Turning On The Lights: Deregulating The Market for Electricity

Policy Reports | Regulations

No. 228
Friday, October 01, 1999
by Vernon L. Smith and Stephen Rassenti


Technical Considerations

Ancillary Services

Generator units used for so-called ancillary services are required to produce and deliver continuous high-quality power. The units include load-following generators, spinning or quick-start reserves, power for voltage control and the dispersion of generation for stability. In greater detail:

  • Load-following generators are units whose output can be readily varied to match load variations in the very short run.
  • Spinning reserves are generators on line and loaded at less than capacity, and therefore available to quickly replace the output of any generator that breaks down. Reserves can also be supplied by quick-start gas or hydroturbine generators. (However, quick-starting generators tend to have low capital costs but high running costs, while spinning reserves are supplied by higher-capital-cost units with low running costs. Either might be used for load following.)
  • Some generators and other control devices produce no usable power but control voltage to maintain the quality of power.
  • Finally, using dispersed rather than concentrated generator sources facilitates stability and protection against outages. Scheduling centers might accept a higher priced bid from one generator rather than a low priced bid from another to maintain a dispersed supply.

Separating generation and delivery would avoid conflicts of interest in choosing among less expensive generators and others that provide ancillary services. However, regulators may deem it too risky to divest all ancillary generator services because they are critical to the supply of reliable service. As an interim step, regulators might prefer to have delivery companies retain control over some amount of generation. But if the wires companies are required to contract with outside sources, supply companies can compete for the contracts - until ancillary services are provided as part of the spot auction market. Reliability is no excuse for avoiding competition among independent generator sources, particularly for marginal or peak power, where market-clearing spot prices are determined.

Transferring Power Between Regions

A utility that divests its generation facilities and operates a spot scheduling market based on bids from independent generators and bulk buyers should not have to restrict its operation to buyers and generators in its own territory. Wires company should have every incentive to schedule generators from the lowest-cost sources, whatever their locations.

At every link point (intertie) between its own electric power grid and adjacent grids, it could export or import power in response to the price differentials at that intertie. Thus, if on its side of an intertie the local spot price was higher than that of an interconnecting utility, a utility could import power in quantities sufficient to close the price gap. If at the intertie its local internal spot price was below that of the adjacent utility, it would export electricity until the prices were equalized. Utilities should have no reason to favor higher-cost over lower-cost generators. Divestiture should cut the ground from under such perverse incentives and allow delivery utilities to obtain energy at the best price.

Price differences at interties will fluctuate daily and seasonally, because adjacent territories do not typically experience peaks at the same times. For example, Arizona has a summer peak and Utah a winter peak; Arizona exports power to Utah in the winter and imports it in the summer. Such power interchanges benefit customers in both regions and are encouraged by the separation of wires and supply.

Divestiture builds naturally on existing practices, but improves incentives through greater reliance on markets. Currently, interregional power transfers are regulated by FERC. Under the divestiture proposal in this paper, FERC could play a new and smaller role in the electricity industry of the future.

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