Electricity Sector Liberalization in the U.S. and MISO's Effort

NOT for quotation

Date June 27, 2012
Speaker John R. BEAR(President & CEO, Midwest Independent Transmission System Operator, Inc. (MISO))
Moderator MITA Noriyuki(Director, Policy Planning Division, Electricity and Gas Industry Department, Agency for Natural Resources and Energy, METI)
Materials

Summary

*As per the author's request, this transcript is not for quotation.

John R. BEAR's PhotoJohn R. BEAR

The Midwest Independent Transmission System Operator, Inc. (MISO) is an independent, non-profit organization which operates the electric transmission system and energy markets in the central United States. Although MISO is a non-profit organization, it is not designed as a charitable organization. Rather, it is a mutually-owned exchange, which means that it is an entity owned by a membership comprised of specific regions of the United States. This membership is largely comprised of vertically-owned utilities, similar to the situation in Japan. There are many utilities which own generation, transmission, and distribution. These utilities turn their transmission assets over to MISO, which then functionally operates the transmission system on behalf of the asset owners.

Part of the process involved in operating physical transmission systems involves providing them with independent access. It was discovered in the past that if competition creation was attempted between vertically-integrated utilities, their own operation of their independent transmission systems is able to block the competition. MISO provides independent access to the transmission system. Therefore, independent utilities maintain and own their own transmission lines, while MISO operates those lines and controls the amount of power scheduled onto them.

MISO also commits to and dispatches the generation as the market operator, thereby monitoring the transmission system on a minute-by-minute basis, and running a merit-ordered dispatch of generators while taking into account the status of the transmission system at any given moment. Therefore, if there is a constraint in the transmission system, MISO reflects this in the dispatch, which allows for very efficient use of assets.

Another function is system planning. Whereas in the past there were 28 entities in the MISO region, each with its own system planning, now there is just one transmission plan for the entire region, which is operated by MISO. The benefit of this regional operation system is that, again, it promotes more efficiency than that of having several independent systems.

MISO also plays an important role in policy development. It provides independent data and analysis to policy makers. This information helps them understand the various implications of potential changes in policy. Examples of policy themes include those of renewable portfolio standards, requirements of MISO's transmission system, and environmental implications of the current systems. Policy development operates on an efficient, regional basis.

The MISO system operates on a very large scale. It comprises approximately 65,000 miles of high voltage transmission lines, an installed generation capacity of around 155,000 megawatts (MW), 1,300 installed generation units, and peak system demand of about 130,000 gigawatts (GW). Therefore, it is an organization of great influence and importance.

One of the main benefits which MISO and other regional transmission organizations (RTOs) have brought about is the enabling of robust wholesale competition, providing great value to end-use consumers. In the United States, gaining a consensus on RTO policies allowed for several beneficial changes in enabling wholesale competition. The removal of transmission barriers allowed for independent operators to provide equal access to operating systems, thus promoting competition. Processes, systems, and incentives were also put in place, which allowed many types of competitors such as independent power producers, marketers, and financial organizations to participate equally. Providing data and information transparency has also helped to bring about wholesale competition. Furthermore, MISO provides an online pricing system, and the frequent pricing changes give policy makers a great deal of information on where investment is required. This allows for the optimization of operating systems at the lowest possible cost to end users. This is highlighted by the fact that, on an annual basis, MISO costs its membership approximately $250 million to operate, and creates $2.2 billion to $2.7 billion in value.

The history of the U.S. electric industry has mostly been dominated by large vertically-integrated utility companies. During the start-up era of the 1880s, there were approximately seven million customers, accounting for total revenue of $500 million. Those figures increased through the golden era, and due to nuclear expansion in the 1960s, the customer base was approximately 58 million, with total revenue of $10.6 billion. During the golden era, as investments were made and systems were integrated, the costs were reduced, which benefited the customers. However, during the nuclear expansion era, the expense of building nuclear power plants led to rising costs. This in turn caused U.S. policy makers to start considering the best method for reducing costs and creating competition within the system.

The early history of the U.S. electric industry was one of rapid growth driven by technical advances, falling prices, and growing demand. From an industry structure standpoint, the U.S. electric industry has been largely vertically integrated over the course of time. Demand growth was rapid during the start-up era due to the country growing and increasingly more people gaining access to electricity. During the golden era, growth was steady, at a high 7% per year. This slowed during the nuclear expansion era, when costs increased and demand decreased. As a result, federal policy makers prompted interstate sales, with their focus still on retail rate-setting.

In more recent history, there has been a focus on increasing competition in the industry by encouraging new generation while removing competitive barriers. During the 1980s, the industry structure was still largely vertically integrated, though due to the efforts of policy makers, new generators were starting to emerge. In the 1990s, the industry structure started to become increasingly modular. With regard to federal regulatory focus, in the 1980s, many companies started to build generators to compete with vertically-integrated utilities, though it was noticed that the lack of even transmission access was preventing competition. Therefore, independent system operators were created with the sole role of providing independent access to transmission systems in the 1990s. Focus was also shifted to that of providing incentives to get new generators online. Other recent changes in the 1990s include the increasing significance of renewable portfolio standards and retail deregulation.

The current industry structure is more accommodating of diverse business structures, with competition across multiple segments. Although the vertically-integrated model is still predominant in the United States, other models also exist at the same time. There are now independent power producers, which account for approximately 30% of generation in the Midwest and can compete on equal grounds with investor-owned utilities. There are also renewable power producers, exempt wholesale generators, and qualified facilities. Furthermore, there are several different transmission structures now in place, which include vertically-integrated utilities, wire companies, and independent transmission companies.

There were several key events which brought about recent changes in the industry structure. Federal Energy Regulatory Commission (FERC) Orders 888 and 889 led to the opening up of transmission access. Order 888 states that utilities are required to file open access, non-discriminatory transmission tariffs, functionally unbundle their generation and power marketing functions, and provide unbundled ancillary transmission services. Order 889 established the Open Access Same Time Information System to reserve transmission service, provide all current and potential users with the same access as the actual transmission owner, and establish standards of conduct to separate the transmission and wholesale power merchant functions. One example of this is that walls were established in vertically-owned utilities in order to prevent the provision of potentially damaging information between generation, transmission, and distribution divisions of the same entity.

Such policies led to independent system operators being established to manage transmission and generation units divested by vertically-integrated utilities. There was also a notable increase in power marketers and independent generators, the development of retail competition in several states, and lower costs for large industrial customers, which was beneficial to economic development.

The FERC Order 2000 created RTOs designed to increase wholesale competition. Its purpose was to eliminate continuing opportunities for transmission discrimination and reduce engineering and economic inefficiencies. Bulk power system reliability, difficulties in computing transmission capacity, regional coordination of transmission congestion, and pancaked transmission rates are all examples of factors considered with regard to reducing inefficiencies. RTOs were also given required characteristics. Minimum functions included transmission tariff administration, transmission system congestion management, transmission access administration, market monitoring to ensure fair competition, transmission planning and expansion, and coordination between regions. There are currently seven entities in North America which coordinate and have agreements on the buying and selling of power across the borders.

The two largest energy markets in the United States are MISO and PJM, which outweigh others by a factor of five. The MISO footprint and business model allow for widespread participation in industry, stretching from Canada to the state of Louisiana. There are often times when the weather is cold in the northern part of MISO's system and warm in the southern part. With MISO covering such a wide area, it allows for the transfer of energy to different regions when required. Therefore, reserve margins of 18% to 20% are not necessary, and instead that of around 12% is sufficient. This wide coverage also supports a host of different market participants, such as 37 vertically-integrated transmission owners, two independent transmission companies, 49 power marketers, over 80 independent power producers, and over 30 transmission dependent municipals. In terms of industry stakeholders, MISO has 16 state regulatory agencies, 12 consumer advocates, and eight environmental groups.

The MISO 2011 value proposition shows the financial benefits brought about by MISO under different headings. About $382 million to $572 million is brought about due to improved reliability. $426 million to $470 million comes from more efficient use of existing assets such as the dispatch of energy, regulation, spinning reserves, and wind integration. Furthermore, $1,590 million to $1,914 million stems from the reduced need for additional assets brought about by footprint diversity, generator availability improvement, and demand response. In other words, the greatest benefit comes from dispatching the region as one portfolio since there is less need for assets. The transmission system can be used to its limit, and generation facilities can be used much more efficiently. This causes a 3% reduction in production costs, which equates to about $248 million in savings.

RTOs have produced a number of benefits for generation and other resources in the United States. One of those is that regardless of ownership or generation method, there is a possibility of competing on a level playing field. RTOs have also encouraged the adoption of emerging technologies, such as flywheels, and the use of renewable generation methods, such as wind, solar, and biomass—none of which would have been possible without RTOs. Providing price signals has also brought about a demand in side resources. All stakeholders also have full access to pricing information. This allows for those making investments to see price differentials across the system in real-time and also in the operating reserves and regulations.

One issue yet to be resolved fully is that RTOs have still not found a proven market solution to incentivize generation and resource investment. How to price capacity is still a major issue of contention in the United States. It is difficult to finance an expensive asset with a 40-year life on a short term basis. PJM advocates a centrally procured capacity market model, whereas MISO backs a resource adequacy market model. The PJM market runs an auction to procure generation and resources on behalf of the load in its area, which is set one to three years in advance. This has worked well to incentivize demand resources, but it has not been proven to do so with new generation construction, especially with base load resources. MISO approaches the regional entities which serve the customers and asks them to provide a plan on an annual basis. Those entities have to prove what capacity they are contracted to serve plus their reserve margin. This, in turn, forces investment as contracts are a requirement and act as an incentive.

Transmission users have seen significant benefits from RTOs. The elimination of duplicative transmission charges led to one rate for electricity across the entire region. Creating equal access to the transmission system and transparency allowed for the ability to see the status of the transmission system at any time and access it on an equal basis, therefore making the required transmission reservations. Market-based congestion management using a merit-ordered dispatch system allowed for prices to be viewed in real time every five minutes. A consistent calculation of available transmission capacity eliminated uncertainty when moving across the region. Most importantly, centrally coordinated transmission planning from the bottom up will continue to help improve reliability, whereas from the top down, economic benefits will continue to rise from RTOs working in concert with stakeholders.

Finally, the U.S. nuclear energy industry has benefited from a strong industry safety organization that is independent from but complimentary to federal regulatory and enforcement efforts. In principle, the whole energy industry is equal to the worst nuclear operator in the country, as reported in the press, and this is on what policy makers focus. The goal was to raise the performance of the nuclear energy industry across the United States. This was achieved by having strong senior leadership from nuclear owners and organizations involved, and by industry participants being transparent in sharing their best practices as well as their problems and issues. Peer plant evaluations including operations, processes, personnel, systems and equipment, training and accreditation of operations, and information exchange are examples of useful activities in relation to this. Over a 10 to 12 year period, this transparency and cooperation have led to significant improvements in plant performance.

Questions and Answers

Q1: Regarding the enhancement of transmission facilities, as time goes by, they age. It seems that it is rare to actually be able to provide such enhancement because of the difficulties involved in having a total perspective of economic optimization. What are your comments on this? And if this is the case in your region, what would be a good countermeasure?

John R. BEAR
MISO tries to take the stance that it is responsible for providing both the reliable delivery of energy and competition. With regard to the transmission system and its planning, we especially focus on the distribution of energy throughout each region, local reliability issues and maintenance, and on an economic basis. Those three factors allow for a system which is upgraded, reliable, and economically efficient.

Q2: You stated that participation in MISO is voluntary, and it can be seen from the map of RTOs in the United States that some states choose not to cooperate with it. What is their motivation, and what options are available for them?

John R. BEAR
The map to which you refer can be misleading. Entities which are not members of MISO but fall in the general MISO zone still have transmission access provided to them by it. However, they are just not participants in the market. Those entities use their own operating systems and generators, which they match to their own loads. MISO still provides transmission access and operates their systems by federal mandate. There are several reasons as to why states would wish to cooperate with MISO. For example, a small utility carries its own reserves and manages its own risk. This is very expensive, though some wish to do this for the sake of being independent. Over time, we have seen that such entities are joining the market as the expense of being independent is too great, and they wish to join a broader portfolio where they can enjoy benefits, such as a greater reserve at a cheaper cost.

TANI Midori
Those states which do not cooperate with MISO might consider that they still have access to a large grid, thus they would be able to buy power from other entities not by participating in the market but through bilateral contracts.

John R. BEAR
In order to access the market, a fee must be paid. As a member of MISO, there is one transmission across the board. In other words, it can be very expensive to access certain areas of the board at a specific moment in time independent of MISO. Also, MISO's coverage is expected to grow and cover other states shortly. The real value in an RTO is when you take several small utilities and combine them into a large efficient one. This is why MISO has grown in the Midwest.

Q3: Could you please elaborate on what kind of competition MISO is confronting from outside of its area, and what is its strategy for dealing with this?

John R. BEAR
Yes, there is a sense of competition from outside of the MISO region. For example, there is a company called Entergy, which is a 30,000 MW utility. Entergy wanted to join an RTO, and this created competition between several RTOs, including MISO.

Q4: I would like to ask about the relationship between the members of MISO which have assets with it and other RTOs. It is presumed that in order to have optimal operations, MISO must have authority over its members and their assets. Is this empowered by law or is it some kind of order?

John R. BEAR
The government structure of an RTO is very important. With regard to the market participants of MISO, there is a stakeholder process whereby, when important decisions are being made, all participants are heard. Seven independent board members are brought in from the outside, and MISO reports to the FERC. Asset holders are heard, and then the best decision is made for the market and the end users. No one stakeholder has more influence than another. It is very important for RTOs to make independent decisions that serve the end users and not to be influenced overly by any one stakeholder.

Q5: From a national policy level, would having one RTO for the whole of the United States create more efficiency? And is there any consideration on the federal level being given to merging current RTOs?

John R. BEAR
Yes, it would be cheaper and more efficient to merge. However, there are significant regional differences, and a balance needs to be struck between the states and those on a federal level. At present, regional differences are allowed, and each market is designed differently. This is due to the way that utilities in each region developed. From a technological standpoint, it will soon be possible to operate only three RTOs across the United States, however, in practice, the processes involved would be extremely complex and problematic.

Q6: It is my understanding that the U.S. government is trying to push for the development of the renewable energy sector. If the consumers and users wanted to push for renewable-based energy development, is there any way that MISO can accommodate this?

John R. BEAR
One thing that MISO does is provide transparent analysis and data to policy makers. We have done many studies on the economics of renewable portfolios. Policy makers base their decisions on economic development and provide jobs, and it is likely that whereas consumers would like to make use of renewable energy, they would not like to pay more to use it.

TANI Midori
It seems that introducing more competition into the market might reduce costs for large-scale consumers but put a greater burden on small-scale consumers. Is there such a view in the United States?

John R. BEAR
This view exists in the United States, so analysis was provided in order for policy makers to test this assertion. It was found that, on a marginal cost basis, large users have more buying power and therefore enjoy better rates. Policy makers tend to consider this as a positive factor since it supports economic development. Small-scale users also enjoy trickle-down benefits, such as not having to buy unneeded risk management, which reduced costs for them as well. Therefore, both large- and small-scale users have benefitted from increased competition.

Q7: You mentioned a 10% peak cut in reducing energy consumption. There are currently many discussions in Japan about demand response. Is such value achieved by direct control or indirect response?

John R. BEAR
The answer is both. The demand response portfolio is about 12.5 GW, of which six is direct control and the rest is price responsive demand. Local distribution utilities use direct control when required, whereas suppliers will make bids in other situations.

Q8: Is there a clear difference in the definition of an independent system operator (ISO) and RTO?

John R. BEAR
The terms have often been merged. ISOs were generally put in place just to oversee the transmission system, and RTOs added the planning and dispatch functions. RTOs generally cover more than one state and are larger.

MITA Noriyuki
MISO makes a dispatch order to each operation control generation, usually in a merit-order format. However, it is possible that sometimes the utility retailers or generators would want to use their own dispatch order. In such situation, how does MISO compromise, or does it simply override such requests.

John R. BEAR
There are specific guidelines that define how dispatch is handled. An independent market monitor oversees the adherence of such guidelines. As such rules exist, those kinds of situations do not tend to occur. MISO simply chooses the most efficient generator.

MITA Noriyuki
In some European countries, market and system operation functions are divided. Do you think that they should be integrated or separated?

John R. BEAR
They need to be separated because the independent market monitor serves two functions. One is to oversee the market operation, and the other is to watch MISO operators in order to make sure that nothing is done to cause bias in the market. This provides a good oversight model, whereby monitors do not function within MISO and report directly to the board of directors. This allows for unbiased, fair reporting.

TANI Midori
Several years ago, a blackout in California was widely reported. Some considered this to be caused by a failure in the market design. What is MISO doing in order to make sure that such problem does not reoccur?

John R. BEAR
California had very poor market rules. Market rule research suggested that many negative incentives were being provided at that time. California has since redefined its market to address issues which used to exist. One year ago, there was a large blackout stretching from Southern California to New Mexico, which was largely due to a lack of an RTO in this area. This can be prevented by the development of a broad, regional system.

*This summary was compiled by RIETI Editorial staff.