Electricity 101: Understanding Maryland's Electricity Market

1. Electricity 101: Understanding Maryland's Electricity Market Tim Brennan Professor, Public Policy and Economics, UMBC Senior Fellow, Resources for the Future brennan@umbc.edu Maryland Public Policy Institute Annapolis, MD March 20, 2008 Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 1

2. Many issues; few answers? • A little Electricity 101 • What’s in Maryland’s control? • Residential not the whole picture, either for or against • Why electricity’s distinctive features matter • The pillars of Maryland policy • Some thoughts on “decoupling” • Last words: reliability, and “yes, this is really hard” • Skipping environmental policy considerations (e.g,. RGGI) but can discuss (some) in Q&A Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 2

3. A few “Electricity 101” basics • Separate wholesale and retail markets • Wholesale: Bulk energy delivered over high voltage transmission lines to “load serving entities” LSEs (including local utility) • Retail: The market in which end users choose their LSE • Supply must equal demand at all times • Too expensive to store • Capacity has to be in place to meet demand at any instant • Top 15% in place used during only 60 extreme peak hours • A problem with “non-dispatchable” sources, e.g., wind • It’s all one big grid • One failure to meet demand can bring down the system • It’s not like cars – reliability is a collective enterprise Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 3

4. “Electricity Regulation” 101: The wires are regulated • Local distribution • Don’t need multiple providers digging up the streets • Rates regulated by MD PSC • Long distance transmission • Nominally separate lines, BUT … • Transmission interconnected into three big “interties” – Eastern, Western, and Texas • Electricity takes all paths – why it is one big grid • FERC sets rates, access policies, rules for wholesale markets • Generation/transmission separation the wholesale issue • Fear of discrimination against entrants • FERC defines “Regional Transmission Organizations” • Functional, full, or no separation? Coordination vs. competition Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 4

5. What can Maryland control? • Many question regulation • The California fiasco • The Northeast blackout • The run-up in prices • Low residential take-up • But Maryland controls only the retail side • Can regulate rates customers pay • But has little control on upstream cost of electricity • Part of the PJM wholesale market • Competitive market, FERC-approved RTO • Multiple markets (day ahead, spot) • Zonal vs. nodal • Capacity markets (“Reliability Pricing Model”) Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 5

6. Where Maryland gets its electricity – PJM’s territory Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 6

7. Residential isn’t everything • Residential nationally about 1/3 of the market • Commercial and industrial (C&I) 2/3 • Source of impetus for opening markets • C&I advantaged even under old top-to-bottom regulation • Credible threats to leave – like tax breaks • C&I seems to work in MD, but not residential • Less than about 3% of residential served by new suppliers • 70% C&I, 94% large C&I • Why the residential reluctance? • In some cases, retail price held down as part of dereg. bargain • But maybe they don’t want to be bothered! • Leave shopping to the MD PSC? Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 7

8. Alberta Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 8

9. Non-storable: What prices should users see? • Why electricity’s non-storability matters • 15% of use during 60 extreme peak hours, less than 1% • Have to recover those costs in less than 1/100th time • Extreme peak prices can be 50 times normal price • Case for allowing “smart metering” • Time of day, seasonal pricing only partial solution • Need ability to monitor use, tie to prices • Focus smart metering on C&I • Enterprise benefits exceed costs of metering • Political alternative: Pay not to use • Give people $1/kwh for electricity not used at extreme peaks? • Sources of funds? Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 9

10. Pricing leads to Maryland Energy Policy • Pillar 1: Electricity prices are too high • Pillar 2: People consume too much electricity • Stress on system at peak times: Only about .2% • Environmental harms, e.g., greenhouse gases • Seemingly irreconcilable, to an economist • Excessive consumption means price below cost • Believe it or not, prices may be too low, as we’ve seen • Economic ideal: Charge the “right” price • Real time, environmental surcharge (e.g., carbon permit price) • Potential painful distributional effects, however! • If pricing stays low, possibly justifies conservation subsidy • Watch out for rebound effect!! Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 10

11. Do consumers make wrong decisions … • Could result in excessive consumption • First explanation: Insufficient information • Information on net savings from energy efficiency, e.g., CFLs • Is there really an information shortage? Internet, TV, etc. • Perhaps for residential, less so for C&I (worth finding things out) • Real uncertainty regarding payoff—will energy prices stay up? • Second explanation: Do buyers/consumers not make self-interested decisions? • Often assumed on the policy end • But consumers may have quality preferences, e.g., CFLs • Judgment over validity of preferences for energy-intensive consumption • Economists lean toward giving people “right prices” Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 11

12. … or do the utilities make us do it? “Decoupling” • Claim that we consume to much because utilities encourage consumption • Rationale for “decoupling” utility revenues/profits from amount we use • The utilities make money the more we use • Take away the profit, they won’t encourage us to use as much • A few cautionary notes • Any evidence that utilities influence demand away from what is in the consumer’s interest (given the right prices?) • The relationship to wholesale price probably drives utility marketing efforts more than • Deregulation blamed for Isabel repair delays because utilities weren’t getting profits from generation. Will decoupling help? Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 12

13. Reliability • Greatest risk to grid on-peak • Reallocating—not even reducing— a small fraction of overall energy use can have a big effect on reliability, prices • 15% of use during 60 extreme peak hours is about .2% of overall annual use • Big reliability gains obtainable at far less than 15% • Leaves aside environmental reasons for reducing use • But main reliability questions wholesale • Transmission grid operation • Transmission/generation separation • Control vs. competition • “Have markets met their match”? Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 13

14. It really is hard – reasonable people can disagree! Brennan, Electricity 101 – MPPI: Annapolis, MD March 20, 2008 14