Articles & Publications

November 12, 2018

For RTOs & ISOs: 'Don't call it a market' (props to LL Cool J)


The following is a viewpoint from managing partner Ray Gifford and partner Matt Larson at the Denver office of Wilkinson Barker Knauer LLP.

To paraphrase the unlikely energy policy influencer LL Cool J, don't call it a market even though it has been here for years.

The term "market" for the fully restructured RTOs/ISOs was brilliant PR, but a category error in describing what amounts to an alternative regulatory model. RTOs/ISOs use market processes the same way state resource planning processes use market bids to assess resource costs. But markets in an emergent — the pedantic among us would say, 'Hayekian' — sense do not exist in electricity, and the term should be abandoned for accuracy's sake.

We are not here to bury markets based on recent turmoil, but instead to point out that stakeholders never believed in them in the first place.

The political economy of states does not allow the price system to have the last word on what resources survive and what resources exit. Transaction cost barriers to customers expressing demand preferences, as opposed to setting the demand curve by administrative fiat, have not been overcome.

Finally, the irresistible urge to manipulate prices, explicitly and implicitly, to advantage some resources over others, means that the fairly-derided rentseeking of state regulatory processes gets channeled to the RTO/ISO bureaucracies, with less accountability and transparency except to the intensely interested 'stakeholders.'

Time for a new name
It is time to rename these regulatory phantasms. The latest developments to accommodate state policy choices without abandoning the fully restructured model remind us the fully restructured RTOs/ISOs are an amalgamation of political fixes and regulatory band-aids cobbled together to keep intact the myth of the fully restructured "market."

But with each of these ever more baroque policy patches, the fully restructured RTOs/ISOs perpetuate themselves to perpetuate themselves, not as a model superior to state integrated resource planning. To the contrary, the alphabet soup of evasive acronyms and descriptions — MOPR, RMR, RA, ReCO — have left states chafing to do their own thing. Think ZECs and RECs.

Meanwhile, stakeholders are exasperated with ever-changing rules that could either damage or save their capital investments. This needs to end with reform and a retreat from mandatory capacity "markets," but first just baby steps — don't call it a market!

A review of the current state of the fully restructured RTOs/ISOs reveals an ailing regulatory scheme infected with 'in-market' and 'around market' interventions that show no sign of stopping.

The problem is not one of 'markets' and their use in electricity procurement and delivery. Stylized market constructs — particularly bidding in for lowest cost resources — are used in both state resource planning processes and the restructured administrative models. Nevertheless, dysfunction reigns in the fully restructured RTOs/ISOs with mandatory capacity "markets."

It is within these constructs that utilities, generators and ultimately customers are forced into short-run marginal cost markets and where interventions, both 'around market' and 'in-market,' are layered on one another.

The equilibria emerging from these markets, then, are not expressions of supply and demand as in a prototypical emergent market. Rather, the short-run marginal cost construct requires the layering of policy interventions to continually correct for market outcomes. With that, we have lost the foundational purpose of restructuring in the first place.

As a result, the fully restructured RTOs/ISOs feature an evolving display case of interventions designed to alleviate the market problem of the moment, ranging from cost-of-service constructs to minimum bid floors to multi-phase auctions. These RTOs/ISOs devolve into a regulatory Escher lithograph of endless interventions to correct and calibrate for prior interventions.

Interventions take many forms, from ZEC programs to retain nuclear generators to de facto integrated resource plans codified through state law to reliability-must-run contracts permitted by the RTOs/ISOs to place a cost-of-service cloak on generators to keep them online. All of these interventions or purported 'market designs' are fundamentally constructed to favor certain resource types and correct the deficiencies created by reliance on a short-run marginal cost market.

As currently structured, the mandatory capacity "markets" in the fully restructured RTOs/ISOs are the worst of both worlds: not enough to cover fixed costs and sustain generators in the particular RTO/ISO, and a payment that serves to increase costs with very little actual capacity benefit.

Reliance on short-run marginal cost markets continues to spawn ever more creative and complex interventions from states and RTOs/ISOs alike. Rather than forcing utilities, merchant generators and other market participants to adapt to constantly changing rules and requirements to accommodate these interventions, we need to take a hard look at returning resource adequacy responsibility to the states and a transition from mandatory capacity "markets."

Time for reform
The time for capacity market reform is now, and it will be a significant and time-consuming task. But today we only propose an incremental first step in that direction that is straightforward and easy for those of us that are not market fundamentalists ready to embrace any and all marketisms that come along to prop up the "market" charade in the fully restructured RTOs/ISOs.

We need to stop calling any of the fully restructured RTOs/ISOs a "market." Whew. See, that was easy.

But what about ERCOT? To be sure, like all things in Texas, they go big for "markets," and Texans are proud of their competitive wholesale and retail markets. Just ask them.

The ERCOT construct has the advantage of a single sovereign — just the state with no federal overlay — and a political will to allow short-run marginal costs energy-only auctions to express prices ($9,000/MWh is the current system-wide offer cap), but still politically impressive nonetheless.

We would be the last commenters to suggest to a Texan they cannot call their electricity regulatory system a market. However, ERCOT uses the decidedly non-market RMR agreements to keep power in places where markets do not provide it. Further, the bolus of PTC-grabbing wind resources and coincident increase in negative and zero price events will squeeze fixed cost operators even more.

We will see if even the political economy of Texas can withstand a price squeeze that takes natural gas resources down, too.

With the days of calling fully restructured RTOs/ISOs a "market" now firmly in our rearview, we need a new name. Regulatory construct? Administrative mechanism? Regulatory mechanism? Administrative construct? The best phrase to our mind is "administrative scheme."

Indeed, the definition of "scheme" hits the nail on the head: "a large-scale systematic plan or arrangement for attaining some particular object or putting a particular idea into effect." Therein you have defined a fully restructured RTO/ISO.

RTOs/ISOs should be in the role of supporting utilities and states in procuring supply to meet resource adequacy requirements, which is what many signed up for in the first place when moving towards a market model.

Let's find a way to return the fully restructured RTOs/ISOs to that supportive role with capacity market reform. But first, let's call them what they are — and they are not a "market."

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