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Regulatedandderegulatedelectricitymarkets

BRCBuyers’BootcampBasalt,CO–August9-11,2016

DeregulatedElectricityMarketsDeregulationcanhappenattwolevelsinU.S.deregulatedelectricitymarkets:

• Wholesale:Deregulationatthewholesalelevelmeansallelectricityproducedissoldinawholesalemarketbyindependentpowerproducers("IPPs").TheIPPsareindependentfromtheutilities.Thereiscompetitionatthewholesalelevel.

• Retail:Deregulationattheretaillevelmeansthatthelocalelectricityutilitydoesnothaveamonopolyoversellingelectricitytoretailcustomers(commercial,industrial,residential).Customersmaychoosebetweenseveralsuppliers.Thereiscompetitionattheretaillevel.

Differentstateshavegreaterorlesserlevelsofwholesalederegulationandofretailcompetition.Forexample,Texasismostlyderegulatedatthewholesalelevel(operatingunderthreedifferentwholesalemarkets—ERCOT,SPP,andMISO)buthasoneregionthatisregulated(thevicinityofElPaso).

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1.WholesaleThefirstaspectofderegulationconcernswhetherorganizationsotherthanelectricutilitiesmayownandoperategeneratingassetsandtradeelectricityatpricessetinamarket.Iftheelectricutility’smonopolyrightsdonotextendoverthegenerationandtradingofelectricity—meaningmanydifferentorganizationsmayownandoperategeneratingassets,competewitheachotheronprice,andtradeelectricity—thenthewholesaleelectricitymarketissaidtobederegulated.Thissection(i)identifiesthewholesalemarketsintheU.S.,(ii)explainshowwholesaleelectricitypricesaresetinthesemarkets,whichiscriticallyimportantforunderstandingdealeconomics,and(iii)brieflydescribestheimplicationsfordealstructures.WholesalemarketsintheU.S.Inderegulatedwholesalemarkets,anindependentorganizationcalledanindependentsystemoperator(“ISO”)orregionaltransmissionorganization(“RTO”)managesthemarket,includingschedulinggeneration,procuringancillaryservicessuchasfrequencyregulation,andensuringsufficientgeneratingcapacity.ThemapbelowshowstheterritoriesoftheISOsandRTOsintheU.S.andCanada.

Image:FederalEnergyRegulatoryCommission

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ThoseintheU.S.are:

• ISONewEngland(ISO-NE)• NewYorkISO(NYISO)• PJMInterconnection(PJM)• MidcontinentISO(MISO)• SouthwestPowerPool(SPP)• ElectricReliabilityCouncilofTexas(ERCOT)• CaliforniaISO(CAISO)

EachofthesewholesalemarketsisgovernednotonlyatthefederallevelbytheFederalEnergyRegulatoryCommission(FERC)butalsobytherulesoftherespectiveISO/RTO.Forthisreason,someoftherequirementsforgeneratingortradingelectricityvarymarketbymarket.PricinginwholesalemarketsInsideeachISO/RTO,themarketdeterminesthewholesalepriceofelectricity.Thatwholesalepricewillvarybybothtimeandlocation:

• Timecanimpactthewholesalepriceduetochangingelectricitysupplyordemand.Ontheonehand,greateraggregateloadduringcertainhoursofthedayequatestogreaterdemandforpower,therebyincreasingthemarket-clearingpriceofelectricity.Ontheotherhand,certainhoursofthedaymayhaveexcesssupply—e.g.,whenwindorsolargeneratemoreelectricitythanthereisdemand,orwhennuclearplantsproducemorethanisneededduringovernighthoursduetotechnicallimitationsintheirabilitytoreducepoweroutput—whichcreatesdownwardpressureonmarketprices.

• Locationcanimpactthewholesalepriceduetotransmissionconstraints.

Becausetransmissionlineshavelimitationsintheamountofpowertheycansafelytransportatagiventime,theycansufferfromcongestionwhensupplyordemandexceedsthoselimits.Congestedlinescancausewholesalemarketpricestofall(onthesideofthecongestionclosertothegeneratingassets)orrise(onthesideofthecongestionoppositefromthegeneratingassets)relativetothepriceonewouldexpectgivenoverallsupplyanddemandlevelsinthemarketasawhole.

Toreflecttheseeffectsoftimeandlocation,eachISO/RTOdividesitsterritoryintoregions(called“hubs”or“zones”),andfurtherdivideseachregioninto“nodes”inthetransmissiongrid.TheISO/RTO’smarketthendeterminesthewholesalepriceofelectricityforeachnodeateachpointintime(usuallyathourlyintervalsorgreater)basedonbidssubmittedbygeneratorsatthatnode,theloadatthatnode,andtransmissionconstraints.Thepriceofelectricityatanodeiscalledthatnode’s“locationmarginalprice”(“LMP”)or“nodalprice.”Thisisthepricethatagenerator

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willreceiveforelectricitysuppliedtothegridatthatnode.ISO/RTOsalsocalculatetheaveragepriceinthatregion(i.e.,theaverageLMPofthenodesinthehub/zone),andthesepricesarethebasisformostlong-termenergytrading.ImplicationsfordealstructuresCorporateoff-takerscansignphysicalorvirtualPPAsinmarketsderegulatedatthewholesalelevel.Formoredetails,seethepagesofthisprimerdealingwithphysicalPPAsandvirtualPPAs.Whenassessingdealeconomics,itisimportantforcorporateoff-takerstousetherelevantprice(e.g.,nodalpriceifthePPAissettledordeliveratanode,hubpriceotherwise).

2.RetailThesecondaspectofderegulationrelatestothelevelofretailcompetition.Ifacustomermaychooseanalternativeretailelectricitysupplier,bypassingthedefaultelectricutility,themarketissaidtobederegulatedandthecustomerissaidtohave“directaccess”toothersuppliers.Notethateveninthesecases,thetraditionalutilitycontinuestoownandoperatethetransmissionanddistributionassets(i.e.,thewires);thequestionisonlywhetherthecustomermayselecttheorganizationwithwhichitwillhavearetailrelationship(i.e.,supplyingtheelectricitythattravelsoverthosewirestothecustomer).RetailchoiceintheU.S.ThemapatrightshowstheU.S.statesthathavesomeformofelectricretailchoice(inlightblue).Notethatretailcompetitioninthesestatesisavailabletocustomersonlyinthoseregionswithwholesaleopenaccess(i.e.,areasmanagedbyISO/RTOsdepictedinthemapabove).

Image:EnergyInformationAdministration

ImplicationsfordealstructuresInmarketsderegulatedatboththewholesaleandretaillevels,corporateoff-takerscanleveragephysicalPPAstosupplytheirlocalloaddirectly.Formoredetails,seethepagesofthisprimerdealingwithphysicalPPAsandvirtualPPAs.

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RegulatedElectricityMarketsIncontrasttoderegulatedelectricitymarkets,regulatedmarketsarethoseinwhichthelocalutilityhasretainedmonopolypowerovertheentireelectricityvaluechain:generation,trading,transmissionanddistribution,andretail.Thisgenerallymeansthatonlythelocalutilitymayoperategeneratingassetssuchasconventionalpowerplantsorsolarorwindfarmsthatsupplypowertothegrid.Thelocalutilityisoftenallowedtodelegatetheownershipandoperationsofgenerationassetstoindependentpowerproducers.Inthiscases,however,theindependentpowerproducersdonotcompeteonpriceinawholesalemarketnorcantheyselltheirproductiontootherparties.IPPscanonlycontractwiththelocalutilityandreceivesapriceforthegeneratedelectricitybasedonanegotiatedagreementwiththelocalutility.Asaconsequence,inaregulatedmarket,itisnotpossibleforcorporateoff-takerstocontractdirectlywithindependentpowerproducerstosourcerenewableenergy.Anymeansofprocuringoff-siterenewableenergymustbenegotiatedwiththelocalutility.Formoredetailsondealstructuresforprocurementofoff-siterenewablesinregulatedmarkets,seetheotherdealstructuressectionofthisprimer.RegulatedmarketscanbemosteasilyidentifiedasthoseregionsoftheU.S.whereanindependentsystemoperatororregionaltransmissionorganizationdoesnotmanagewholesalemarkets(seetheprevioussectiononderegulatedelectricitymarkets).RegulatedmarketsaremostlyfoundintheU.S.WestandSoutheastregions.