electric markets

U.S. Electric Utility Markets:An evolving paradigm

Karthik Krishna, 2008

Copyright © 2008 by Karthik Krishna

U.S. Electric Industry

Undergoing restructuring and moving towards deregulation.

Traditionally dominated by regulated monopolies that vertically integrate generation, transmission and distribution.

Shifting towards an industry featuring a mix of competitive generators, common transmission operators, and distribution companies.

Source: Energy Information Administration, Status of Electricity Restructuring by State, September 2008. http://www.eia.doe.gov/cneaf/electricity/page/restructuring/restructure_elect.html

Electric Utility Industry Structure

• Investor owned utilities• Public Utilities• Independent Power Producers• Cogenerators

• Utilities• Power marketers • Aggregators

• Power Exchanges - ISO Controlled Exchanges - Private Exchanges

Load Serving Entities

• Utility Distributors• Power marketers • Aggregators

Retail Customers

Power Sellers Power Wholesalers and Buyers Power Retailers and Buyers

Wholesale Bilateral

Transactions

Competitive Markets

Direct Sales

Bilateral Retail

Futures Markets

Pilot Programs

FERC Standard Market Design

Major Elements Independent Transmission Provider (ITP) Organized Exchange Markets Market Power Mitigation (unbundling) Regional Transmission Planning, ATC*, OASIS**

*ATC – Available Transfer Capacity **OASIS – Open Access Same-Time Information System

Source: Federal Energy Regulatory Commission, RTO/ISO Map, January 2008. http://www.ferc.gov/industries/electric/indus-act/rto/rto-map.asp

1935 – Federal Power Act (FPA)Made the Federal Power Commission (later became FERC) the regulatory body for electric industry.

1978 – Public Utility Regulatory Policies Act (PURPA)Required utilities to buy power, at avoided costs, from non-utility generating facilities that use renewable energy sources or cogeneration.

1992 – Energy Policy Act (EPAct)Opened transmission networks to allow wholesale transactions for electricity.Left it up to individual states to determine opening of retail markets.

1996 – FERC Order 888 and 889Established standards for non-discriminatory transmission access and stranded cost recovery.Required utilities to establish electronic systems to share information on a non-discriminatory basis.

Electric Market Restructuring - Landmark Policies

1999 – FERC Order 2000Requested formation of Regional Transmission Organizations (RTOs) to

- Improve efficiencies in grid management. - Improve reliability and planning.

2002 – FERC Standard Market Design (SMD)Proposes standards for establishment of competitive electric markets.

2005 – Energy Policy Act - Improved reliability standards and modernized transmission

infrastructure.- Net metering and smart metering standards for states to consider.

Electric Market Restructuring - Landmark Policies (cont.)

Composition of U.S. Electricity Industry

Source: Energy Information Administration, Electric Power Annual 1996, Volume II, DOE/EIA-0348(96/2) (Washington, DC, 1997).

Net Generation, Average of 1990-1996

Investor-Owned, 74.80%

Cooperative, 5.60%

Municipals, 4.50%

Federal, 6.20%

State Government, 9.00%

Composition of the US Electric Industry, 1996

80

1994

2010

932

243

10

0 500 1000 1500 2000 2500

Power Marketers

Nonutilities

Publicly Owned

Cooperative

Investor-Owned

Federal

Today’s U.S. Electricity Cost Landscape

• Conservative forecasts show residential electricity prices reaching 12 c/kWh by 2009

• EIA shows historic national average retail electricity prices outpacing inflation by ~1.2%

EIA National Retail Electricity

2007 10.642006 10.402005 9.452004 8.952003 8.722002 8.44

+ 4.7%

(cents / kwh)

per annum

Source: United State Department of Energy Solar Energy Technologies Program, May 2008. www.eere.energy.gov/solar/solar_america/

• Coal prices have nearly tripled over the past five years.

• Coal power plants face increasing project uncertainty due to carbon and siting concerns.

• Natural gas prices have more than doubled during the same time period.

• Nuclear industry groups estimate the next generation nuclear plants will not be online until 2015.

Hurdles Faced By Traditional Generation Sources

Coal and natural gas prices are increasing at much faster rates than 4.7% per year, while nuclear faces regulatory, financing and siting issues.

Coal and natural gas prices are increasing at much faster rates than 4.7% per year, while nuclear faces regulatory, financing and siting issues.

$ /

sh

ort

ton

Source: Simmons & Co.


U.S. Electric Retail Prices

In states that implemented retail market deregulation, prices have increased faster that the national average.

2007 Average Residential Retail Prices

0

2

4

6

8

10

12

14

16

18

20

Ce

nts

/kW

h

States with restructured electric markets

States with regulated rates

Electric Industry Deregulation

Why has competition in electric industry not brought price benefits to consumers?

Inelastic demand and lack of price signals.

Technical feature of the industry that requires supply and demand to be in balance at all times (electricity cannot be stored).

Poor market design which essentially has the least efficient plant set the wholesale market price for all generation.

Lack of incentives for consumers switching electric suppliers since there is little to choose from in terms of service differentiation.

Sources:[1] Rosenberg, A. E., 2008, “A way to reorganize organized markets”, The Electricity Journal, Vol. 21, Issue 1,ppg 9-17.

[2] Joskow, P., and Tirole, J., 2006, “Retail Electricity Competition”, Rand Journal of Economics, Vol. 37, No. 4, ppg. 799-815.

Existing Power Marketers

Some recently started power marketers in Texas (Jan 2008)

Green Mountain Energy- Marketed as nation’s leading provider of cleaner energy.- Customers are given the opportunity to choose how their power is made via

direct access retail electric service.

Affordable Energy- Sells electricity through a large independent sales base which increases

their sales organization through word of mouth and enthusiastic sells pep rallies.

- Untested customer service and billing system.

Cirro Energy- Appears to offer most competitive electric rates but requires a 12 month

contract at variable energy rate (which can be raised for any reason). - Most other companies offering variable electric rate products leave the

agreement as a month to month contract.

Champion Energy - Lehman Brothers company which is well-capitalized and has tremendous

experience in commodity marketplaces.- Ensures you will receive accurate and straightforward billing.

Distributed Generation

Definition

Small-scale production of electricity at or near customers’ homes and businesses.

Drivers Decline in costs of small-scale generation Increase in utility-supplied power prices

Benefits Improved reliability Reduced costs Increased use of renewable energy Increased energy security

Barriers Difficulty in standardizing technology and grid interconnection. High initial costs. Utility monopoly rules (stranded costs & interconnection fees) Public’s lack of knowledge about the electric industry.

Source: Sovacool, B. k., and Brown, M. A., 2007, “Energy and American Society – Thirteen Myths”, Springer Publishing, Netherlands

Costs of Selected DG Technologies

- Levelized Cost is the average cost of electricity (cents per kWH) over the operating life of the generating equipment.

- Cost estimate that the systems powered by fossil fuels will be operated 90% of the time and that wind and solar PV systems will run 40% and 27% of the time respectively.

- Costs do not include effects of tax credits and other direct subsidies for specific technologies.

U.S. Solar PV Industry

Despite being the most expensive DG technology, Solar PV industry has had exponential growth recently and is projected to continue this growth pattern.

Growth is due to :- Volatile electric prices

- Tax incentives and policy initiatives

- Advances in PV technologies

- Consumer interests in renewable energy and to be more energy independent

U.S. Domestic PV Shipments (1997 - 2006)

0

50000

100000

150000

200000

250000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Year

PV

Mo

du

les

(Pea

k K

W)

Sources:[1] Sovacool, B. k., and Brown, M. A., 2007, “Energy and American Society – Thirteen Myths”, Springer Publishing, Netherlands

[2] Borenstein, S., 2008, “The Market Value and Cost of Solar Photovoltaic Electricity Production” Center for the study of Energy Markets Working Paper, University of California – Berkeley campus. http://www.ucei.berkeley.edu/PDF/csemwp176.pdf

U.S. Solar PV Industry


17

2007 Residential PV Price Attractiveness

• Currently PV is financially competitive where there is some combination of high electricity prices, excellent sunshine and/or state/local incentives.


Electricity Price differences with Existing Incentives

18


• Attractive in about 250 of 1,000 largest utilities, which provide ~37% of U.S. residential electricity sales.

• 85% of sales (in nearly 870 utilities) are projected to have a price difference of less than 5 ¢/kWh between PV and grid electricity.

• In large areas, PV is cheaper than grid electricity


Electricity Price differences without incentives and moderate increase in grid prices

19

• Attractive in about 450 of 1,000 largest utilities, which provide ~50% of U.S. residential electricity sales.

• 91% of sales (in nearly 950 utilities) have a price difference of less than 5 ¢/kWh between PV and grid electricity.

• Across most of the highest U.S. population areas, PV is cheaper than grid electricity.

Electricity Price differences without incentives and aggressive increase in grid prices



Electric Supply Business Models

Traditional Model (Customer view)

Use electricity supplied by monopolistic utilities.

For implementing DG, invest your own resources (time, money, knowledge) and undertake risks on investment due to intermittent generation.

Sustainable Model (Customer view)

Get into a contract to buy electricity from a electric service provider/power marketer and allow suitable DG to be installed and maintained by the provider.

Decentralizing Generation

Service Provider

Offering from New Model

Financial solution for greater penetration of DG.

- Cost structure over contract life of DG technologies is internalized by the service provider (lease to own approach).

- Risks due to generation intermittency is shifted away from consumers.

Commercial engine that drives technological advances towards localized energy independence/sustainability.

- DG technology management.

- Smart metering.

Industry savings from reduced transmission costs and congestions.

Lower carbon footprint for the industry that is the single largest in emitting CO2.

Financial Derivatives and Electric Markets

Electricity spot prices are volatile due to unique physical attributes of electricity- Non-storability- Uncertain and inelastic demand- Most renewable resources are dependent on weather- Steep supply function

Financial derivative tools are not fully understood and utilized in the electric industry.

In Feb. 2004, persistent high prices in TX during a 3-day ice storm led to the bankruptcy of a retail electric provider that was exposed to spot market prices.

The 2000 California electricity crisis is largely attributed to the fact that major utilities were not properly hedged through long-term supply contracts.

Source: Deng, S. J., and Oren, S. S., 2006, “Electricity derivatives and risk management”, Energy Journal, 31, ppg. 940-953.

Financial Derivatives and Electric Markets

Most of electricity futures and options are traded on the New York Mercantile Exchange (NYMEX).

Types of electricity financial instruments:- Electricity forwards, futures and swaps- Options (call, put, spread, swing options)- Structured transactions (tolling, load-serving contracts)- Financial derivatives on transmission capacity

Risk management applications- Hedging a generators output- Ensuring generation adequacy- Callable service contracts- Hedging congestion risk of bilateral transactions.

Tools for planning under uncertainty and asset valuation.

Source: Deng, S. J., and Oren, S. S., 2006, “Electricity derivatives and risk management”, Energy Journal, 31, ppg. 940-953.

References

• Borenstein, S., 2008, “The Market Value and Cost of Solar Photovoltaic Electricity Production” Center for the study of Energy Markets Working Paper, University of California – Berkeley campus. http://www.ucei.berkeley.edu/PDF/csemwp176.pdf

• Deng, S. J., and Oren, S. S., 2006, “Electricity derivatives and risk management”, Energy Journal, 31, ppg. 940-953.

• Energy Information Administration, Electric Power Annual 1996, Volume II, DOE/EIA-0348(96/2) (Washington, DC, 1997).

Energy Information Administration, Status of Electricity Restructuring by State, 2008. http://www.eia.doe.gov/cneaf/electricity/page/restructuring/restructure_elect.html

Federal Energy Regulatory Commission, RTO/ISO Map, 2008. http://www.ferc.gov/industries/electric/indus-act/rto/rto-map.asp

• Joskow, P., and Tirole, J., 2006, “Retail Electricity Competition”, Rand Journal of Economics, Vol. 37, No. 4, ppg. 799-815.

• Rosenberg, A. E., 2008, “A way to reorganize organized markets”, The Electricity Journal, Vol. 21, Issue 1,ppg 9-17.

• Sovacool, B. k., and Brown, M. A., 2007, “Energy and American Society – Thirteen Myths”, Springer Publishing, Netherlands.

• United State Department of Energy Solar Energy Technologies Program, May 2008. www.eere.energy.gov/solar/solar_america/

Contact Information

For any questions or comments on this presentation

ContactKarthik KrishnaGraduate Student, School of Business & EconomicsMichigan Technological UniversityEmail: [email protected]: (330) 685 7278

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