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California: Nuts & Bolts Lessons from the “School of Hard Knocks”

Susan R. SchneiderJuly 6th, 2014

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CALIFORNIA EXPERIENCE

California/CAISO market overview

Restructuring motivation & “horsetrading”

How things actually worked

Lessons & reflections

Challenges ahead

CALIFORNIA MARKET OVERVIEW

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CALIFORNIA REGIONAL SYSTEM OPERATORS

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CAISO STATISTICS Combined service areas of PG&E, SCE, SDG&E,

and several municipal utilities

Peak demand >50,000 MW

124,000 square miles

25,000 circuit-miles (~75% of California grid) 1,400 power plants (~55,000 MW), more than England and

France combined Serves ~12% of U.S. population (30 million people)

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TRANSMISSION CONGESTION CONSTRAINS ECONOMIC DISPATCH

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CAISO FEATURES

Structure: Non-profit “public benefit corporation” (not a state agency)

Funding: Surcharges (Grid Management Charges) on market schedules, transactions, & other grid use (first call on funds)

Governance: 5-member independent Board appointed by the California Governor

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CAISO ACTIVITIES Forward schedule management:

Day Ahead (10am), Hour Ahead, Fifteen Minute Congestion management & market optimization (energy, unit

commitment, reserves), based on economic bids

Real-time (RT) operations: 15-minute unit commitment, 5-minute economic dispatch

After-the-fact settlements and billing

Transmission/generation outage coordination

Transmission & grid planning

Generation interconnection studies/contracts

Market monitoring

MARKET PRICING STRUCTURE

Market-clearing prices for energy: Maximum bid and clearing prices Zonal pricing structure first Nodal pricing now (3,300 pricing nodes)

Ancillary Services Regulation, Spinning Reserve, Non-Spinning Reserve Includes opportunity costs for energy if not dispatched

Real-time differences from forward schedules billed/paid at RT price

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OTHER KEY MARKET ENTITIES Government entities

California Public Utilities Commission: Oversees energy procurement & contracting (IOUs), transmission siting/permitting, retail rates

California Energy Commission: Oversees generation siting & permitting, long-range planning & policy

Other entities Participating Transmission Owners (3 large IOUs, 13 others) Scheduling Coordinators (100+) Load-Serving Entities (LSEs) – Utilities, Community Choice

Aggregation, others Suppliers – Generators & import suppliers/traders

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RESTRUCTURING – MOTIVATION & “HORSETRADING”

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RESTRUCTURING DRIVERS (1980s – Early 1990s)

Trend toward deregulation (“Reagan revolution,” airlines, natural gas (30% of market)) – “Government is part of the problem.”

Utility monopoly under fire (cost overruns, high rates, capacity surplus, modular technology) – perception of utility inefficiency, “Markets can do better.”

Muni pressure for transmission access

Business pressure for retail competition (natural gas deregulation, high costs, bad economy, relocation threats) – competition as a way to “do something” without hurting others.

AB1890 – The “Steve Peace Death March”

CPUC examination of open markets in 1993-1995, but legal authority for change not clear

Big battles in California State Legislature between utilities, business/competition advocates, labor/unions, & consumer interests

Grand bargain struck between these interests, and legislation passed both houses of the legislature unanimously in late 1996

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ORIGINAL BARGAIN – SOMETHING FOR EVERYONE! Retail customer protection (especially small ones)

All customers get “choice” at the same time (1/1/1998) 10% rate reduction (bonds), then rates frozen Consumer protection rules for new retail suppliers &

education effort

Independent System Operator (CAISO) Transmission control – IOUs still own assets (and earn

returns) but don’t control them operationally Open-access system – transparent tariffs & operating

procedures (corporate doc on CAISO Web site – www.caiso.com) 16

ORIGINAL BARGAIN (2)

Instant competition, labor protection - multiple suppliers immediately through utility divestiture 50% of gas capacity required, incentives to divest more Buyers required to keep existing workforce for 2 years

Cost coverage: Use “headroom” between frozen retail rates & lower market energy costs to: Recover utility “stranded” & transition costs

(including labor severance, retraining, early retirement, and outplacement) and rate-reduction bond payments

Continue “Public Purpose” programs (low-income, conservation/energy efficiency, renewables)

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SO WHAT COULD GO WRONG?

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IMPLEMENTATION

Implementation was difficult, expensive, and rushed.

Design details took years – not enough time for 1/1/98 “start-from-scratch” effort

Late market start – 4/1/98, just before peak season

Had to use off-the-shelf software, multiple vendors – interface issues, high costs ($200m)

Some elements (e.g., market monitoring) not sufficiently addressed

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CONSUMER PROTECTION

Many consumer protections did not work as expected.

All got 10% discount

Large customers were courted by suppliers

Small customers were mostly not, and only got additional real and sustainable options later

Reliability suffered, and rolling blackouts were called in northern California in winter 2000-2001

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RECOVERY OF STRANDED & TRANSITION COSTS

Insufficient “headroom” – wholesale energy costs exceeded frozen retail rates.

Wholesale energy prices fell initially but then rose: $29/MWh in 1998, $31/MWh in 1999, $110/MWh in 2000

Generation surplus became shortage Annual demand growth 1-2% in early 1990s, 3-4% in 1998-9, >5% in

2000 (demand growth also in surrounding import markets) Lack of new capacity – no entity would sign contracts; utilities

stopped building for several years, and no one stepped in right away Questionable maintenance & forced outages

Market power issues with congestion & market structure – extensive litigation for refunds from private & public suppliers21

INSTITUTIONAL FAILURES

One of the two largest utilities declared bankruptcy

Utilities couldn’t pay bills – wholesale power exchange failed

Recall of California governor (out went Gray Davis, in came the “Governator”) – energy crisis an important factor

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EVENTUAL RECOVERY (1) New resources came on-line

State stepped in to execute long-term contracts for new generation (creditworthy counterparty)

Contracts were expensive, rushed, & not well-negotiated, but they did bring on new capacity

Improved market monitoring & rules, e.g.: Imposition of bid-price caps, other conduct rules Establishment of conduct rules, performance metrics Institution of generation maintenance and outage

standards & practices

Settlement of much crisis-era litigation23

EVENTUAL RECOVERY (2) – LSE Procurement Obligations

LSE “obligation to serve” clarification: Must procure (own/contract) resources for their loads

Resource Adequacy (RA) Requirements Capacity to serve peak load + Planning Reserve Margin Specific RA requirements in “load pockets” Bilateral PPAs with performance incentives & penalties Must-offer obligations for RA Resources (key feature)

Return of integrated resource planning (CPUC): Procurement separated from transmission functionally but considers transmission “adders”

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REFLECTIONS & LESSONS LEARNED

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TRANSITION, TRANSITION!

The journey can be as important as (or more important than) the destination

With multiple complex changes all at once, things will not turn out as expected – flexibility and contingency plans are needed in case problems arise

“Trust, but verify.” (RR)

Market roles & rules must be clear throughout – don’t leave gaps, especially for obligation to serve and conduct rules

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IMPLEMENTATION MECHANICS

Small details can take a lot of time to address (e.g., meter-data sharing, billing procedures & disputes)

Consider building on existing software, processes

Consider phased implementation(e.g., wholesale before retail, critical changes in stages, large

customers before small customers, gradual granularity improvements)

Don’t deploy major changes before peak season

Provide authority/process to reverse or delay changes if problems arise

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DIVESTITURE REQUIRES CAREFUL CONSIDERATION Added suppliers but also problems

Quick, low-risk California market entry by buying removed the need for new entrants to build

Divested assets (gas gen) were market-critical Utilities divested 100% (40% of total nameplate capacity) “Pairing” of divested plants reduced buyer diversity Natural gas was the supply “at the margin,” i.e., set

market prices and needed for system balance Plants located in critical areas (load pockets) – that’s why

they were sited there in the first place28

LONG-TERM, SECURE FUNDING CRITICAL FOR NEW INVESTMENT

Short-term markets don’t facilitate long-term investments - financing new plants requires: Coordinated resource procurement & transmission –

requires coordination by multiple oversight entities Creditworthy counterparties, secure revenue sources Limitation of long-term market risks to generators

Short-term price signals don’t necessarily incent the “right” new resources, in the “right” place

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RISK MANAGEMENT BY LSEs – Typical PPA provisions LSEs & suppliers execute bilateral PPAs LSE receives all capacity benefits (RA credit) and

any renewables credits for project PPAs provide for:

Payment terms for project output Availability & production guarantees Any curtailment provisions

LSE is Scheduling Coordinator for project Bids project output into CAISO markets, receives revenues Manages market revenue-PPA difference

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PRICING STRUCTURE – Short-term Market Clearing Price

Theoretically efficient for dispatch and encourages bidding at marginal cost, but has shortcomings

Bidding prices/practices (and outages) for one plant can affect revenues suppliers receive for others

Inflexible demand can cause price spikes

Other thoughts Tradeoffs between accuracy and simplicity (80-20 rule) Negative prices needed for market solutions

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MARKET MONITORING

Clear market conduct rules & consequences

Transparent & regularly reported metrics – how do you know the market is working well?

Congestion/load pockets and MCP structure require additional monitoring

Diverse monitoring staff is desirable, including personnel with actual market experience

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ELEMENTS THAT WORKED (1)

Open transmission access: Posted tariffs, operating/interconnection procedures, etc.

Open stakeholder processes Standard, open decision-making process Decisions take longer, but all parties have a say,

and hopefully the decisions are better

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ELEMENTS THAT WORKED (2)

Generator interconnection process reform Private investment & financing requires defined study

processes & timelines Applications may increase greatly – consider cluster

studies, diverse cost allocation, up-front upgrade funding

Transparent transmission planning process Publicly available study plans & study results Stakeholder meetings & comment opportunities Recent institution of competitive construction

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SMALL-CUSTOMER OPTIONS

Significant transaction costs prevented mass-market penetration of third-party energy marketing to individual customers (a la Enron)

Most consumer benefits via other means: Energy efficiency – appliance & building standards,

audits/retrofits, and rebates/tax credits Community Choice Aggregation: “Opt-out”

community-based energy procurement programs, usually offering higher renewable-energy service/options

“Behind-the-meter” applications like rooftop solar (highly subsidized)

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“UNCONVENTIONAL” RESOURCES CAN HELP

“Intermittent” resources can be predictable and dispatchable with the right data & forecasting tools

Flexible demand can be a viable resource Can mitigate market power, lower peak supply costs Works best under same structure as new generation

– long-term programs or contracts Is usually undervalued – credit not given for MCP

reduction or infrastructure impacts36

ARE “WE” BETTER OFF NOW?

Difficult to know – there is no control group or objective standard.

The market is more open, broader, and possibly more efficient – larger operational areas, strong incentives to run plants efficiently, greater procurement planning/oversight

There are more options available in the market

Restructuring is probably not the only way to obtain these benefits (80-20 rule) 37

CHALLENGES AHEAD

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SELECTED CHALLENGES AHEAD

Integration of renewable resources Renewable Portfolio Standard: 33% of retail sales must

come from specific renewables (wind, solar, geothermal, biomass, biodiesel, small hydro) by 2020

40% & 50% RPS under consideration Flexible RA requirement, new “ramping” product

Storage valuation & deployment Now expensive but helps energy production follow load,

and costs may decline over time 1,300 MW CPUC-mandated procurement Pumped-storage proposals 39

THE “TRANSITION” IS NEVER REALLY FINISHED

New generation technologies

New end-use technologies

New societal/market objectives & tradeoffs

“The only constant is change.”

- Anonymous

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Susan Schneider

Founder & Principal of Phoenix Consulting, Inc.

Former CAISO VP (at start-up)

Former PG&E executive supervising retail electric & gas market restructuring

Published newsletter on CAISO wholesale market issues for 10 years

Advises generation clients in interconnection process, PPA negotiations, CAISO stakeholder processes

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