Competitive Markets Breathe New Life into New England's Power Sector

By David LaPlante, Vice President, Wholesale Markets Strategy, ISO New England

TEN YEARS AGO, NEW ENGLAND launched an effort to restructure its regulated, vertically integrated electricity system and introduce more efficient, competitive markets. The cost-of-service system had served us for decades, but the time had come to breathe new life into the industry.

The chief objectives were to:

*Stimulate investment in supply-side resources and provide a road map for where that investment was needed;

*Shift the risk associated with multi-million dollar power plant investments from consumers to investors;

*Ensure the most efficient selection of resources, and

*Guarantee open access to the transmission system and encourage investment in transmission improvements.

There is strong evidence that markets and deregulation are meeting these policy objectives in New England and sending the proper price signals to prompt investment in needed infrastructure.

Between 1999 and 2002, more than $6 billion in private investment was made in new power plants, increasing our electricity supply by 30 percent. After a three-year hiatus from 2003 to 2006, interest in developing new power plants is on the rise again in response to recent improvements in the markets. Since private firms and not public utilities are making this investment, consumers are shielded from the investment risk. This consumer protection was a cause of restructuring in New England where billions of dollars in stranded costs had accumulated from poor investment decisions.

A comprehensive regional planning process and a stable cost recovery mechanism have improved the climate for transmission investment. After decades of inertia, five bulk transmission projects valued at more than $2 billion are in various stages of construction, and a sixth, multi-state project is being planned. These new projects will improve the ability to efficiently move power throughout the region by eliminating costly bottlenecks on the system.

Efforts to efficiently use electricity have also proven successful. There are almost 1,000 MW of demand response assets enrolled in the ISO's programs, which provide the dual benefits of lowering prices and ensuring reliable operations. Last summer, when the temperature soared into the high-90s and the region set all-time demand records on three occasions in a two-week period, Demand Response programs shaved more than 500 MW off the peak.

Last year, we took a vital step toward ensuring long-term resource adequacy through markets with the approval and implementation of the Forward Capacity Market. This new market, which is based on an auction that procures the most cost-effective resources, will encourage development of new supply-side and demand-side resources, provide incentives to improve the availability of existing resources in times of greatest system need, and compensate market participants that provide the needed resources.

In spite of these accomplishments, recent increases in retail rates have caused many to question the wisdom of restructuring, but these higher prices are the result of price increases in the inputs, such as fuel, needed to produce electricity (Figure 1). Wholesale electricity prices have actually dropped when you factor out fuel price increases.

Figure 1. Electricity prices track natural gas prices. Source: ISO New England Inc.

Although significant progress has been made, the region faces several challenges. Markets help to identify these challenges, acting as barometers that measure the strengths and weaknesses of the electricity system and providing an efficient way to value available alternatives. Market price signals tell developers to invest. They help direct consumers to use more or less electricity and they ultimately prompt the development of solutions to improve the efficiency, competitiveness, and reliability of the system.

Among the challenges facing our region is its increasing demand for electricity. The growth in summer peak electricity demand is approximately 600 MW annually, which is equivalent to adding one new power plant every year. Complicating matters is the seasonal difference in electricity demand between the summer peak of slightly more than 28,000 MW and the rest-of-year average of 18,000 MW. Because of this difference, nearly a third of the region's generating fleet is needed only a few weeks a year. This gap is expected to widen because summer peak is growing at a more rapid rate (2%) than average use (1.3%).

Another challenge is our increasing reliance on natural gas, which now provides approximately 40% of our electricity. This is stretching our region's natural gas infrastructure and creating problems in the winter when there is a simultaneous need for gas for power production and home heating.

Addressing these challenges will require a concerted effort by the region's policy makers, industry executives, and business leaders to implement market-based policies that encourage investment in — and siting of — needed resources.

Thus far, the track record for the region has been mixed. For example, natural gas power plants are typically the easiest to site because of low emissions, but New England has become over-reliant on it. This leaves the region with a choice to either accept alternative fuels like new coal and nuclear or site LNG tanks and natural gas pipelines, but neither option has been embraced.

Some believe the solution is to throw in the towel and return to the "good old days" of cost-of-service regulation. But the markets have proven themselves effective in the short time they have been given to operate. What's needed is a level-headed view of that progress and a clear-headed approach to the future.

There are several initiatives we are working on that will require a regional resolve to get them done. These include:

*Aligning environmental and energy policies;

*Adoption of dynamic retail pricing for large customers to give them more control over their use and their costs;

*Streamlining the siting of resources;

*Adoption of policies that encourage the development of a more diverse set of resources, and

*Continuing active involvement in the regional planning process.

To provide input to policy makers, the ISO has convened a working group of experts to take a long-term look at the needs of the system and analyze the economic, reliability, and environmental impacts of various solutions. These options include an increase in energy efficiency programs, building alternative fuel resources, and increasing imports from Canada and New York. Markets provide a strong foundation for meeting the region's future needs for electricity in an environmentally sound manner. We hope this effort will help policy makers identify the regulatory and legislative changes needed to meet our future needs for electricity and fulfill important public policy objectives.

It is clear that New England's markets have facilitated a tremendous amount of progress toward creating a more reliable and efficient system. They will continue to be the appropriate path forward to achieve the goals of reliability, energy efficiency, demand response, and the integration of renewable resources in the most efficient manner possible.