PR01: 255
FOR IMMEDIATE RELEASE
May 29, 2001
ECONOMISTS EXPRESS "DEEP CONCERN" OVER
FAILURE OF FEDERAL GOVERNMENT TO TEMPER WHOLESALE ELECTRICITY PRICES
LOS ANGELES - Governor Gray Davis today released a letter from
ten top economists who have expressed "deep concern over the failure of
the Federal Energy Regulatory Commission (FERC) to act effectively to enforce
the provisions of the Federal Power Act that require it to set just and reasonable
wholesale prices for electricity in California." The economists warn that "FERC's
failure to act now will have dire consequences for the State of California."
"This letter is a very
significant validation of what we've been saying," Governor Davis said. "The
marketplace is not working and FERC has an obligation to act. We're not
pleading for relief, we're entitled to it."
The following is the complete
text of the economists' letter:
May 25, 2001
The Honorable George W. Bush
The President
The White House
Washington, D.C. 20500
The Honorable J. Dennis Hastert
The Speaker of the House of Representatives
Washington, D.C. 20515
-more-
Economist Letter 222
The Honorable Trent Lott
Majority Leader
United States Senate
Washington, D.C. 20510
Dear Mr. President, Mr. Speaker, and Mr. Leader:
We write to express our deep concern about the failure of the Federal
Energy Regulatory
Commission (FERC) to act effectively to enforce the provisions of the
Federal Power Act that require it to set just and reasonable wholesale prices
for electricity in California. Under the terms of the Act, FERC is required to
ensure that wholesale electricity prices are just and reasonable.
FERC historically met this responsibility by approving
wholesale prices that were no higher than the total costs suppliers incur to
produce electricity. More recently, FERC has given suppliers "market-based
pricing authority" in situations where it was able to conclude that
market-based pricing would lead to better outcomes than continued cost-based
regulation. FERC retains the responsibility to ensure that wholesale prices are
just and reasonable when a state decides to rely on a competitive wholesale
electricity market to provide for its citizens' electricity needs. In
particular, once FERC has granted suppliers market-based pricing authority it
has an ongoing responsibility to ensure that these prices reflect the outcomes
of well-functioning competitive markets. If well-functioning competitive
markets do not exist and, as a consequence, the resulting prices are not just
and reasonable, then FERC should act either to remedy the market failures or to
return to cost-based regulation.
In its November 1, 2000 preliminary order and December 15, 2000 final
order, FERC stated that wholesale electricity prices in California were unjust
and unreasonable. The actions taken by FERC in its December 15, 2000 final
order have not remedied the problems. Moreover, as forecast by many parties
commenting on the November 1, 2000 preliminary order, these actions resulted in
significantly higher wholesale prices and contributed to further degradation of
system reliability in California. Our review of FERC's most recent proposals
for remedies leads us to conclude that they will be ineffective and unlikely
either to enhance system reliability or reduce prices during the summers of
2001 and 2002.
Well-designed competitive wholesale electricity markets can provide
long-term benefits to consumers. For sixty years FERC implemented its obligations
to set just and reasonable rates under the Federal Power Act by regulating
wholesale market prices. During the 1990s, based
on the belief that if appropriate criteria were met "market - based
rates" could produce lower prices and a more efficient electric power
system, FERC changed its policy. It began to allow
suppliers to sell wholesale electricity at market - based rates but,
consistent with FERC's continuing responsibilities under the Federal Power Act,
only if the suppliers could demonstrate
-more-
Economist Letter 333
that the resulting prices would be just and reasonable. Generally, FERC
allowed suppliers to sell at market-based rates if they met a set of specific
criteria, including a demonstration that the relevant markets would be
characterized by effective competition.
All generators and marketers selling power into California were granted
the ability to receive market-based rates rather than cost - of - service rates
because they were able to demonstrate to FERC that their participation in the
California market would result in market prices reflecting the interplay of
supply and demand in well-functioning competitive markets. These showings were
based on a variety of market-structure screens adopted by FERC before
California's wholesale electricity markets went into operation. Numerous
subsequent studies based on actual market behavior and performance
have identified a number of serious problems of market design, supplier
behavior, and market performance that were not anticipated or considered in
FERC's initial market - structure screens. There are numerous flaws in
California's wholesale electricity markets, and their consequences have been
significantly exacerbated by the tight supply situation in the Western U.S. We
cannot expect a market to operate to benefit consumers or for the resulting
wholesale prices to satisfy the requirements of the Federal Power Act if
effective competition does not exist.
We strongly advocate that FERC be directed to fulfill its
responsibilities and take the actions necessary to alleviate the
market-performance problems that have led to unreasonable prices. We are
mindful of the potential dangers of applying a simple price cap, the maximum
price that all sellers can receive, to a truly competitive market where the
interplay of supply and demand happens to yield prices higher than some might
like. But California's electricity markets are not characterized by effective
competition. In this case, cost-of-service prices are an obvious remedy that
satisfies the just and reasonable rate standard. In addition, various parties
have submitted proposals to FERC for temporary market interventions that would
ensure just and reasonable wholesale electricity prices in California until
many of the new power plants currently under construction in California are
completed. These proposals do not require price caps on the spot market and
thus avoid the problems caused by a simple price cap. However, all of these
proposals require FERC to implement market-rule changes that guarantee
wholesale prices in California are just and reasonable by setting selling
prices for a significant fraction or for all of the output sold by generators
and marketers serving California. These proposals have also been very sensitive
to ensuring that prices will not be constrained to levels below the costs of
new entrants or levels that will discourage sales from existing facilities into
California over the next two years.
The events in California during the last year have done serious damage
to the evolution of competitive wholesale and retail electricity markets in
many parts of the country where
electricity industry restructuring and competition have not progressed
very far. Several states that had planned to introduce reforms soon are now
delaying them. Others will not consider further reforms until FERC demonstrates
its ability to identify and its readiness to remedy quickly and effectively
serious wholesale market-performance problems.
-more-
Economist Letter 444
Creating a well-functioning electricity
market in California as soon as possible is the best way to ensure that
competition in wholesale electricity will spread throughout the US and provide
the greatest possible benefits to consumers.
Designing a well-performing competitive electricity market is an
extremely complex evolutionary process. The public must have confidence that
the federal government will work cooperatively with the states to establish
appropriate restructuring, market-design, and market - monitoring programs so
that when market-performance problems emerge FERC will act quickly and
effectively to mitigate them. The Federal Power Act gives FERC both the
responsibility and the tools to act when wholesale markets produce unjust and
unreasonable rates for sustained periods of time. FERC's failure to act now
will have dire consequences for the State of California and will setback,
potentially fatally, the diffusion of competitive electricity markets across
the country. Moreover, this negative experience with electricity re-structuring
could delay or reverse current efforts to introduction competition into other
formerly regulated industries.
Sincerely,
Roger Bohn
Associate Professor of Management
Graduate School of International Relations and Pacific Studies
University of
California - San Diego
(Former Member, California Power Exchange Market Monitoring Committee)
Peter Cramton
Professor of
Economics
University of
Maryland
(Member, California
Power Exchange Blue Ribbon Panel)
Severin Borenstein
E.T. Grether Professor of Business Administration and Public Policy
Haas School of Business
University of California
Director, UC Energy Institute
(Member, Board of Governors of California Power Exchange)
Alfred Kahn
Robert Julius Thorne
Professor of Political Economy, Emeritus
Cornell University
(Chair, California
Power Exchange Blue Ribbon Panel)
-more-
Economist Letter 555
Paul Joskow
Elizabeth and James
Killian Professor of Economics
Massachusetts Institute of Technology
Director, MIT Center for Energy and Environmental and Policy Research
James Bushnell
Director of Research
University of California Energy Institute
(Former Chair and Member,
California Power Exchange Market Monitoring
Committee)
Alvin K. Klevorick
John Thomas Smith Professor of Law
Professor of Economics
Yale University
(Former Chair,
California Power Exchange Market Monitoring Committee)
Robert Porter
William R. Kenan, Jr. Professor of Economics
Northwestern
University
(Member, California Power Exchange Blue Ribbon Panel)
Frank Wolak
Professor of
Economics
Stanford University (Chairman, Market Surveillance Committee of the
California Independent System Operator)
Carl Shapiro
Transamerica Professor of Business Strategy
Haas School of Business
University of California
(Former Member, Market Surveillance
Committee of the California Independent System Operator)
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