Finally, FERC should empower a Market Monitoring Unit that reports directly to the Commission as well as the board.

With these steps, the birds of a feather that PJM, NYISO, and NEISO really are could finally flock together.
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