Can FERC's Standard Market Design Work in Large RTOs?
1 July 2002
By Hamish Fraser
In this article for the Electricity Journal, NERA Special Consultant Hamish Fraser discusses FERC's two major initiatives in the electricity industry: Standard Market Design (SMD), which includes Locational Marginal Pricing (LMP); and consolidation of Regional Transmission Organizations (RTOs). Fraser cautions that SMD in combination with large RTOs can cause serious new inefficiencies unless corrective actions are taken.
LMP, SMD and the formation of large RTOs involve a fundamental change in the way that transmission is priced in much of the United States, and in turn, in the way the system is used and in how new generation investment decisions will be made. However, the nature of transmission investment planning suggests that the short-run marginal cost of transmission will continue to be systematically lower than the long-run marginal cost of transmission under SMD. This could cause considerable inefficiencies since LMP only charges short-run redispatch costs for transmission usage. Other (long-run) costs caused by generator location decisions are not passed on directly.
As a consequence, market participants could have incentives to locate in the wrong areas. Generators could build in the states where the fuel is sourced, knowing they will not be charged the extra long-run cost of the transmission investment necessary to accommodate them and to get their electricity to the load center states. Rather, this cost could be averaged over the whole industry. Total costs would increase, and by not aligning the cause of increased cost with responsibility for bearing the increased cost, bad investment decisions could be encouraged because they will be subsidized by the industry as a whole.
Mr. Fraser discusses potential solutions and questions at what point RTOS become too big.
