THE REGULATION AND RESTRUCTURING OF THE US POWER SECTOR

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THE REGULATION AND RESTRUCTURING OF THE US POWER
SECTOR
ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC

• TSINGHUA UNIVERSITY LAW SCHOOL
• BEIJING, PRC
• 3 NOVEMBER 2006

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Overview

• Current projection for electricity demand in the
  United States, and forecast of resources required
• Steps taken to restructure U.S. electric sector
  to introduce greater competition in wholesale and
  retail markets, and outcomes
• Gaps or issues created as markets evolved, and
  how newly enacted federal legislation addresses
  them
• Lessons learned

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Basic Cornerstones of U.S. Energy Policy

• Secure supply generally maintained through
  diversity of fuel types and source locations
• Safe no threat to public health and welfare
• Reasonably affordable
• (For electricity) Always available (i.e.,
  reliable and not subject to unintended
  interruption)
• Clean (non-polluting to air or water)

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Projection From 2004 Through 2025 The U.S.
Thirst for Energy Will Continue Unabated

• U.S. electricity demand expected to grow by 1.6
  percent annually (from 3,729 billion Kwh to
  5,208 billion Kwh)
• Demand for natural gas expected to grow from 22.4
  Tcf to 27.7 Tcf
• Coal consumption will grow by 1,104 million short
  tons to 1,592 million short tons

Source Energy Information Administration /
Annual Energy Outlook 2006
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U.S. Electricity generation by fuel,
1980-2030(billion kilowatthours)

• Coals share of electric generation escalates,
  ramping up from 49 percent in 2020 to 57 percent
  by 2030
• Natural gas share of electric generation peaks
  at 22 percent before falling to 17 percent by
  2030 when displaced by new coal-fired generation
• This projection does not factor in US adoption
  of carbon emission controls
• Nuclear generation expected to grow from 100 Gw
  in 2004 to 109 Gw in 2019 and remain static until
  2030
• Renewable generation will grow at average annual
  rate of 1.7 percent per year, from 358 billion
  kwH to 559 kwH by 2030

Source Energy Information Administration /
Annual Energy Outlook 2006
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Key Milestones Over The Last Half Century

• For most of the last century, natural gas and
  electric power have been highly regulated by
  government as public utilities
• These services were considered natural
  monopolies, unable to draw competition because
  of high costs of market entry
• Both the infrastructure-related delivery service
  and the commodity costs were regulated, based
  primarily on historic acquisition cost
• Natural gas prices subject to ceilings
• Electric wholesale retail power prices subject
  to regulated tariffs
• However, by the 1970s, natural gas shortages
  occurred because of lack of financial incentives
  for producers
• Eventually, federal government chose to phase in
  deregulation of interstate natural gas prices
  gas pipelines became transporters, rather than
  owners of gas volumes
• Natural gas supplies grew and prices stayed level
  for almost a decade

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Electricity Sector Market Reforms

• Until 1990s, electric utilities held monopolies
  for transmission, distribution and generation
  services in all markets
• However, electric power generation technology
  advances made generation of efficient, affordable
  power from independent owners of power plants
  feasible
• Previously successful reforms of natural gas
  sector influenced movement toward restructuring
  and reforming power sector
• Early 1990s Federal government allowed creation
  of independent power producers, thereby creating
  a competitive wholesale power market and
  deregulating the generation sector transmission
  and distribution remained regulated monopolies
• Mid-1990s states began to require unbundling of
  services or functional separation of services/
  some generation was sold to independent power
  producers

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Some States Opened Retail Power Markets To
Competition

• Retail Choice gave customers (industrial,
  commercial, and residential) direct access to
  power generators
• Approach favored generally in states with
  higher-than national-average power costs

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Status of State Retail Restructuring Efforts
(2003)
Source Energy Information Administration
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The Picture Today

• Steep escalation in natural gas prices
• Over reliance on natural gas as fuel for power
  generation for peaking capacity
• New baseload generation needed
• Underinvestment in transmission capacity
• Mixed record of success of retail experiments

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U.S. Natural Gas Markets Today Higher Prices

• Initially, experienced higher spot prices and
  greater volatility than during the 1990s when
  gas prices were around 2.00 3.00 per MMBtu
• 6.50 8.00 per MMBtu in summer
• 10.00 per MMBtu in winter
• Although allegations of market manipulation were
  claimed by some, and state and federal
  investigations were triggered, reason was
  attributed to economic forces of supply (which is
  declining) and demand (which is increasing)
• Current spot prices are within 7.00 8.00 per
  MMBtu range, and expectation is that prices will
  continue to be high for foreseeable future

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Electricity Generations Growing Dependence on
Natural Gas

• Natural gas became the fuel of choice for new
  power generation
• Environmental advantages
• Shorter lead times of completion
• Improved efficiencies
• From 2000 to 2004, 200,000 Megawatts (MW) of new
  power plant capacity was added to existing
  capacity base of 903,000 MW
• 94 percent of this new capacity was natural gas
  fired
• This has meant higher risks for power plant
  developers
• Exposure to higher fuel costs
• Exposure to price volatility

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Natural Gas The Fuel of Choice For Electric
Generation in late 1990s early 2000s
Annual Additions To Electricity Generation
Capacity By Fuel, 1950-2002 (Gigawatts)
Source Energy Information Administration /
Annual Energy Outlook 2004
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The Generation Outlook From Boom to Bust to
Boom Again

• Initially, markets were vastly oversupplied by
  much as 25-40 excess and some by as much as 100
• Surplus plants were mothballed, and reserve
  margins brought back into reasonable balance
• However, current forecasts indicate new
  generation needed
• 130 GW over next 10 years
• Possibility of near-term shortages in certain
  urban areas (i.e., New York City, Washington) and
  subregions
• Most will be new baseload
• High gas costs mean any new gas capacity will be
  used for peaking only
• 150 coal plants currently under development, but
  will face environmental challenges
• New nuclear capacity also being proposed

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An Electricity Delivery System In Need of New
Investment
Source E.Hirst, Transmission Crisis Looming?
Public Utilities Fortnightly, September 15, 2000

• Transmission investment declined in real dollar
  terms for 23 years from 1975 to 1998, while load
  has more than doubled
• Estimated 25 percent increase in transmission
  investment necessary to meet anticipated growth
  in customer demand over next two decades

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Current Status of State Retail Power Market
Reforms

• Successful in providing commercial and industrial
  customers choice of providers
• Higher magnitude of volumes purchased conferred
  bargaining leverage
• Sophistication driven by desire to lower costs of
  doing business
• Less successful doing likewise for residential
  customers
• Smaller volumes purchased per customer
• Savings negligible for time expended to shop for
  alternative providers
• Some states designed markets poorly, unduly
  exposing customers to price risk (i.e.,
  California)
• Some states erred in imposing 5 6 year price
  caps or conferring discounts on rates provided by
  incumbent utility, disincentiving customers from
  switching to new provider, and discouraging new
  market entrants
• No additional states will embark on experiment
• In states where price caps are being lifted,
  political controversy has ensued

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Energy Policy Act of 2005 (EPAct) Alteration of
the State-Federal Relationship

• Legislative thrust is remedial in areas where
  issues have persisted or gaps have emerged
• Transmission siting
• Responsibility for reliability
• Legislation clarifies responsibility between
  states and federal government, creates new
  decision-making mechanisms, and establishes
  procedure for resolving conflicts

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The Transmission Issue

• During previous decades, utility service was
  primarily local, and transmission was built to
  suit local needs
• States and local entities held authority to site
  transmission
• Markets have now assumed, multi-state, regional
  proportions
• Concern is that states would behave parochially
  in deciding whether to allow new transmission to
  be built, if no immediately discernible benefit
  for state
• Past instances cited of state resistance to -- or
  delay of -- siting of interstate transmission
  lines ( Example 765-kV line proposed by American
  Electric Power in Virginia and West Virginia
  which took 16 years)

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The Energy Policy Act Remedy

• Grants Federal Energy Regulatory Commission
  (FERC) authority to approve the siting of
  electric transmission facilities located in
  national interest electric transmission
  corridors
• if states lack authority to do so or they cannot
  consider interstate benefits of a project
• or when the applicant is essentially a
  wholesale-only transmitter
• or when states have withheld approval for more
  than a year or have conditioned approval in such
  a way that the project will not significantly
  reduce congestion or would not be economically
  feasible
• The Department of Energy (DOE) must identify such
  corridors, which may include any geographic area
  experiencing electric transmission capacity
  constraints or congestion, within one year of
  enactment and every three years thereafter
• Holders of a FERC siting permit may exercise
  eminent domain authority in federal court,
  allowing court to preempt state decision
• DOE has identified critical congestion areas
  for comment and is expected to designate
  national interest electric transmission
  corridors by end of year

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Reliability Responsibility Now Federalized

• Pre-Energy Policy Act Enactment
• Reliability responsibility rested primarily with
  states at local distribution level (regulating
  outage frequency, continuity of service)
• Industry reliability requirements for planning
  and operation of bulk power system were voluntary
  
• Northeast-Midwest power outage was a watershed
• Energy Policy Act Federalizes Reliability
• Congress directed development of mandatory,
  federally (FERC) approved, enforceable
  reliability standards
• FERC will certify a single Electric Reliability
  Organization (ERO) to oversee reliability of US
  portion of interconnected North American
  Bulk-Power System, subject to FERC oversight
• The ERO may delegate enforcement responsibilities
  to a Regional Entity, but only after the FERC
  approval of delegation agreement
• Either ERO or Regional Entity may propose
  reliability standards, monitor compliance, or
  impose a penalty on user, owner or operator for
  standard violation, subject to review by, and
  appeal to, FERC

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FERCs Reliability Standards Balancing National
Vs. Regional Interests

• FERC seeks standards uniformity as much as
  possible across interconnected North American
  bulk power system
• Will permit regional differences to extent more
  stringent than continent-wide or necessitated by
  physical system
• Will not defer to ERO or Regional Entity with
  respect to the effect on competition of proposed
  reliability standard
• North American Electric Reliability Council
  applied for, and has been designated by, FERC to
  be the ERO

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The States Authority No Preemption, But FERC
Resolves Alleged Conflicts

• Energy Policy Act savings clause State action to
  ensure the safety, adequacy, and reliability of
  electric service within that state not preempted
  as long as such action is not inconsistent with
  any federal reliability standard
• FERC rule sets out procedure for resolving
  before FERC all federal/state conflicts upon
  petition by ERO, Regional Entity, or other
  affected person

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State Authority to Form Regional Advisory Bodies

• Upon petition of at least two-thirds of the
  states within region with more than one-half of
  their electric load served within the region
• Requires member from each participating state in
  the region, appointed by governor of each state
• May include representatives of agencies, states
  and provinces outside of US
• Regional Advisory Body may provide advice to ERO,
  Regional Entity, or FERC concerning
• Governance of an existing or proposed Regional
  Entity within the same region
• Whether reliability standard proposed to apply
  within the region is just, reasonable, not unduly
  discriminatory or preferential, and in the public
  interest
• Whether fees for all activities proposed to be
  assessed within the region are just, reasonable,
  not unduly discriminatory or preferential, and in
  the public interest and
• Any other responsibilities requested by the FERC
• FERC may give deference to Regional Advisory Body
  that is organized on an Interconnection-wide
  basis
• Regional Advisory Body comprised of 10 Western
  states has been formed

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What does the Power Sector Look Like Today?

• The power sector is no longer a declining cost
  industry
• Cost of fuel for electricity (coal natural gas)
  will continue to rise, and for natural gas could
  be volatile
• Lack of transmission investment in prior years
  will require significant upgrades to meet demand
  expectations, further boosting consumer energy
  costs
• The need for higher rates will place
  extraordinary pressure on state utility
  commissions charged with regulating electric
  utility companies
• Rate increases will likely be politicized,
  heightening risk for investors

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Lessons Learned

• Power sector reform has had mixed outcomes
• Induced utilities to operate more efficiently and
  to focus on core capabilities (good)
• Created boom/bust generation cycles in the
  absence of long-term planning (bad)
• We will likely be thrust into more robust
  long-term resource portfolio management
• Reforms have spawned a variety of utility
  business models
• Traditional vertically integrated
• Distribution companies with competitive wholesale
  but closed retail markets
• Distribution companies with competitive wholesale
  and open retail markets
• Generation-only companies
• Transmission-only companies
• These various business models could pave the way
  for learning which are optimum from a consumer
  and investor standpoint
• We learn from our mistakes since we have made
  many, we must be learning!

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Thank You For Your Attention
Xie Xie
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Robert W. Gee President Gee Strategies Group
LLC 7609 Brittany Parc Court Falls Church, VA
22304 U.S.A. 703.593.0116 703.698.2033
(fax) rwgee_at_geestrategies.com www.geestrategies.co
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