Rate Regulation Redux

Abstract

In the 1990s, the Federal Energy Regulatory Commission (FERC) stopped treating
power generation as a regulated monopoly and supported the development of competitive
electricity markets. Competition has encouraged innovation and reduced costs, but the
payment system FERC and grid operators developed has struggled to provide low-cost
electricity without leaving itself vulnerable to market power abuses. In a payment system
based on marginal costs, generators necessary for grid reliability cannot recover their fixed
costs unless they charge high prices when supply is scarce. However, because these generators
have market power, permitting them to recover their fixed costs leaves energy markets
vulnerable to market manipulation. To mitigate market power abuses, every grid operator
in the United States has introduced offer caps that limit revenues available in energy
markets. Offer caps can prevent some generators from recovering their fixed costs, leading to
a “missing money” problem as critical suppliers are forced out of business and potential new
entrants cannot cover their start-up costs. Today, growing penetration of renewables is
exacerbating the missing money problem. Regulators and grid operators are responding by
administratively pricing certain resources and supporting specific units deemed too important
to retire. These interventions lead to excess capacity and undermine competitive markets. As
a result, current regulatory responses to the missing money problem recreate the inefficiencies
that competitive markets were designed to solve, and they do so under questionable legal
authority and at the expense of a clean energy grid.

Rather than quietly revive cost-of-service rate regulation, this Article argues that FERC
should simplify reserve requirements, stop counteracting state clean energy programs, and
support the development of competitive markets for services that support grid reliability.
Specifically, FERC and grid operators need not administratively reprice resources or force
load-serving entities (LSEs), which distribute electricity to consumers, to transact with
specific generators. Instead, the Commission should support long-term resource procurement
markets that would be built on top of today’s short-term energy markets. Wholesale markets
would consist primarily of short-term energy dispatch and balancing markets. They would
not be relied on to ensure that revenues are sufficient to maintain resource adequacy.If LSEs
were permitted to determine for themselves how to comply with resource procurement
requirements, they could balance renewable policies, flexibility needs, and reserve mandates.
This approach would maintain reliability while respecting FERC’s jurisdictional limits.
Most importantly, it would prevent the Commission from quietly reviving cost-of-service
regulation in regions that ostensibly abandoned that market structure decades ago.