Beware the Giga-NOPR

Issue 9 and Volume 106.

By Brian K. Schimmoller,
Managing Editor

The Federal Energy Regulatory Commission (FERC) filed its Standard Market Design (SMD) Notice of Proposed Rulemaking (NOPR) on July 31, 2002. While predominantly focused on transmission and open market issues, the SMD NOPR will have significant impacts on the power generation sector as well, particularly with respect to generation planning to meet resource adequacy requirements.

FERC strongly endorses a regional planning framework, exemplified most explicitly by its determined support of the RTO (regional transmission organization) as the fundamental building block of an efficient power market. The NOPR encourages market participants to take a long-term outlook to operation and planning, emphasizing the importance of bilateral contracts and investment in long lead-time generation and transmission projects. To head off concerns about runaway power prices, FERC supports the implementation of price caps, nominally in the $1,000/MWh range. Admittedly, such a cap likely won’t satisfy generation owners and developers without some sort of corresponding capacity payment provision. “The incentive to build peaking capacity in a market with a $1,000 cap likely will be too low unless a installed capacity payment mechanism is in effect,” says Jim Owen with the Edison Electric Institute. Still, although I believe the cap was accepted more out of political necessity stemming from the California crisis than from a fundamental analysis of market principles, the certainty provided by the cap will likely enable the majority of industry stakeholders – utilities, certain merchant developers, equipment manufacturers, corporate board members, consumers, and, notably, Wall Street – to sleep better at night.

Moreover, the shaky status of the energy trading market likely will diminish the chances of running up against this cap. “With the current demise of many trading shops, I don’t believe that exceptional volatility, and associated high prices, will occur often,” says Jeff Schroeter, principal with merchant developer Genova Power Company LP. “There just aren’t enough credit-worthy players left to bid the prices up.”

While price caps provide last resort protection under extreme conditions when supplies are short, price caps can distort signals, not just for demand response, but for stimulating new resource development as well. As a result, adequate infrastructure may not be developed unless a resource adequacy provision is in place (e.g., reserve margin, capacity margin).

Establishing the appropriate level of resource reserves will be left to Regional State Advisory Committees in each region, made up of state representatives that would have direct contact with the RTO governing boards. This coordinated oversight is intended to ensure “fulfillment of federal public interest responsibilities in a manner that includes the views of states throughout the region.” Although the NOPR recommends a reserve margin floor of 12 percent, FERC recognizes that regional differences may result in a wide range of reserve levels. While many regions could function effectively with reserve margins of 15-20 percent, regions such as the Western States Coordinating Council may need a higher margin since it is heavily dependent on hydropower, which may not be available year-round.

Hand-in-hand with establishing a resource reserve level is establishing a resource planning horizon. The planning horizon for each region is the number of years ahead that the independent transmission provider must forecast its area’s load, as well as the number of years ahead that load-serving entities must show they have adequate resources. The choice of the planning horizon is important because it affects the lead-time for construction of new facilities and the duration of forward contracts to satisfy a given resource adequacy requirement.

The language of the NOPR indicates that both the reserve margin and the planning horizon selected for a given area will depend on the makeup of generation sources already in the region. To an extent, this is true. I believe, however, that the cause and effect relationship will actually be reversed. The reserve margin and planning horizon selected for a given area will dictate the types of generation assets that will be developed in a given area, not the other way around. In regions that select shorter planning horizons, gas will remain the technology of choice; in regions that select longer planning horizons, coal and nuclear generation and new transmission lines will stand a better chance.

This could make for some interesting bedfellows. Generation developers, for example, may ally with the environmental community to prevent major linear transmission corridor projects, says Schroeter. Far fewer people are disturbed by a 100-acre power plant than a 50-mile transmission line.

In other words, and not unsurprisingly, the Regional State Advisory Committees, and the RTOs of course, will wield a lot of clout in the new energy marketplace envisioned by FERC, at least with respect to the generation sector. A justified approach in my opinion, but I can hear the lobbyists coming now.

Nonetheless, FERC’s commitment to regional and long-term planning is attractive since it will provide some certainty to an uncertain market. The boom and bust swings in project development and capital investment we’ve seen the past few years will likely moderate and once again enable rational business planning beyond the month-to-month survival planning being practiced by many companies today.

As you read this, the NOPR’s 75-day comment period is drawing to a close – and with it, your opportunity to impact the shape of the still-evolving electricity marketplace. A rash of events – particularly the accounting and energy trading scandals – probably forced FERC to act sooner than it may have liked, but FERC is to be commended for proposing a more solid framework within which deregulation and open markets can coexist with public accountability and system reliability.

Simply based on the number of places in which FERC requests comment, the SMD NOPR will undergo significant modification prior to final approval – to say nothing of the formidable opposition already forming, particularly out West. And as noted by EEI’s Owen, “since the SMD NOPR represents such a sea change in the management of the power industry, we have nothing to judge it against.” So buyer beware and stakeholder stay tuned.