FERC Eliminates Barrier to a Cleaner, More Efficient Market

By Miles Farmer, Natural Resources Defense Council

In a huge win for clean energy, the Federal Energy Regulatory Commission (FERC) has issued an order eliminating a barrier to customer savings and better electricity system efficiency in New York.

The order, announced on February 3rd, allows customers and companies to simultaneously participate in both state and federal programs that provide compensation for reducing energy usage in order to help alleviate different types of stress on the electric grid (a practice known as “demand response”). FERC’s order stems from a complaint that NRDC filed, together with a coalition led by the New York Public Service Commission, arguing that wholesale market rules unfairly prevented such simultaneous participation.

FERC’s decision is meaningful for both its direct impact and its broader policy implications. Directly, the order promises to lower electricity prices for New York customers and could help prevent the construction of unnecessary power plants. From a policy perspective, it signals FERC’s understanding that the wholesale electricity markets it oversees should be designed to work in harmony with state policies. States are important leaders in the fight for clean energy. FERC policies that complement rather than conflict with state policies will help states advance renewable energy, electric vehicle grid integration, distributed energy resources, and a host of other important clean energy initiatives to improve environmental quality and save consumers money.

Understanding FERC’s order requires a bit of background:

Demand Response

During times when electricity use is especially high (like hot summer days), or where supply is lower than anticipated (when a big power plant unexpectedly shuts down due to mechanical failure, for example), the electricity system can be strained in multiple ways. First, local infrastructure like distribution lines (the lines running through neighborhoods) may approach or exceed its maximum capacity. Second, the quantity of wholesale energy supply and the limits of the bulk transmission system (which sends electricity from large centralized power plants to distribution network substations) can be tested.

A problem at the wholesale supply or bulk transmission level doesn’t necessarily signal a constraint at the distribution level and vice versa. But whether the problem is local (distribution scale) or more widespread across counties and states (transmission scale), or even at both levels, demand response can help reduce the stress that high demand brings to the grid and thereby maintain the flow of power. It can entail a factory, home or business simply “curtailing” energy demand by lowering lighting or temporarily halting an assembly line or using distributed generation, which in New York, is governed by strict new emissions controls.

FERC and the States Regulate Different Aspects of the Electricity System

Unfortunately, the complicated regulatory structure governing our electricity system has made it harder to compensate demand response for both distribution-level and bulk transmission-level services. States oversee the distribution system by regulating local utilities and their “retail” demand response programs, which help alleviate stress on the local system.

But FERC, not state government, oversees wholesale electricity supply and bulk transmission system operation. In this role, FERC approves the market rules for several regional entities known as Regional Transmission Organizations (RTOs) or Independent System Operators (ISOs). These regional grid operators have had a difficult time establishing rules that properly account for state policies and allow market participants to take advantage of both state and federally regulated markets and programs. One example was presented in the markets regulated by New York’s regional operator, the New York Independent System Operator (NYISO).

In addition to overseeing an “energy” market that balances real-time supply and demand for electricity, NYISO also runs a “capacity” market, which ensures that enough energy resources are available to meet peak energy demand when the transmission grid is stressed even though all of these resources won’t be needed on a day-to-day basis. The “capacity” bought and sold in this market is a promise to deliver electricity or reduce future demand in one or more of several specific regions (known as capacity zones) should the need arise.

Market Rules Intended To Prevent Manipulation Can Frustrate State Policies

In regulating this capacity market, NYISO enforces rules to prevent participants from engaging in manipulative conduct to artificially suppress prices. The economics of supply and demand dictate that sometimes adding a relatively small amount of cheap supply can significantly reduce market prices. Because of this, and because utilities and other companies may act as both buyers and sellers in capacity markets, a company that buys more capacity than it sells could seek to manipulate prices by submitting artificially low sales bids. For example, a utility might submit bids to sell capacity at $10,000 per megawatt for a given year even if the capacity cost ten times that amount to generate. This “uneconomic” behavior could yield a profit for the utility by reducing market prices and thereby saving the utility a greater amount of money in its purchases of capacity than the amount lost through artificially low sales bids.

To prevent this, NYISO and other grid operators created “buyer-side mitigation” rules in areas of the grid where the risk of price suppression is highest. The rules basically subject certain supply bids to an offer floor. By forcing suppliers to bid no lower than the floor, NYISO weeds out artificially low bids and ensures that prices accurately reflect demand and the “true” costs of supply.

While these rules were initially designed to prevent gaming, they now sweep too broadly. NYISO’s minimum bid rules, for example, can now apply to bids that are lower than they otherwise would have been because the supplier receives revenue from state-administered programs outside of NYISO’s markets. When a supplier sells in both markets, it should be permitted to sell its product more cheaply in both, just as sellers do in other types of markets throughout the economy. Amazon, for example, may be able to offer cheaper books because its web hosting service that runs Amazon.com also sells hosting service to other websites (and Amazon can sell that hosting service more cheaply because it also uses its web hosting expertise to sell books).

Among the victims of NYISO’s overbroad buyer-side mitigation rules are demand response suppliers who could otherwise take state-regulated program revenues into account in their NYISO capacity market bids. NYISO’s rules effectively force demand response suppliers to forgo participation in distribution-level demand response programs in order to sell into NYISO, lest their bids be “mitigated” to an offer floor so high that no one buys from them.

To remedy this problem, NRDC joined a coalition led by the New York Public Service Commission in filing a complaint at FERC. We explained that NYISO’s rules, by subjecting demand response suppliers to an offer floor in this manner, were “unjust and unreasonable.” We argued that by forcing demand response to choose to participate in either state or federally regulated markets despite the separate and distinct nature of the services provided in each, NYISO’s rules frustrated New York’s legitimate policy objectives furthered by the distribution-level programs. We requested that demand response resources be exempted from NYISO’s buyer side mitigation rules to remedy this problem.

FERC’s Order

FERC agreed, reasoning that while New York’s state and federally regulated demand response programs “may complement each other, they serve different purposes, provide different benefits, and compensate distinctly different services.” FERC ordered NYISO to modify its buyer-side mitigation rules to exempt demand response, as we had requested. This will allow demand response resources to seamlessly provide both distribution and bulk transmission system benefits. By efficiently leveraging all demand response, it could help eliminate the need for power plants that would otherwise be necessary.

FERC’s decision also has broader implications for other resources. Wind and solar generators, like demand response suppliers, receive revenues outside of FERC’s regulated markets, often selling renewable energy credits pursuant to state laws and regulations. While these generators have largely been exempt from buyer-side mitigation rules for other reasons, a disturbing trend across different RTOs and ISOs of broadening buyer-side mitigation rules threatens to ultimately hinder them. The FERC order signals a retreat from this expansion, and it recognizes that revenue from state programs for separate products can be legitimately accounted for in wholesale market bids.

This conclusion is further supported by Commissioner Norman Bay’s powerful concurring opinion in the order. Bay argues (correctly) that FERC’s market rules for setting capacity market price ranges should take state programs into account, not ignore them. Accordingly, he urges a systemic rethinking of buyer-side mitigation rules.

Responding to the threat that buyer-side mitigation rule expansion could pose for renewables, we recently submitted filings (linked here and here) arguing that state programs compensating generators for providing environmental benefits do not cause artificial price suppression because environmental benefits are additive to (and separate and distinct from) the electricity sold by these generators in FERC-supervised markets.

The FERC decision makes us more optimistic about the outcome in those proceedings, and more generally about the future of FERC regulation that better enables states to continue to make their own energy policy choices.

Originally Posted Here.

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