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<title>August 2000: Demand Common Sense</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<td width="75%" valign="top"><img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" WIDTH="375" HEIGHT="75"><p><b><u>August
2000</u><br>
</b></p>
<p><b><font face="Arial" size="6">Demand Common Sense</font></b></p>
<p><strong>by Roger Feldman -- Bingham, Dana L.L.P.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine Magazine:
2000/08</em>)</font></p>
<p><font face="Arial" color="#000000">By the time this column is
published, it will be time for post mortems on the "great legislative
fix" of 2000. One may have a certain confidence, however, that
however substantial or modest or non-existent that fix may turn out to be,
it will be at best ameliotory and likely addictive (i.e. necessitate more
fixes to come).</font></p>
<p><font face="Arial" color="#000000">The reasons are simple: Deregulation
is not as great a thing in the electric industry as it has been (at least
by some key criteria) in other formerly regulated industries. To the
extent deregulation is going to be made to work, the key lies in the
substantial physical revamping and upgrade of the grid on a national basis
and emphasis on demand management breakthroughs. While the best aspects of
the proposed legislation would create a better regionally based
infrastructure to oversee "reliability," it at best offers an
improved long-term institutional approach to a market that is physically
discontinuous.</font></p>
<p><font face="Arial" color="#000000">A key data point which supports this
observation is the great price cap war currently raging. Regulator after
regulations in the Deregulated States of America now has sought to address
the summer shortage and price spiking phenomenon by one of the most
ancient of means: fiat, California has been the most visible battleground.
There, the godfather of that state’s mother of all deregulation bills
– paradoxically surnamed "Peace" - now wrestles with the ISO
over whether it should have price control power. The debate is framed in
classic economic terms – but unfortunately without reference to the
unique characteristics of the commodity in question. It runs like this,
distorted markets produce unjust and unreasonable pricing. Would be
suppliers are diverted to more attractive markets. The prospects of
shortage and rationing are induced. The wraith of reregulation unleashed
on the land by pusillanimous populists.</font></p>
<p><font face="Arial" color="#000000">To which the aforesaid populists
respond by arguing that California’s so-called deregulation which
effectively preserved incumbent utilities market shares – thereby
permitting stranded cost recovery – is not a true deregulated "open
market" at all. They then go on to challenge deregulation as being
supported on the flawed premise that raising prices now somehow will lead
to lower prices. They further point out that this proposition represents
the abandonment of the rationale for deregulation when it was originally
proposed: that it</font> <font face="Arial" color="#000000">would lower
prices, because, that is simply what competition necessarily does.</font></p>
<p><font face="Arial" color="#000000">Insight into the merits of the
argument may be gained from a recent article. "Electricity
Restructuring: Deregulation of Reregulation" which appeared recently
in Regulation, a publication of by the generally</font> <font face="Arial" color="#000000">pro
free market Cato Institute. Focusing on consumer price response to market
price signals as the likely best source of the</font> <font face="Arial" color="#000000">beneficial
efficiency desired from industry deregulation, it reaches the</font> <font face="Arial" color="#000000">following
empirical conclusion which lies at the crux of the debate described
above: </font></p>
<p><font face="Arial" color="#000000">"Thus far in the United States,
real time consumer price response has not developed either in regions that
have restructured or in those that have remained under traditional
regulation… (T)he need for price responsive demand is made greater in a
less regulated</font> <font face="Arial" color="#000000">environment."
(emphasis added) </font></p>
<p><font face="Arial" color="#000000">The article then emphasizes the
potential adverse effects of deregulation unaccompanied by consumer price
signal response. While electric generation may have become a commodity
(and one that has been underdeveloped in recent years), it is a commodity
marked by a high-cost of storage; for which there is a need to balance
supply and demand on a second-for second basis; and for which (at this
stage of technology development), end use consumer demand price
observation and response capability is minimal. The result is a situation
where producers can, at certain times, command extremely high prices
(particularly as reserve margins shrink). This is because the electric
good is not storable to defend against vulnerability and because, market
demand cannot shift to other willing suppliers. Under these circumstances,
there are times when even firms with small market share can exercise
significant power. Concentration measures suitable to measure market power
in other industries may well not be suitable to</font> <font face="Arial" color="#000000">electric
power. </font></p>
<p><font face="Arial" color="#000000">Moreover, "free trade"
scenario which is supposed to accompany deregulation, i.e. power flowing
competitively among markets, is a partial fiction. Analyses of prices
under "free trade" and "regulated trade" in the
Northeast in this regard, to determine if interregional</font> <font face="Arial" color="#000000">power
movement will respond to deregulated market opportunities is revealing in
this regard. Application of optimal computer flow (OCF) algorithms produce
conclusions like the following: in a scenario where more power is freed up
in ECAR and PJM to be made available to NEPOOL, nevertheless calculated
NEPOOL prices actually may rise as a result of the operation of
transmission constraints. </font></p>
<p><font face="Arial" color="#000000">This analysis in Regulation suggests
that the great price cap war ought to be understood by regulators to
suggest a need for a larger number of more specific demand side oriented
solutions than are being proposed in the "comprehensive"
standards presently being proposed on the Hill. Some recent examples
illustrative of the directions which, if properly coordinated and writ
large, might begin to address the difficulties electricity deregulation
has presented include the following: </font></p>
<p><font face="Arial" color="#000000">• PJM’s initiative to make it
easier for distributed generators to hook up to the grid and to encourage
large users to generate onsite during peak demand periods (the Customer
Load Reduction Pilot Program);</font></p>
<p><font face="Arial" color="#000000">• Proposals by EEI to encourage
investors to enter the transmission business (e.g. risk adjusted returns
on equity to attract capital to profit-making incentives to encourage
transmission operators to reduce congestion).</font></p>
<p><font face="Arial" color="#000000">• Emergence of e-commerce web
clearinghouse end-to-end load management service for utilities and
aggregators to sell to commercial and industrial customers, e.g.
sell excess onsite generation and curtailed load to utilities, retail
energy service companies and aggregators when prices spike. </font></p>
<p><font face="Arial" color="#000000">It is measures like these which will
enable the industry to get beyond rhetorical battles of "freedom of
choice" versus "people power." Electricity is a
sophisticated commodity; facilitating meaningful market demand response to
price signals is the key to common sense. We should demand common
sense.</font></p>
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<p class="MsoBodyText" align="left" style="margin-bottom:0in;margin-bottom:.0001pt;
text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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