New Kind of Electricity Market Strains Old Wires Beyond Limits
(Alternate title: Power grid neglected in deregulation)
By Neela Banerjee and David Firestone
Saturday 23 August 2003
With the lights back on after the biggest blackout in North American history, consumers have learned a difficult lesson about the electricity grid: it was an afterthought during the decade-long process of deregulating the power industry.
No single authority is in charge of the grid, and few have an incentive to invest the money needed to improve its reliability. Deregulation increased the vulnerability of the grid to failure, regulators and industry executives broadly concur.
Deregulation is actually a misnomer for the restructuring of the power industry, because only the generation of electricity was freed from strict government controls, beginning in 1992. Companies were allowed to charge market-based rates for generating electricity, creating the financial incentive to build more power plants.
But the transmission of electricity over high-voltage lines and the distribution into homes and buildings remained regulated. Power companies received only a relatively low, government-set return on their investment in the grid, so they allocated far less to improving transmission reliability than to building power plants.
As a result, much more electricity is moving over virtually the same transmission wires, pushing them to carry loads they were not built to handle, according to many regulators and experts.
"Right now we have a highway" to transmit power, said David Owens, executive vice president of the Edison Electric Institute, an industry lobbying group. "But we need a superhighway."
Federal regulators and some industry groups realized long before the blackout that sweeping measures were needed to improve the reliability of power supplies. For the last four years, mandatory reliability standards have been proposed for the grid, along with the creation of independent regional operators to enforce those standards.
These plans would produce greater regulation of the grid than existed in the days of utility monopolies, but politics have stymied their progress. While some plans may win approval in the wake of the blackout, other ideas may be delayed amid confusion and finger-pointing.
"Now is when we really need new rules and new institutions to help manage this market," said James J. Hoecker, former chairman of the Federal Energy Regulatory Commission, or FERC, the independent body in the Energy Department that oversees the power system. "But with the swirl of different agendas surrounding this event, it may be more difficult now."
The transformation of the American electricity industry began because businesses in California and the Northeast, where electricity rates have historically been high, threatened to abandon those regions for places with cheaper power. Federal and state governments, determined to cut rates, remade the industry, dismantling monopolistic utilities and encouraging new companies to compete to supply power.
As deregulation started to take hold, investment in transmission waned. The old utilities understood that they might be compelled to divest themselves of some assets, so they delayed many investments, including transmission upgrades.
"The transmission network needed for a wholesale market should be much larger," said Frank A. Wolak, an economics professor at Stanford University and chairman of the market monitoring committee at the California Independent System Operator, which runs the state's transmission grid. "The utilities said, `If we don't know what kind of returns we'll be getting or whether we get to keep our assets, then don't build it.' So leading up to restructuring, they didn't build transmission."
Nick Winser, group director of transmission for National Grid Transco, which owns and runs the grid in England and Wales, said the United States needed to invest $60 billion to $100 billion to make its grid big enough and robust enough for a fast-growing, deregulated market. But he estimated that the United States had spent $800 million a year over the last decade.
About 70 percent of an electricity bill covers power generation; transmission costs make up 10 to 15 percent, and the rest goes for distribution.
Restructuring led to a glut of power plants, and electricity rates have fallen in many areas. But few regulators or electric generation companies considered how best to connect the power plants to customers.
Industry analysts say that Mississippi provides an example of the folly that sometimes characterized restructuring. Merchant generation companies, which build power plants, rushed there in the late 1990's, drawn by financial incentives. Their plan was to pump electricity into growing markets in Florida and Georgia, the analysts said.
By the end of the year, Mississippi will have about 30,000 megawatts of excess capacity, industry experts said, but there is no way to transmit that electricity to the intended markets because no one wants to build the transmission lines.
"This is the best example in the country of sending the wrong price signals and locating in the wrong area," said an industry executive who spoke on condition of anonymity. "But that's the way deregulation is. It creates confusion and chaos for some time."
Under the old system, power plants shipped electricity to nearby communities. Now the search is for the cheapest, not the closest, source of power.
Industry regulators and experts warned Congress and power companies years ago that the grid could not easily handle increased power loads over long distances. In July 2001 the North American Electric Reliability Council, an industry group formed to monitor transmission after a blackout in 1965, told Congress that "the grid is now being used in ways for which it was not designed."
The council is a pivotal investigator in the blackout inquiry that is being led by the Energy Department. The council listed a host of weak spots in the system: rate formulas that encouraged utilities to upgrade transmission but that did not reflect risks in the new markets; companies making money from pushing the limits of the reliability rules; and "reliability responsibilities" being divided among many entities because the old integrated utilities had been broken up.
Transactions to buy and sell power, which have grown exponentially under restructuring, move over a balkanized web of transmission lines connecting 142 "control areas" with 6,000 power plants owned by 3,000 utilities.
Nowhere is the web more tangled than in the Midwest, where experts say that line failures apparently helped start the blackout. The independent system operator for the region monitors the flow of power but does not manage it. That is left to 23 utilities in Ohio, Indiana and Michigan to coordinate among themselves.
The Midwest Independent System Operator has asked the federal government for the authority to run the grid in the region. "There would be a smaller number of parties involved, so it would most definitely be an increase in reliability," said Ron McNamara, vice president of regional affairs at the system operator.
Not everyone agrees. Robert McCullough, an independent energy consultant in Portland, Ore., raised concerns in a recent analysis that more interconnections could raise the risk of widespread blackouts.
Why did regulators and companies fail to set up safeguards when restructuring began? Industry experts and economists say that the assumption was that the free market would smooth all bumps.
"We're Americans, and we think if it wasn't invented here, it wasn't invented," Mr. Wolak said. "A lot of problems could have been avoided if we had looked at other countries' experience that deregulated before us, like Australia, New Zealand, Norway, Sweden and the U.K."
Now, FERC is scrambling to push measures through Congress that it and many in the industry say would enhance the reliability of the grid. But some of these steps rekindle aspects of a long-simmering debate over what government intervention and oversight the power sector needs.
The blackout built a solid consensus for mandatory technical standards to keep the electricity system from failing. Until now, utilities and merchant generators have followed the standards voluntarily.
FERC wants the authority to enforce mandatory standards, and such a provision is part of the energy bill being negotiated in Congress.
The most contentious issue, one that has divided the industry for years, is the creation of regional transmission organizations to supervise the grid throughout the country, imposing uniformity on a system that has a few strong regional groups, a few weak ones, and several regions with no groups at all.
Regulators at FERC envision a system in which power generation remains deregulated to encourage competition, while transmission becomes a much more heavily regulated monopoly. The system would be shaped by new rules and controlled by regional transmission groups closely supervised by the commission.
Others in the industry also favor this approach. "When you do this stuff state by state, it doesn't work," said Craig Glazer, vice president of government policy for PJM Interconnection, the independent operator of the transmission system for all or part of seven Northeast states and the District of Columbia. "It's like having an air traffic control system state by state."
The move toward regional transmission groups, in particular, may become a casualty of the very blackout that the groups were intended to prevent. For years, the plan has been thwarted by opposition from utilities in the South and Northwest that fear a loss of autonomy. That opposition, in turn, has held up progress on an energy bill that included mandatory reliability standards for the grid. Now the Bush administration has proposed delaying work on the regional groups in order to obtain swift Congressional approval of the mandatory standards.
For now, the political fight over how to improve the transmission grid gives the industry little room to maneuver. Many industry experts have called for an increase in transmission lines, but others have begun to caution against throwing money at the problem.
In a recent analysis of the blackout, PennFuture, an energy research and advocacy group in Harrisburg, Pa., said that increased energy conservation and generation from smaller sources of on-site building energy, like microturbines, would help lessen the demands on the grid. Many industry experts have called for installing new technology on the grid to improve its ability to ship more power and to prevent failures.
Utilities are also seeking further deregulation by trying to persuade Congress to repeal the Public Utilities Holding Company Act, a Depression-era law that prohibits companies from owning several utilities in scattered parts of the country. Congressional proponents of the repeal, who have inserted it into the energy bill, say it would allow new capital reserves to flow into the industry and the grid. But consumer groups say it would concentrate the industry in a few powerful hands and would be a burden on ratepayers.
Any significant changes, from building new transmission lines to providing better technology for existing ones, will require sizable investment. Most likely, consumers will have to foot the bill, but transmission constitutes a small portion of that bill, industry analysts say.
Patrick H. Wood III, chairman of FERC, and other Washington supporters of competition acknowledge that serious mistakes have been made in the decade since the restructuring process began. But commissioners argue that now would be the wrong time to halt a process that has learned its lessons about transmission and was moving toward stronger federal oversight at the time of the blackout.
"We just need to get there," Mr. Wood said. "If people have got problems with some of our rules, if we're being too strict or not onerous enough, hell, we'll talk about it and negotiate. But dadgum it, we just need to get there. This very prolonged transition has not served anyone well at all."