FERC Staff Report On Reactive Power: Part Of The Institutional Change Process

Lynne Kiesling

On Friday the Federal Energy Regulatory Commission released a staff report on reactive power. This extensive and thoughtful report is a useful contribution to advancing the policy debate about institutions governing the electric power network in a changing and increasingly distributed and market-oriented environment. This report digs down into the technical and economic specifics of reactive power, one of the most complicated aspects of the electric power network.

In an alternating-current power network, voltage provides the equivalent to pressure in a water or gas network ? voltage has to be in a particular range for current to flow in the network. Reactive power supports that voltage level. The report offers the incredibly useful simile that reactive power is like the bounce in your step when you walk across a trampoline; the energy involved in bouncing up and down actually contributes to your being able to proceed across the trampoline in the most efficient manner (p. 17).

The increasingly commercial and decentralized nature of the industry means that transactions that used to take place within firms are now more often taking place in markets. This transition creates great value, but also necessitates rethinking other transactions that complement the exchange of real power in wholesale markets, including reactive power. In fact, reactive power has traditionally been such a fixed, static aspect of operating a vertically-integrated utility that historically there was little reason to think of reactive power as a scarce resource that could be a candidate for transaction-based exchange.

The report provides parallel technical and economic analyses of reactive power provision in a decentralized network, including a useful model in Appendix C. The technical information includes detailed background on the physical characteristics of reactive power, and the various static and dynamic, fixed and mobile means of producing it. These different technologies for producing reactive power have various costs and benefits, and so may all be useful in a dynamic, decentralized network. However, some planning, siting, and other policy barriers prevent the use of some of these newer technologies, and the report discusses these barriers.

The report?s economic aspects include an overview of reactive power pricing in the U.S. and in other countries. Further analysis will enhance the benchmark economic model put forth in the report (pp. 89-90), which has three characteristics: prices reflect marginal cost, prices are equal across all sellers of the same product, and long-term contract prices reflect expected future market prices. While this is a pretty standard articulation of a blackboard competitive model, it misses some features of real markets in important ways. In dynamic markets, conditions change so often and so quickly that prices cannot equilibrate to some static notion of long-run marginal cost. In fact, economic research increasingly shows that the competitive equilibrium in networks is not characterized by price equating to long-run marginal cost. Evaluating complex markets in networks by price?s deviation from marginal cost may mean committing the nirvana fallacy and comparing the market design to an unattainable ideal. Similarly, sellers do not all receive the same price unless all sellers participate in a uniform price auction where they submit offer schedules and there is no bilateral contracting; however, even when sellers receive different prices the result can be both efficient and fair. Even in simple open-outcry double auction experiments, buyers pay and sellers receive different prices, yet they still achieve the benchmark competitive equilibrium, and get there through a fair process governed by consistent and transparent rules.

One recurring theme in the report is the claim that network reliability (and thus reactive power provision) is a public good. This claim is debatable; indeed, in other work Michael Giberson and I have argued that reliability also has private good characteristics, and that a system of priority insurance can take advantage of those private good features and also lead to better information about how customers actually value reliability. The report does point out that reliability is a congestible public good (p. 22), and that it is even a local public good (p. 89). But the report fails to incorporate the private good aspects of reliability, or the extensive economic literature on institutions that support private provision of goods that have some public characteristics.

Throughout human history, social interaction involving mutually beneficial exchange has usually evolved into organized markets in an organic way. Given the 85-plus years of government regulation of vertically-integrated, government-granted monopolies, the spontaneous, organic evolution of robust electric power markets is unlikely. Yet we can still use this spontaneous order evolution of markets as a benchmark concept that also provides questions to ask and ways of evaluating the consciously designed markets that continue to evolve through the policy process as the economy, industry, and technology change. That evaluation applies to institutional change in all aspects of the electric power network, including reactive power.

The report concludes with four recommendations as the basis for further discussion and research (p. 105):

1. Reactive power reliability needs should be assessed locally, based on
clear national standards.
2. These needs should be procured in an efficient and reliable manner.
3. Those who benefit from the reactive power should be charged for it.
4. All providers of reactive power should be paid, and on a
nondiscriminatory basis.

As a means of initiating a process of thinking carefully about institutional change in a dynamic, decentralized economy, this report provides a valuable set of information and ideas. It contributes to the foundation on which we can design new institutions, test them experimentally before implementation, and evaluate them to see how well they will adapt to changing and unknown conditions.