| Efficient Organization of the Transmission System |  The institutions necessary for full and open competition to operate in the electricity industry will not magically appear. Some reorganization guided by government may efficiently speed the process. The most critical part of the system in this regard is transmission. Transmission was always the one element of the electric utility industry that bore the greatest resemblance to natural monopoly. Transmission facilities exhibit declining average cost in the sense that, for most routes, a larger set of transmission lines is more effective in moving power than duplicate sets of smaller wires. In this sense, it will not be necessary for existing public utilities or new generators to string additional transmission lines to open the market for electricity. In general, there is sufficient carrying capacity in the current transmission network to handle the existing load and the 13-42 percent increase that we envision will result from competition and lower prices. Transmission reliability is essential to system reliability and NERC is the overseer. While there are issues here that require further study, indications are that the existing system is capable.note 1 In general, there is sufficient carrying capacity in the current transmission network to handle the existing load, and the increase that we envision will result from competition and lower prices. The question is how will the existing transmission facilities be allocated in a competitive environment? Examine Figure 9. A number of generators exist to sell power to a large number of heterogeneous consumers. The producers can have multiple generators, but this is not required. Producers contract with consumers to supply electricity on demand. The nature of this contract requires elaboration and we discuss this in detail below. However, the important feature for purposes here is that there is a one-to-one connection between the buyer and the seller. This means that the seller must supply at every moment whatever power is used by the consumer. The consumer is free to buy from multiple sellers, and the seller is free to sell power to multiple consumers. These transactions will occur between power producers and large individual users (industrial and commercial buyers) and power marketers and aggregators. However, we also envision a system that can accommodate power producers negotiating directly with individual households. There is no reason, in principle, that households in Florida cannot buy power directly from a power producer in South Carolina or even Indiana. Unlike telecommunications signals, electricity is not directionally oriented. Electrons do not have header messages on them like communication signals, which are directed from point A to point B. Instead of being addressed, electricity goes where the impedance is lowest. Thus, while there appears to be a one-to-one, quid pro quo relation between a buyer and seller mapped out by a transmission line in the middle, a better description of the process is that there is a common pool of power in the middle of multiple buyers and sellers. In order to ensure that the maximum benefits of competition are enjoyed in production and distribution of electricity, the organization of the management of the transmission system is crucial. Under the current system, the owner/operator of the transmission line stands as a classical monopolist between transacting producers and consumers. If a buyer in New York wants to purchase power from South Carolina, the owner of the transmission line in-between has to be paid. This is true in spite of the fact that the electricity produced in South Carolina and consumed in New York may not actually go over the transmission line in the direct path. The electricity produced in South Carolina does not necessarily take the shortest path to New York. The transmission system is like a pool of power with producers pouring power in and users draining it out. In the pool analogy, the proper organizational structure is one of controlled access. In this framework, the owners/operators of transmission lines would be required, for fees, to give access to all buyers and sellers who meet standards. The transmission system across various regions would be treated as a whole. Transmission facilities in the region would be paid based on the total load produced and consumed in the region as opposed to the mapping of transactions between specific buyers and sellers. In other words, we can imagine that producers in South Carolina negotiate to sell to buyers in Indiana, producers in Indiana sell to users in Virginia, and producers in Virginia sell to consumers in South Carolina. All of these transactions are negotiated without regard to the distance between buyers and sellers. This is efficient because, when all is said and done, distance is unimportant. The producers are putting power onto the grid based on their contracts with consumers to take power off the grid. The power consumed in Indiana is produced in Indiana; so too, for South Carolina and Virginia. The random and more-or-less uniform distribution of buyers and sellers of power across the grid means that the net distance traveled by electricity across the grid is much less than the gross contracted flow. South Carolina buyers negotiate with Virginia producers making it appear that power will flow from Virginia to South Carolina. However, because of the round robin nature of the many competitive contracts, the actual distance traveled by electricity in the system is minimal. With a large integrated electricity grid, it is inappropriate to think of power actually flowing between contracting buyers and sellers. It is more appropriate to think of each seller putting power onto the grid in proportion to the amount it has sold to its contracted buyers, no matter where those buyers are. Some coordination of the grid is necessary to adjust for periodic imbalances in one direction or another, and there are some line losses overall. However, it is inefficient to impose transactions costs on the system as if all of the contracted power did flow the full length from each and every buyer to each and every seller. In the deregulation of telephony, multiple long-distance carriers were ultimately given open access to the local telephone loop so that each could compete with the others on something like a level field. The maximum gains to competition in electricity will only accrue if producers have open access to the power transmission and distribution grid. Efficient Organization of the Transmission System Most observers see the transmission system continuing to be regulated in some form or another although this is arguable. One approach is for transmission facilities to be separated from generation facilities and transmission to continue to face rate regulation. In this world transmission operators would continue to operate under rate-regulation. They would be paid based on their historical costs times an allowed rate of return. An obvious improvement on this would be to compensate them on the basis of true economic, replacement cost. Most importantly, if regulation proceeds down this path of transmission price regulation, it should evolve to incentive compatible forms. There are a number of ways to achieve incentive compatible regulation. The one that economists have studied the most is franchise bidding which replaces rate regulation with competition for the field. In this structure, various firms bid to operate the transmission system, and the lowest price bidder wins. This system, properly arranged, can emulate the effects of competition even with just one supplier in the end. An alternative approach is for an independent system operator to be created for each unified electricity grid region. The idea is that this agency is franchised out by a competitive-bid based process. In other words, the operation of the grid in a region is contracted to a firm much like canteen services are awarded in an office complex. The electricity grid operator will bid on the terms of transmission price. The lowest qualified price wins the contract. The system operator contracts with transmission facility owners for the use of their lines and equipment. Regardless of which system is adopted, there are some considerations that are important in designing the perfect pricing structure for the use of the transmission facilities. Except during peak load periods, the transmission system has no opportunity cost, and hence the efficient marginal price is zero. Consequently, the appropriate form for payment is access fees. These fees will be tied to generation capacity and consumer line size. Larger generators and bigger consumer lines at the point of connection will be associated with higher access fees. The access fees will be designed to recover the fixed costs of installation and the continuing costs of maintenance and operation. In addition to the access fees, time-of-day pricing can be used to allocate line use when the system approaches capacity. Again, buyers and sellers will negotiate contracts with each other in order to determine the appropriate action to take when a peak-load price is applied to the fixed, access charge. Whenever transmissions are less than available power, the time-of-day fee is zero. The system is free to be used by any generator or consumer. As demand, and hence transmission, increases towards capacity, the time-of-day price advances from zero and goes to whatever level it takes to keep the transmission line open. System capacity is maintained. It is not necessary for both generators and consumers to "see" this time-of-day increment. Either one is sufficient. For instance, suppose that the generator is required to pay the time-of-day fee, the generator can contract with its customers to reduce load, to pay the fee, or to shift to other producers. These contractual features will surely vary among buyers and sellers who use electricity for many different purposes. Leaving each to its own designs is the safest way to insure efficiency in contracting. Presumably the generator is in superior position to manage the peak-loading problem and to decrease demand, either by shut-off or higher prices. For instance, some customers may desire uninterruptable service irrespective of price for certain uses. These might include commercial customers using electricity for security and lighting. At the same time, these same customers may not care if their water heater is operable for any given 15 minute interval and may contract for service interruption in lieu of higher spot prices. The buyer and the seller are informational insiders to the spot value of electricity, and we presume to let them contract for their own desires and needs without undue burden. The operation of the long-distance telephone market may provide some insights about the operation of the transmission system in a competitive electricity market. Currently there are basically four complete fiber optics long-distance networks: AT&T, Sprint, MCI, and a consortium of regional carriers. There is abundant excess capacity in this system. In fact, the smallest, Sprint, has capacity to carry all the current long-distance calls. However, at some peak periods, and over some portions of the network, some callers can get blocked. A busy signal ensues. The system is temporarily unable to carry their call. The long-distance telephony market has responded in a variety of ways to this situation. First, repackagers have appeared. These firms buy chunks of time from the four major carriers and resell it in increments to consumers. At present, there are hundreds of repackagers, and they offer a broad spectrum of alternatives to their customers. One of the ways that packages differ is based on combinations of prices and probability of blocking. For instance, a buyer can select relatively high priced connect time coupled with a very low chance of receiving a system-busy signal. At the other end, the buyer can accept a high probability of blocking, as high as 50 percent, in exchange for a very low price when connected. Prices allocate the temporary long-jam in the telephony system. Already, power marketers and aggregators have begun to appear in the electricity market to play a role similar to the repackagers of the telephone industry. We expect them to offer variety to their customers, free to choose among the alternatives as it suits their particular demands for power. The question of system reliability is critical in this adjustment. Currently, producers in the nine NERC regions use a variety of system control devices to shift load and power from one firm to another to meet temporary ups and downs in demand. Similar controls will be required under competition. And while there may be additional generators which will have to be incorporated into the network at some point, the most likely scenario is that these new generators will be smaller in capacity than the current average. This reduces the risk of any one unit failing and, by itself, raises system reliability. Put another way, a system of multiple small producers is more inherently reliable, ceteris paribus, than the same system with fewer but larger producers. The main point here is that reliability does not have to be an issue in the move to retail competition. The relations between buyers and sellers can be organized to create responsibility for demand fluctuations that can be as easily managed as the current variabilities. Moreover, decreasing average size of generating capacity, to the extent that it happens in the future, will further relax the reliability margins required for system safety. We close by noting that there is a clear and present danger in unleashing too much administrative authority in the move to competition. If the Federal Energy Regulatory Commission were to be made more powerful without ample checks and balances, the resulting regulations could actually make the industry and its consumers worse. We absolutely are not calling for a remake of an ICC, CAB, or similar structure in FERC. There is growing concern that deregulation in telecommunications may have vested too much authority in a single agency, the FCC. Rules, regulations, and decisions are for the most part best left to disperse regulators at the state legislative and public utility commission level. Note:
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