Draft Report to Congress on Wholesale and Retail Competition in Electricity

Lynne Kiesling

Yesterday the Federal Energy Regulatory Commission released the draft Report to Congress on Competition in the Wholesale and Retail Markets for Electric Energy on behalf of the Electric Energy Market Competition Task Force. This report, required by Section 1815 of the Energy Policy Act of 2005, provides an overview and summarizes the progress toward wholesale and retail competition over the past 25 years, the current state of wholesale and retail competition in the U.S., and the economic and political issues surrounding the transition to wholesale and retail competition.


After providing a historical overview of industry and regulatory structure and the context for this study, the draft report surveys competition in wholesale power markets. The authors state, clearly and honestly, the difficulty of evaluating whether or not existing wholesale competition has led to efficient resource allocation. That evaluation is difficult for a host of reasons that it’s really important for policymakers to understand, and that the report discusses. It is difficult because concerns over generator exercise of market power has led to a variety of types of price caps in wholesale markets; these price caps frequently cut in to scarcity profits as well as reducing the profits to witholding supply from the market, and distinguishing between scarcity rents and market power rents is often difficult or impossible. Thus market designs with price caps could lead to higher prices than would have occurred without price caps, if the price caps deter otherwise profitable investment in new generation capacity. The report discusses the use of capacity payments in some markets as a proxy for those lost scarcity rents, and the report does a great job of pointing out the knowledge problem facing regulators and system operators who believe that they can come up with the right capacity payments in the absence of a double-sided market process. It is also difficult to evaluate wholesale market competition because wholesale markets are not double-sided; like much of the market design in this industry, wholesale markets are overwhelmingly supply-focused. Without true demand-side participation in wholesale markets that reflects the preferences of retail end-use customers, competition in wholesale markets has been and continues to be incomplete (although there has been some isolated improvement in making some markets double-sided, in places like PJM). The report also goes in to some useful detail on the interaction between regulatory intervention and returns to investment in generation and transmission.

The draft report’s analysis of retail competition is particularly clear and useful, and will provide timely perspective and context, given the scheduled removal of retail price regulations in some states juxtaposed with increasing fuel costs. The retail chapter looks at the right question: are customers able to see accurate price signals and to hedge price risk through freedom of contract choice? The authors do a good job of explaining how retail price caps in the transition to retail competition confound their ability to assess the effects of retail competition; in other words, retail competition is incomplete in the presence of such price caps, which distort price signals to customers and distort entry incentives to potential competitors. Most importantly, the discussion of designing a provider of last resort (POLR) rate option in the transition to competition is splendid. Few policymakers truly understand the extent to which incumbents can use POLR offerings as entry barriers in retail markets; this report articulates that problem clearly and succinctly.

While treating wholesale and retail competition separately, the report accurately points out that wholesale and retail markets are inextricably economically integrated: “… an important component of effective market operation is customer response to prices. The demand for wholesale power, however, is derived entirely from consumption choices at the retail level. The lack of electric power inventories only intensifies the direct link between wholesale and retail electric power markets. Yet state regulators set the prices for retail customers.? (p. 44) This integration makes the state/federal jurisdiction split between wholesale and retail all the more pressing to consider if we are to realize the efficiency and innovation benefits of competitive market processes in electric power, benefits that ultimately redound to end-use customers in the form of the lowest feasible prices for a portfolio of differentiated products and services.

This report, intended to inform Congress on wholesale and retail competition, provides a clear, thorough analysis of the current state of competition policy relating to this industry. It captures the economic aspects of the issues well; in particular, throughout the report the authors take care to point out both the benefits and costs of coordinating economic activity through regulation and through market processes. For example, in discussing different mechanisms for coordinating investment decisions, they discuss government control of generation investment:

“The final alternative is a regulatory rather than a market mechanism to assure that adequate generation is available to wholesale customers. As a method to spur investment, regulatory oversight of planning has some positive aspects, but it also has costs. Using regulation through governmentally determined resource planning to encourage entry could result in more entry than market-based solutions, but that entry may not occur where, when or in a way that most benefits customers. Regulatory oversight of investment also means regulators can bar entry for reasons other than efficiency. The stable rate of return on invested capital offered under rate-regulation can encourage investment. On the other hand, rate-regulation can lead to overinvestment, excessive spending and unnecessarily high costs. Regulation also lacks the accountability that competition provides. Mistakes as to where and how investments should be made may be borne by ratepayers. In competitive markets, the penalties for such mistakes would fall on management and shareholders. The specter of future accountability for investment decisions can lead to better decision-making at the outset.?

Its appendices also provide extensive information, including detailed descriptions of retail competition market designs in 7 different states, which will enable readers to learn about the effects of different retail designs – the laboratory of the states.

The report does have some shortcomings. The authors could be more emphatic about the effects that retail transition price caps (over times as long as a decade) have in deterring entry in retail markets. They could make more explicit the undercurrent in the text that we are in the midst of a shift from regulatory policy to competition policy in this industry, which requires thinking differently about transactions, contracts, and the role of regulators. Similarly, they could have couched their discussion in the ongoing transition from cost recovery to risk management as an important focus of business models in this industry. Most importantly, though, they should have included a discussion of the role of technological change, especially in building automation, metering, and grid-friendly appliances, in empowering end-use customers and making retail choice a valuable tool for injecting resiliency and integration into double-sided retail and wholesale markets with active demand.

I encourage you to read and circulate this report, and to submit comments to ensure that members of Congress and their staff have the most comprehensive knowledge about the current state of wholesale and retail competition, and the potential for competitive market processes to produce efficiency, innovation, and customer value in the electric power industry.


4 thoughts on “Draft Report to Congress on Wholesale and Retail Competition in Electricity

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