Liberalization of energy markets was meant to be a wholly positive move for efficient decentralized energy. However, in many parts of the world, the execution of the liberalization process was flawed, leaving incomplete and cumbersome market structures. Now, following suggestions to roll back energy liberalization in parts of the US, Elisa Wood looks at the likely impact on DE.

When US consumers saw rate increases that in some cases doubled their electricity bills this year, their previously quiet grousing about liberalization grew to a bellow. Critics of competition proclaimed deregulation a failure and went to work trying to persuade decision-makers to return the industry to a utility-centred model.

Their arguments caught the attention of lawmakers in key Mid-Atlantic and Northeastern states, areas that along with California led the way restructuring the US electric sector at the end of last decade. Some state leaders now wonder if they moved too quickly to deregulate electricity markets, and they are taking a hard look at rolling back reforms.

On-site power developers are concerned. ‘Cogeneration advocates have little reason to support re-regulation; it will not correct today’s market problems, and may exacerbate existing barriers by further concentrating the market power of established utilities,’ said Sean Casten, President of Massachusetts-based Turbosteam Corp., and Vice Chair of the United States Combined Heat & Power Association (USCHPA).

Critics of energy market competition are suggesting rolling back liberalization, which brings both good and bad news for on-site power (Capitol Region USA)
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Indeed, the attack on liberalization was a major topic of discussion at the 7th Annual Policy Summit of the USCHPA in Washington, DC during 2-4 May 2006. John Anderson, President and Chief Executive Officer of the Electricity Consumers Resource Council (ELCON), warned the group that ‘there are storm clouds far closer than on the horizon that I believe will result in some significant change – and it might not be the kind of change that either you or we really want.’

ELCON, an influential group of large manufacturers that consumes about 6% of the nation’s power, and includes such companies as Anheuser-Busch, DuPont, and Shell Oil, sees need for reform, but not a return to pre-liberalization. Back when utilities were in charge of generation, rates were too high, innovation was stifled, and on-site power was treated ‘with real hostility’, Anderson said. Yet as he sees it, liberalization hasn’t lived up to its promise and has created new problems, among them expensive grid operators, faulty capacity markets and pricing structures, and disincentives to construct infrastructure.

‘Residential customers, whose electricity prices had been reduced and frozen at the start of restructuring, began facing rising – sometimes significantly rising – electricity prices as the price caps expired. These consumers were mad – mad as hell – and they made their feelings well known to policymakers,’ Anderson said.

Lawmakers befuddled by electricity markets

During the late winter and spring, state political leaders tried to sort through the havoc, but found themselves at times befuddled by the growing complexity of the electric industry and the language it speaks.

Lawmakers in Connecticut quickly organized a two-day energy summit after they were unable to come to a consensus in May on an energy bill that would usher utilities back into the generation business – a move being promoted by Northeast Utilities, a large regional utility. No bill in the last decade had attracted as much lobbying in the state, according to legislative leaders, and it came from all aspects of the electric energy industry – independent generators, utilities, distributed generators, energy-efficiency companies, consumer interests and others.

De Anza College near San Jose lowers its energy demand from the local utility and incurs savings by installing an array of four microturbines on-site (Capstone Turbine Corp.)
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Legislators found themselves confronted with a host of arguments, counter-arguments and new proposals, many of which left them with more questions than answers. After an energy attorney attempted to explain capacity markets at the summit, Connecticut State Representative Lawrence Cafero said: ‘Most of what you said … I don’t know what the hell you were talking about.’

Confusion did not stop leaders in some states from attempting rapid action, some of it radical, and most in the direction of at least partial return to pre-liberalization policies. In Maryland, the state legislature voted to fire the state’s public utilities commissioners, as well as give the state the unusual power to block a merger between two energy industry powerhouses, Constellation Energy and Florida Light & Power. Both moves were later vetoed by the state’s governor. Consumer advocates in that state continue to press for a return to utility cost-of-service regulation. Delaware and Connecticut are both looking at a return to integrated resource planning, a form of centralized utility planning of power supply, which was done before restructuring.

In Connecticut, state Attorney General Richard Blumenthal is pushing for a windfall tax on independent power producers and state-sponsored power plant development and generation purchases. Specifically, his plan would create a state authority to build power plants and secure electricity for consumers. Blumenthal’s goal is to put ‘the reins on a runaway market’.

‘If you think prices are high now, you ain’t seen nothing yet,’ Blumenthal said. ‘The federal government’s attempt to create a free market has cratered, and Connecticut must act swiftly to stop skyrocketing power prices from strangling our economy’.

In Massachusetts, NSTAR, a Boston-based utility called on federal regulators to investigate wholesale power contracts in New England, alleging that merchant suppliers were overcharging.

One of the most dramatic actions occurred in the northern-most state, Maine, which borders Canada on the eastern coast of the United States. After more than two years of trying to negotiate a new capacity market structure with neighbouring states, Maine walked out of talks at the 11th hour. The problem? As Maine leaders saw it, the plan would sock their state with high costs to create incentive for capacity development elsewhere in New England. Maine is considered one of the country’s success stories when it comes to competitive electricity markets – retail and wholesale trade is vibrant and it has a capacity surplus.

The Equity Office building in Manhattan satisfies 60% of its electricity, heating and cooling needs with a CHP system (Northern Power Systems)
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However, the way the capacity plan formula works, Maine gets financially penalized for its healthy market and must subsidize nearby states that failed to build enough generation and transmission, according to Kurt Adams, Maine’s chief energy regulator. He says his state is being punished for doing a good job at developing competitive markets, for following the market roadmap that the Federal Energy Regulatory Commission set out for the states. In what has become an oft-repeated quote, he lamented publicly that Maine had made the mistake of drinking ‘FERC’s Kool-Aid’. Maine is now considering cutting its relationship with ISO New England, the grid operator and wholesale market manager, and instead forming legal and operational ties with neighbouring Canada.

ELCON’s Anderson calls these events ‘the New England Electricity Tsunami’. The problem is not only that electricity prices are high, but also that the region may soon experience reliability problems. In fact, ISO New England says its six-state region could face rolling blackouts within one year. Little new power is being built, and even if it were, the transmission system cannot accommodate large power plant additions until new transmission lines are completed near the end of the decade.

The good news for on-site power

All of this bad news – high electricity rates, attempts to roll back liberalization, possible rolling blackouts – offers some good news for on-site power, however.

Anti-competitive forces call for reversing liberalization. Pro-competition forces say the US made the mistake of only partially deregulating, and now should let the market do its work. And increasingly lawmakers ask, ‘Is there a less radical middle ground?’ The answer frequently repeated in public forums is that the US needs more energy efficiency, more demand response, and more distributed generation.

‘Thus far, I am pleased to report that most of the changes that have happened which – superficially – look like re-regulation can be seen as a rethink of restructuring processes,’ said USCHPA’s Casten. ‘There is reason to support certain refinements made to restructuring rules – necessary because we have not let market forces work fully – such as decoupling, bilateral contracts and the removal of utility disincentives to support DG.’

A car manufacturer in South Carolina cogenerates its power and heat using landfill gas methane which fuels gas turbines (BMW Manufacturing Corp.)
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Indeed, Gordon van Welie, President and Chief Executive Officer of ISO New England, says the high electricity prices are signalling that the system needs more fuel and technology diversity. ‘Our markets are doing what they were created to do: sending us clear signals about what infrastructure is needed so that we can provide electricity at the lowest cost.’

To encourage development of these new resources, several policy changes are under consideration. For example, the forward capacity markets (FCM) structure for New England – the plan Maine walked out on – includes new opportunity for distributed generation. Specifically, it attempts to put DG, energy efficiency and demand response on the same footing as traditional supply in the marketplace by allowing those resources to collect capacity payments, just as power plants will. The overall idea behind the plan is to create incentive for development of resources – both supply- and demand-side. Developers say they have not been building in the region, despite a growing need for new power, because regulatory price controls prevent them from recovering their fixed costs through energy sales. Thus, they cite the need for the new capacity payments.

Approved in June 2006 by the FERC, the FCM plan works in two parts. During an initial transition period, from December 2006 to June 2010, resources receive set capacity payments. After that, ISO New England will determine how much capacity is needed and hold competitive auctions to secure it. Two working groups are now trying to determine how best to incorporate and compensate distributed generation into both the transition period and auction. The groups expect to propose specifics by the end of the fourth quarter of 2006.

An animal feed supplier in Goshen, California uses gas-engine based CHP to reduce its electricity costs (Cummins Power Generation)
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Demand response is considered an important tool in New England, in particular, because of the region’s rapid growth in peak demand and lack of corresponding development of peaking resources. In this case, distributed generation is seen as a form of load management for the grid. The idea is to create incentive for large energy users to ramp up their on-site power generators during peak periods and relieve demand on the grid. DG, energy efficiency and demand response are seen as good solutions to New England’s looming capacity shortage because they can generally be installed more quickly than large-scale power plants.

Another positive for on-site generation is that utilities throughout the country are responding to regulatory pressure to consider decoupling rates. ‘The talk of utility revenue decoupling can be seen as a push towards re-regulation. After all, a utility who earns the same amount of revenue no matter how much they sell sounds an awful lot more like a civil servant than a capitalist’, Casten said. ‘However, this is a way to remove the revenue incentives that utilities have to block load-sited efficiency, and thus is a good step in the right direction’.

He added, ‘Over a long enough time frame, it may be a bigger boon to society if it forces us to confront the fact that utilities really are a lot more like civil servants than capitalists and perhaps ought to be regulated accordingly (for instance, why have obligations to shareholders when those obligations are in direct conflict with your obligations to the public at large?) We’re not there politically, but revenue decoupling helps us get there, and is thus a good thing in my opinion.’

Change will happen at a state level

One thing for certain, whatever meaningful change does occur, will likely happen at the state – not the federal – level. ‘The states are where the traction is’, Casten said. ‘What happens in one state percolates to others’. This is particularly true now because Congress passed a major energy bill last year – the Energy Policy Act of 2005 – and generally does not take on the issue in a comprehensive way more than once in a decade. And even that legislation is mostly a ‘hodgepodge of subsidies to those who are politically well connected, with lots of different tax credits, but not a lot of focus,’ said Dick Munson, Executive Director, Northeast-Midwest Institute, at the USCHPA conference.

Many new policies are in the works at the state level that will help on-site power. For example, in Connecticut – seen by energy planners as one of the country’s most troubled areas because of severe congestion and predicted capacity shortages – regulators are in the process of putting the final touches on a series of reforms that boost distributed generation, particularly, combined heat and power. These include subsidies to customers and utilities to encourage DG installations and a CHP renewable portfolio standard set to start in 2007. Neighbouring Rhode Island recently adopted a ‘Least-Cost Procurement’ plan that would require utilities purchase all cost-effective energy efficiency and distributed generation before buying power from more traditional sources. The provision, approved in June 2006 by state lawmakers, applies to any customers on standard offer, the service taken by those who stay on utility power rather than buy from the competitive market.

Another shift that may prove beneficial to on-site power is the growing role that large energy users, like ELCON, play in influencing public policy. Since many large manufacturers use CHP, they tend to support the policy goals of the on-site power industry. Their emerging influence became apparent during the debate over EPACT 2005, according to Michael Parr, Government Affairs Manager for DuPont. Before that, energy producers and environmentalists dominated the conversation. Now, policymakers see industrial consumers as the middle ground and listen first to their economic arguments.

Doing the right thing … eventually

Lawmakers also are becoming increasingly aware that the over-dependence on gas and oil-fired generation plays a larger role in causing price spikes than any particular electric market structure. Whether utilities or market forces control the playing field, price volatility is unlikely to disappear quickly, warned Donald Downes, Chairman of the Connecticut Department of Public Utility Control during the state’s energy summit in May. In his argument in favour of maintaining competitive markets, he asked lawmakers why they thought Exxon-Mobil would sell fuel any cheaper to a utility than a merchant generator. In addition, he said, re-regulating will carry new costs of its own. If Connecticut’s utilities are allowed to build just 500 MW of new rate-based generation, customers will pay US$500 million over the next two to three decades just to cover the capital costs. Should Connecticut completely re-regulate its industry, and put all generation back under utility ownership, the cost will be about $6 billion to ratepayers, he said.

Casten doubts that this kind of total rollback of liberalization is likely to occur in the United States, despite the current posturing among some lawmakers and consumer advocates who are angry about high electric prices.

‘Contractually, you really can’t undo the little deregulation that has occurred. Any re-regulation would violate a whole lot of generation, transmission and fuel contracts, thus imposing a “takings” violation, in violation of the due process language in the 14th Amendment. This would inevitably trigger lawsuits and raise constitutional questions that would almost certainly be found in favour of the current market participants, given the historical primacy that courts have placed on contract law,’ he said.

Still, there appears to be more political support for re-regulation than market economics at this point in time, he said. As a result, areas that began liberalization such as New England, California, New York and Texas are unlikely to open their markets further. And those areas that have done little or no restructuring, such as the south-eastern region, are looking at the price spikes and threatened outages in the liberalized states and concluding falsely that competitive markets are to blame, he said.

ELCON’s Anderson is unsure that the United States will ever do what’s necessary to promote a vibrant market. Quoting baseball legend Yogi Berra, he said: ‘If I didn’t wake up, I’d still be sleeping.’ ‘Unfortunately, I am not optimistic that, collectively, we will wake up in time to make the necessary changes to keep the movement toward a competitive electricity market alive. Too many stakeholders may still be sleeping. And that is sad’.

USCHPA’s Casten is more optimistic: ‘Re-regulation is bad, and while I don’t think it’s really going to happen, it is unfortunate that it has more political legs than actually allowing markets to work. So we’ll go through some fits and starts over the next few years – none of which will likely help our longer-term energy issues – but it’s probably the only way to get us to a point politically where we finally have the will to do what we should have done years ago’. He summed up his thoughts on where the US competitive markets are heading with a quote from Winston Churchill: ‘You can always count on the Americans to do the right thing, after they have tried everything else.’

Elisa Wood is US-based writer on energy issues. E-mail:

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