ELECTRICITY RESTRUCTURING

TRENDS AND IMPACTS

presentation by

George Gross

University of Illinois At Urbana - Champaign

at the

NSF Sustainable Energy Systems Workshop

Georgia Tech Campus

Atlanta, Georgia

November 29 - December 1,2000© Copyright George Gross, 2000

OBJECTIVES

To provide an overview of the environment in which

the discussions on sustainability are undertaken

To review the key developments in electricity

restructuring

To assess the key trends in the new electricity

business and their impacts

To identify specific challenges and research needs

OUTLINE

Importance of electricity

Key federal legislative and regulatory developments

Direct access at the state level

Key trends and developments

Dispersed resources

Major challenges

Electricity will continue to substitute for less Electricity will continue to substitute for less efficient and less productive energy formsefficient and less productive energy forms

ENERGY CONSUMPTION AND ELECTRICITY USE

5050

7070

9090

110110

130130

150150

Energy/GNP Ratio (Index is 100 for the year 1900)Energy/GNP Ratio (Index is 100 for the year 1900)Electricity use as aElectricity use as a percentage of totalpercentage of total energy consumedenergy consumed

2000200018801880 19001900 19201920 19401940 19601960 19801980 20202020

5050

4040

3030

2020

1010

%%

00

1970 1980 1990 50%

100%

150%

200%

250%

1970 = 100% Electricity use

Total energy

use

CO2 Emissions

ELECTRICITY / ENERGY DEMAND

IMPACT OF ELECTRICITY

The National Academy of Engineering - the nation’s

most prestigious collection of outstanding engineers -

named electrification - the development of the vast

networks of electricity that power the world - as the

most important of the twenty engineering achievements

that have had the greatest impact on the quality of life

in the 20 th century

IMPACT OF ELECTRICITY

Electricity ranked ahead of the automobile, airplane,

safe and abundant water, electronics, computers and

space exploration

The widespread electrification implemented in the 20 th

century gave us power for our cities, factories, farms

and homes, forever changing the lives of people

COMPETITION IN THE GENERATION MARKET

The 1978 Public Utility Regulatory Policies Act

(PURPA) unleashes competition through the

introduction of qualifying facilities (QF’s)

PURPA mandates each investor-owned utility to

purchase power at avoided cost from QF’s located in

its service territory

Implementation of PURPA was left to individual states

resulting in nonuniform definitions of avoided cost

The once fledgling private power enterprises

constitute today a multi-billion dollar industry and play

a critically important role in the electricity business

ENERGY SOURCES OF NUG CAPACITY

WindWind 3.4%3.4%

Waste 7.0%Waste 7.0%

Geothermal 1.8%Geothermal 1.8%

Oil 2.6%Oil 2.6%

Hydro 5.3%Hydro 5.3%

Coal 15.2%Coal 15.2%

Biomass 16.5%Biomass 16.5%

Solar 0.7%Solar 0.7%

Natural Gas 47.2%Natural Gas 47.2%

Other 0.3%Other 0.3%

Source : 1993 Capacity and Generation of Non-Utility Sources of Energy, Source : 1993 Capacity and Generation of Non-Utility Sources of Energy, Edison Electric InstituteEdison Electric Institute

OWNERSHIP OF NEW GENERATING CAPACITY ADDITIONS

1985 1987 1991 1992

84 73 51 36 39 66

0%

100%

UTILITY OWNERSHIP NON-UTILITY OWNERSHIP

19951994

16 27 49 64 61 34

84 73 51 36 39 66

1992 NATIONAL ENERGY POLICY ACT

Addresses all major elements of national energy supply and use

Marks the end of a highly regulated and structured period for utilities

Pushes aggressively wholesale competition by changing federal policies governing electric power in the wholesale marketplace revision of PUHCA of 1935 establishment of the new class of exempt

wholesale generators (EWGs) reform of the FPA broadening the powers of FERC

to mandate wheeling

Customers

Self-generation

IPP

THE EXISTING ELECTRIC INDUSTRY STRUCTURE

Generation

Transmission

Distribution

Customer Service Customer Service

Distribution

Transmission

Generation

THE EXISTING ELECTRIC INDUSTRY STRUCTURE

Customers

Self-generationIPP

Generation

Transmission

Distribution

Customer Service

Customer Service

Distribution

Transmission

Generation

RESTRUCTURING IN OTHER INDUSTRIES

The recent past has witnessed major changes in

virtually every other regulated industry:

airlines

telecommunications

railroads

trucking

natural gas

Electric utility industry was the last major regulated

monopoly to undergo this “been there, done that”

phenomenon

SOME LESSONS LEARNED FROM RESTRUCTURING IN OTHER DOMAINS

Basic driver was the market -- emergence of real

economic opportunities

Breakup of strong vertically integrated industries can

be done rapidly

Prices decrease rapidly as products become more like

commodities

Decreasing prices encourage product differentiation

and innovation

SOME LESSONS LEARNED FROM RESTRUCTURING IN OTHER DOMAINS

Far more customer segments emerged than anyone

ever imagined or believed possible

Pace of change has continuously accelerated

The winners are the innovators who understand

customer needs and effectively apply technology - -

they create new opportunities rather than just

compete more aggressively for the existing ones

ELECTRICITY VS. OTHER SERVICES

electricity

busy signal

airline reservations

bumpingnext available flight

obligation to serve

telephone

DRIVING FORCES OF CHANGE

CHANGES

MARKETS

ENVIRONMENTREGULATION

TECHNOLOGY

FERC ORDERS 888 AND 889

On April 24, 1996, FERC released

Order No. 888 - Open Access Transmission and

Stranded Cost Recovery

Order No. 889 - Open Access Same-Time Information

System (OASIS)

The orders constitute a generic remedy for the undue

discrimination in the industry’s past practices in providing

transmission services

KEY OBJECTIVES

To promote aggressively robust competition in

wholesale markets

To remedy undue discrimination in transmission

To establish standards for recovering stranded costs

MAJOR THRUSTS

Utilities must provide non-discriminatory open access

through tariffs of general applicability

Utilities must functionally unbundle transmission and

generation services

Transmission providers must set up electronic bulletin

boards

MAJOR THRUSTS

Utilities must abide by the standards of conduct

Standards and procedures provide the recovery of

stranded costs resulting from increased competition

under the new FERC rules

Limited reciprocity must be provided by nonjurisdictional

entities requesting transmission services

UNBUNDLING EXAMPLE

Baggage Service

Takeoffs

Landings

In-Air Pillow/Blanket Service

Oxygen

Bath rooms

Backup Service* Bundled service available upon customer request

FLY THE FRIENDLY SKIES WITH

UNBUNDLING ‘R’ US*}

SAME INFORMATION AVAILABILITY

TransmissionProvider

TransmissionProvider

TransmissionCustomer

TransmissionCustomer

Transmission Service:

Palo Verde to Midway

200 MW at $4/MWhCall SCE

For Sale

Transmission Service:Four Corners to Midway

200 MW at $3/MWhCall SMUD

WantedRINOASIS

For Sale Wanted

200 MW at $3/MWhFour Corners to Midway

Call SMUD

200 MW at $4/MWh

Palo Verde to Midway

Call SCE

Transmission Service:Transmission Service:

THE FERC ORDERS NO. 888 AND 889

Signal FERC’s intention to establish universal open access

Aim to aggressively promote the development of a competitive wholesale electricity market by mandating non-discriminatory open transmission access

Provide a generic definition of a utility’s comparable transmission service obligations

Address transition costs associated with industry restructuring

Use the OASIS to provide functional unbundling of transmission and generation services

“COMMON CARRIER” TRANSMISSION SERVICE

Broker /marketer

Broker /marketer

Broker /marketer

Transmissionsystem

Utilitygeneration

Oth

erut

ility

QF

IPP

EWG

Broker /marketer

Selfgeneration

SALIENT CHARACTERISTICS OF CALIFORNIA RESTRUCTURING

Basic principles embodied are

customer choice

competition in generation

open access transmission

Physical direct access: flow based bilateral transactions coexist with the PX spot market

Independence of the ISO and PX: separation of security and economics functions

ISO has primary responsibility to facilitate transactions while maintaining system reliability/security

THE CALIFORNIA SYSTEM

... ...

load aggregatorend userESP

ISO

SC

...

PX AS market

D I S T R I B U T I O N (W I R E S)D I S T R I B U T I O N (W I R E S)

GG GG GG GG GG GG GG GGGGGGGGGG

bilateral contracts

THE POWER EXCHANGE

Seller 1

PX

Seller M Seller i

Buyer N Buyer j Buyer 1

MWh MWh MWh

MWhMWhMWh

.$

.

. . .. . .

. . .

$$$

$ $

.

RETAIL ENERGY COSTS 4/1/98 - 3/31/99

wholesaleenergy

21%

distribution30%

strandedcosts23%

ratereduc-

tionbonds13%ISO costs

5%

transmission4%

public purpose

5%

total costs = $ 28 billion CA ISO estimates

ELECTRICITY RESTRUCTURING IN ILLINOIS

The Electric Service Customer Choice and Rate Relief LawElectric Service Customer Choice and Rate Relief Law

was enacted and signed in 1997

The LawLaw is a 261 page document which

provides customer choice to all by 2002

lowers residential base rates

addresses utilities’ stranded cost recovery and

transition issues

reshapes the utility industry for the competitive

environment

refocuses the scope of regulation in Illinois to reflect

the future competition in electricity

ENERGY SOURCES FOR ELECTRICITY

66,418 78,481 267

45.7% 54.1% 0.2%

IL

Legend

coal/ oil/ diesel

nuclear

natural gas/ biomass/ renewable (hydro, wind, solar)

37,170 10,970 2,872

72.9% 21.5% 5.6%

27,933 13,243 1,327

65.7% 31.2% 3.1%

28,652 3,730 1,120

85.5% 11.1% 3.4%

WI

MI

IA

Source: DoE EIA

RENEWABLE ENERGY AND ENERGY EFFICIENCY

A Renewable Energy Resources Trust Fund (RERTF) is established with funding to equal $100 million over 10 years

All customers will be assessed charges starting 1/1/98:

$0.05 on each residential electric customer

$0.05 on each residential gas customer

$0.50 ($37.50) on each nonresidential electric customer with peak load below (above)10 MW

$0.50 ($37.50) on each nonresidential gas customer with annual load under (above) 4 million therms

RENEWABLE ENERGY AND ENERGY EFFICIENCY

These amounts will be shared equally by the RERTF and

the Coal Technology Development Assistance Fund

The Energy Efficiency Trust Fund is established through

the collection of $3 million annually over 10 years from

each electric utility and ARES

KEY TRENDS IN THE ELECTRICITY BUSINESS

State-by-state patchwork restructuring pattern

Breakup of the vertically integrated utility

Growing importance of energy trading

Underperformance of electric utility stocks

Horizontal aggregation

Generation divestiture

Normalcy of price volatility and price spikes

Grid regionalization

Increasing use of e-commerce in electricity

RETAIL ACCESS STATUS

25states withlegislation

1state withPSC order

19states with

studies

7states withno activity

VERTICALLY INTEGRATED UTILITY STRUCTURE IS DISINTEGRATING

Transmission ownership

Customer

Service

Marketing/trading

ISO

Ancillary servicesPower exchange

System

OperationsGeneration

Distributio

n wires

Generation

Transmission

CustomerService

Distribution

UNIT/PLANT SALES

CAPACITY ALLOCATION

reserved for real-timebalancing market

spinningreserve

hour-ahead market

day-ahead market

ENERGY PAYMENTS

balancing market energy( including AGC)

hour-ahead energy market

day-ahead energy market

AGC downward capability

WHOLESALE COMMODITY MARKETS

Petroleum

Aluminum

Gold

Electricity

Cattle/Calves

Grains

Natural Gas

Coal

Copper

Dairy

$ Billions Annually

91.5

53.8

39.6

33.6

31.7

22.4

18.1

34.6

26.6

21.0

UN

ITE

D S

TA

TE

SW

OR

LD

WID

E

THE POWER MARKETING AND ENERGY TRADING EXPLOSION

Utilities, financial houses, marketers, generating entities,

brokers, and speculators are buying, selling and swapping

power/energy on a huge scale with the total volume of trade

worth multiples of the value of the underlying commodity Electric power marketing is dominated by Houston

each of the top 20 power marketers trades gas 75% of all unregulated power marketing volume is

conducted from Houston with 25% of all the power

marketers headquartered there Multimillion dollar bets are placed on how weather can

affect demand for gas, heating, oil and electricity

0

100

200

300

400

500

600

700

800

900

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Source: Edison Electric Institute, Regulatory Research Services

POWER MARKETERS’ SALES

19960.2 billion

19992.5 billion

1998

2.3 billion19971.2 billion

INDEX COMPARISON

Data sources for Jan 1, 1995 - Dec 31, 1999

50%

195% 215%

455%

0%

100%

200%

300%

400%

500%

S&P UtilityIndex/ Dow

Jones UtilityIndex

Dow JonesIndustrialAverage

S&P 500 NASDAQComposite

Index

KEY IMPACTS ON THE ELECTRICITY BUSINESS

Underperformance of electric utility stocks push

companies into adopting new strategies:

diversification, including many nontraditional

businesses;

mergers

separation of high and low growth assets

Divestiture of assets of electric utilities by

transfer from regulated to unregulated; or

outright sale

THE M&A SCENE

Acquisitions of regulated utilities by IPP’s

Acquisitions of U.S. entities by foreign companies

Mergers of vertically integrated utilities

Purchases of energy businesses by investor groups

Convergence mergers of electric and gas utilities

QUICKENING PACE OF M & A

12

0

3

1

54

67

12 12

8

26

5

0

5

10

15

20

25

30

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Data source : EEI

GENERATION DIVESTITURE

27.4 TW

24.1 TW

17.8 TW

1997 1998 1999

$3.98 B

$10.2 B$10.6 B

Monday Tuesday Wednesday Thursday Friday

MAXIMUM AND AVERAGE HOURLY PRICES FOR JUNE 22 - 25, 1998

pu

rch

ase

pri

ce $

/MW

h

3000

1000

0

1 5 9 13 17 21 1 5 9 13 17 21 1 5 9 13 17 21 1 5 9 13 17 21 1 5 9 13 17 21

2000

4000

5000

6000

7000

8000

THE SUMMER 2000 MARKETSm

on

thly

to

tals

(B

illi

on

s) $

aver

age

pri

ce (

$/M

Wh

)

0.0

1.0

2.0

3.0

4.0

May June July August*(1-29 only)

0

50

100

150

200

cap price $750 $500 $250

average price $/MWh

DECLARATIONS OF EMERGENCY BY THE CA ISO

stage one appeals (operating reserves ≤ 7%)

stage two curtailment of interruptible (operating reserves ≤ 5%)

stage three load shedding (operating reserves ≤ 1.5%)

33

3

6

1998 1999 2000

3

38

24

14

summer

REGIONAL TRANSMISSION ORGANIZATION (RTO)

FERC’s functional unbundling has not resulted in the desired separation of transmission and market functions

Certain structural impediments to greater competition elimination of pancaked rates improved congestion management curbing of market power undertaking of improved regional planning procedures

are best addressed regionally RTO is a generic term for a new independent

transmission management structure that will control transmission operations and planning uniformly in large regions of the US

RTO’s may come in various flavors -- ISO, TRANSCO, grid or some combination

DISPERSED RESOURCES

Direct access coupled with advances in fuel cell and

microturbine development are leading some to

forecast that DR will replace the role played by today’s

power plants

The utilization of DR to date is, by and large, limited to

specific niche applications

Some DR companies have enjoyed dot - com success

in terms of stock appreciation

DISPERSED RESOURCES

Emergence of DR represents both opportunities and threats to the restructured business

new sources to help the supply - demand balance

disruptive technology to change the transmission system through generation solutions

The future penetration of DG is uncertain due to factors such as

technology advances

environmental aspects

economics

“integration” into the existing system

The future role of transmission is also uncertain

ELECTRICITY AND THE NEW ECONOMY

The electricity business is on the cutting edge of the

new economy

new economy runs on electricity

400 million plus web users internationally

62% growth in U.S. internet industry in 1999

over 80 million PC’s shipped annually

Reliable and competitively priced electricity is a key

requirement for the myriad applications and the

operations of web-based e - businesses

MAJOR CHALLENGES

Smoother operations of the balkanized electricity markets

Effective integration of new technology and application of

advances in information technology

Monitoring of market performance

Implementation of demand-side responsiveness

Green electricity

Efficient economic signals for robust and reliable

transmission system

Market-based congestion management schemes