Electricity Markets: FERC's Role in Protecting Consumers

Published by the Government Accountability Office on 2003-06-06.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States General Accounting Office
Washington, DC 20548

              June 6, 2003

              Congressional Requesters:

              Subject: Electricity Markets: FERC’s Role in Protecting Consumers

              The electricity industry is currently undergoing a restructuring, evolving from an industry
              characterized by monopoly utilities that provide consumers with electricity at regulated rates to
              a competitive industry in which prices are largely determined by supply and demand. The
              Federal Energy Regulatory Commission (FERC) has been engaged in this restructuring effort and
              is currently working, among other things, to foster competitive wholesale energy markets across
              the nation while protecting consumers against abuses of market power. At the retail level, about
              half the states have pursued restructuring their retail electricity markets in order to allow
              consumers such as residential, commercial, and industrial customers to choose their electricity
              suppliers. Proponents of electricity restructuring believe that it will ultimately provide
              consumers with lower electricity prices, more services, and technological innovation. However,
              opponents cite extremely high prices and market manipulation in California as evidence that,
              without more stringent oversight, restructuring may leave consumers vulnerable to higher prices,
              market manipulation, and less reliable service.

              In light of ongoing electricity restructuring efforts, you asked us to describe FERC’s role in
              protecting electricity consumers. This report does not evaluate FERC’s success in serving this
              role, but does provide examples of how FERC has acted previously to protect consumers. GAO
              plans to issue a report in the summer 2003 on the progress FERC has made so far in preparing
              itself to monitor competitive energy markets. A complete list of the requesters appears at the end
              of this report.

              Results in Brief

              FERC’s role in protecting electricity consumers is to ensure that prices in the wholesale
              electricity market are just and reasonable. Traditionally, FERC has ensured rates are just and
              reasonable in the wholesale market by regulating them based on a utility’s costs of service plus a
              regulated return on the utility’s investment. However, with the advent of greater competition in
              the electricity industry, FERC believes the best ways to ensure wholesale prices are just and
              reasonable today is by (1) fostering competitive regional wholesale markets that have balanced
              market rules (i.e., rules that encourage efficient behavior and infrastructure development and
              deter abusive behavior), (2) continuously monitoring these markets for anticompetitive behavior,
              and (3) enforcing or correcting market rules as needed. As part of these efforts, FERC oversees
              the interstate transmission system to ensure it remains open without discrimination to all buyers
              and sellers of electricity. This oversight also works to protect consumers by ensuring companies
              that generate electricity will be able to transmit their power without disruptions or inefficiencies.

              Page 1                                                          GAO-03-726R FERC Consumer Protection
FERC has limits on where and how it can protect consumers. For example, FERC does not
oversee wholesale electricity sales and transmission in areas where it generally lacks
jurisdiction, such as the areas served by federally owned utilities including the Tennessee Valley
Authority and the Department of Energy’s four federal Power Marketing Administrations,
publicly owned (municipal) utilities, and most cooperative utilities. In addition, states, rather
than FERC, have authority over the retail electricity rates paid by customers, the local
distribution of electricity, and the construction and siting of power plants and transmission lines
within their boundaries.


Established in 1977 as the successor to the Federal Power Commission (FPC), FERC is the
principal federal agency that regulates the electricity industry. An independent agency, FERC
obtains much of its legal authority over electricity from three sources: the Federal Power Act of
1935, which created the FPC and charged it with overseeing the rates, terms, and conditions of
wholesale sales and transmission of electric energy in interstate commerce; the Public Utility
Regulatory Policies Act of 1978, which opened the door for competition in the U.S. electricity
supply market by allowing nonutility generators that met criteria set by FERC to enter the
wholesale market; and the Energy Policy Act of 1992, which created a new class of electricity
supplier—the exempt wholesale generator—and led to FERC Order No. 888, which opened up
the national transmission system to wholesale suppliers. In fiscal year 2002, FERC had a budget
of about $191 million and funding for about 1,200 full-time staff.

The electricity industry is based on four distinct functions: generation, transmission, distribution,
and system operations. (See fig. 1.) Once electricity is generated, it is sent through high-voltage,
high-capacity transmission lines to electricity distributors in local regions. Once there, electricity
is transformed into a lower voltage and sent through local distribution wires for end-use by
industrial plants, commercial businesses, and residential consumers.

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Figure 1: Functions of the Electricity Industry

A unique feature of the electricity industry is that electricity is consumed at almost the very
instant that it is produced. As electricity is produced, it leaves the generating plant and travels at
the speed of light through transmission and distribution wires to the point of use, where it is
immediately consumed. Because electric energy is generated and consumed almost
instantaneously, the operation of an electric power system requires that a system operator
balance the generation and consumption of power. The system operator monitors generation and
consumption from a centralized location using computerized systems and sends minute-by-
minute signals to generators reflecting changes in the demand for electricity. The generators then
make the necessary changes in generation in order to maintain the transmission system safely
and reliably. Absent such continuous balancing, electrical systems would be highly unreliable,
with frequent and severe outages.

Since the early 1900s, electric utilities have been largely considered natural monopolies because
they have high fixed costs (the costs of large-scale power plants, transmission lines, and
distribution wires) and can lower their production costs as they increase the volume of
electricity they generate. At that time, large, centralized power plants were seen as the most
efficient and inexpensive way to produce and distribute electricity to retail customers. As a
result, utilities obtained exclusive service territories in exchange for the regulation of their retail

Page 3                                                            GAO-03-726R FERC Consumer Protection
rates and terms of service by state public utility commissions. Wholesale electricity generated
and transmitted for the interstate market came (and still resides) under FERC’s jurisdiction.

Technological advances, such as the development of smaller, less costly generation units, and the
passage of the Public Utility Regulatory Policies Act of 1978 created opportunities for companies
other than utilities to generate and sell electricity in the wholesale market. The Energy Policy Act
of 1992 gave FERC the authority, on a case-by-case basis, to require utilities to provide nonutility
generators with access to the utility’s interstate transmission lines. Subsequent FERC orders
advanced this principle, requiring most utilities to provide nonutility generators access to their
interstate transmission lines on a nondiscriminatory basis. Several states have restructured their
intrastate market to allow retail customers to choose their electricity provider while retaining
their utility’s traditional distribution services. As we reported in December 2002, 24 states and
the District of Columbia had enacted legislation or issued regulations opening their retail
markets to competition.1 Of those, 17 states and the District of Columbia were implementing
programs that enable retail customers to choose their electricity supplier.

FERC’s Role is to Protect Consumers through the Wholesale Markets

FERC’s role with respect to protecting electricity customers is to ensure that prices in the
wholesale electricity market are just and reasonable and to oversee the interstate transmission of
electricity.2 Traditionally, FERC approved its regulated rates for wholesale electricity based on a
utility’s cost to generate and transmit the power, plus a rate of return on investment. Opponents
of cost-based rate regulation contend that it is less efficient than market pricing and results in,
among other things, over investment in a utility. In light of the advances in technology, the
introduction of nonutility power generators, and the nation’s general shift in policy over the past
three decades away from government regulation and toward markets, FERC now believes that
the best way of achieving just and reasonable rates is to

•   foster competitive regional wholesale markets that have balanced market rules (i.e., rules that
    encourage efficient behavior and infrastructure development and deter abusive behavior),

•   continuously monitor these markets for anticompetitive behavior, and

•   enforce or correct market rules as needed.

Under this approach, FERC’s first goal is to advance the development of competitive wholesale
markets by implementing clear and balanced market rules and regulations on sales and
transmission. According to FERC, establishing balanced market rules up front encourages
efficient behavior and infrastructure development and deters abusive behavior in the market.
More specifically, following Order No. 888, FERC approved the creation of independent system
operators for New England, the Mid-Atlantic states, New York, and California to operate

 U. S. General Accounting Office, Lessons Learned from Electricity Restructuring: Transition to Competitive
Markets Underway, but Full Benefits Will Take Time and Effort to Achieve, GAO-03-271 (Washington, D.C.: Dec. 17,
 Although FERC has authority to oversee the interstate transmission system, the North American Electric Reliability
Council (NERC) makes sure the interconnections among transmission systems work reliably by developing and
monitoring standards of operation.

Page 4                                                                    GAO-03-726R FERC Consumer Protection
wholesale energy markets and transmission systems within their regions. Then, in December
1999, FERC issued Order 2000, which encouraged all privately owned utilities to voluntarily place
their transmission facilities under the control of a broader market entity called a regional
transmission organization (RTO). RTOs are intended to bring the nation’s transmission systems
under regional control in order to increase access for all suppliers, improve management of
system congestion and reliability, and achieve fully competitive wholesale power markets. Since
issuing Order 2000, FERC has approved the creation of two RTOs—the Midwest Independent
Transmission System Operator, Inc. (Midwest ISO) and the PJM Interconnection. Five others are
in various stages of the approval process—GridFlorida, GridSouth, RTO West, WestConnect, and
SeTrans3. Additionally, in July 2002, FERC issued a Notice of Proposed Rulemaking to establish a
standard market design for all jurisdictional electric transmission providers. In FERC’s view, the
proposal will enable sellers to transact for electricity more easily across transmission
boundaries, thus potentially bringing more sources of electricity to consumers and allowing them
to receive the benefits of lower-cost and more reliable electricity supply. Since 1992, FERC has
granted authority to more than 850 companies to charge market prices for their electricity,
provided that the companies comply with market rules and charge wholesale prices that are just
and reasonable.

Second, according to FERC, it will also monitor these markets and thereby protect consumers by
proactively identifying market violations or mismanagement. In order to better monitor markets
for anticompetitive behavior, in August 2002, FERC established the Office of Market Oversight
and Investigations (OMOI). The role of this office is to scrutinize wholesale energy markets in
order to identify issues before they develop into major problems and to monitor the market to
ensure that participants play by the rules. In addition, to help monitor the markets, the Office of
Market Oversight and Investigation manages FERC’s Enforcement Hotline, which is designed to
provide industry participants and the public a way to tell the commission their concerns or
complaints about behavior in electricity markets. In 2002, the Hotline handled 584 calls.

Finally, to enforce or correct market rules, FERC, through OMOI, is conducting investigations
that are either self-initiated or result from Hotline complaints or other referrals by industry
participants. According to FERC, as of May 1, 2003, OMOI’s Divisions of Enforcement and
Operational Investigations were conducting 38 investigations related to electricity matters such
as generator practices, undue discrimination, or market manipulation. Between June 2002 and
midApril 2003, the division resolved or terminated 18 investigations. Several of these
investigations led to enforcement actions that either provided payment of refunds, civil penalties,
or investigation costs or provided corrections to market rules to help ensure generation can
adequately meet increased demand.

 As we reported in December 2002, Midwest ISO operates in Illinois, Indiana, Iowa, Kentucky, Michigan, Minnesota,
Missouri, Montana, North Dakota, Ohio, South Dakota, Virginia, Wisconsin, and Manitoba (Canada). PJM operates in
Delaware, the District of Columbia, New Jersey, Maryland, Ohio, Pennsylvania, Virginia, and West Virginia. GridFlorida
operates in Florida. GridSouth operates in North Carolina and South Carolina. According to FERC, RTO West operates
in Washington state, Idaho, Montana, Oregon, Nevada, Wyoming, Utah, and a small part of northern California.
WestConnect operates in Arizona, Colorado, New Mexico, and Utah. SeTrans operates in Alabama, Arkansas, Florida,
Georgia, Louisiana, Mississippi, South Carolina, and Texas.

Page 5                                                                     GAO-03-726R FERC Consumer Protection
Portions of the Wholesale Market are Not Subject to FERC Jurisdiction

Some entities in the wholesale electricity market operate outside FERC’s statutory jurisdiction.
These entities include the Tennessee Valley Authority and the Department of Energy’s four
Power Marketing Administrations.4 In addition, the Federal Power Act of 1935 excludes publicly
owned utilities, such as municipal utilities, public power districts, and irrigation districts, as well
as most cooperatively owned utilities from FERC’s jurisdiction. Publicly owned utilities are
usually nonprofit and are regulated by the government organization that owns them, while
electric cooperatives are owned by and provide service primarily to their members. Most
cooperatives do not sell electricity on the wholesale market or transmit electricity interstate.

Figure 2: Jurisdictional Territories of FERC and Power Entities Not Subject to FERC, 2002

                                     Notes: Areas served by entities generally not subject to FERC jurisdiction include areas
                                     served by publicly owned entities such as municipal utilities, cooperative utilities, and

                                     Data on service territories include some overlaps, indicating that some areas are
                                     served by both entities subject to FERC jurisdiction and entities not generally subject to
                                     FERC jurisdiction, particularly some areas in Pennsylvania, Michigan, Wisconsin, and
                                     Iowa. Data reflected above depict those areas of overlap as not generally subject to
                                     FERC jurisdiction.

                                     Portions of the map without shading indicate either that no electric service is provided
                                     or the service area is very small.

The Power Marketing Administrations are Bonneville, Western Area, Southeastern, and Southwestern.

Page 6                                                                        GAO-03-726R FERC Consumer Protection
As shown in figure 2, power entities generally operating outside FERC’s jurisdiction represent a
significant share of the electricity market. Together, they currently provide service for about 25
percent of the nation’s consumption of electricity and constitute an even larger portion of the
electricity market in some areas. For example, in Nebraska, municipal utilities, cooperatives, and
other suppliers not explicitly subject to FERC’s jurisdiction provide almost all of the state’s
electricity. Many of the entities operating outside FERC’s jurisdiction reside in the Southeast,
Midwest, and West. In addition, municipal utilities, cooperatives, and federally-owned power
entities own about 30 percent of the nation’s transmission system. Lines owned by
nonjurisdictional entities are prominent in the South and West.

States Regulate Retail Electricity Markets

Although FERC has regulatory authority over most of the interstate wholesale market in
electricity, states have authority over the retail electricity and distribution markets and thus
regulate the retail rates paid by residential, commercial, and many industrial customers.5 In a
majority of states, public utility commissions set consumers’ retail rates based on a utility’s cost
of service plus a rate of return on investment. As we reported in December 2002, 24 states have
enacted legislation or regulations to open their retail electricity markets to competition.
Seventeen of those states and the District of Columbia have implemented programs enabling
residential, commercial, and industrial customers to choose their electricity provider. However,
of these 17 states, most have frozen their retail electricity prices at levels equal to or less than the
retail cost-of-service rates that were in place at the outset of competition.

In addition to setting rates in the retail electricity market, states have the authority to approve
the construction and siting of power plants and transmission lines. To be built, these facilities
usually require the approval of the state’s public utility commission as well as the consent of
other state and local government agencies on environmental, zoning, and energy policy issues.
Although transmission lines increasingly serve regional needs and can cross state boundaries,
state and local governments make many of the decisions on whether and where to site new lines
and thus potentially have significant impact on the transmission system’s reliability and the
amount of electricity it can deliver to consumers.

Agency Comments

We provided FERC with a draft of this report for its review and comment. In general, FERC’s
Chairman agreed with our report and its depiction of the commission’s role in protecting
electricity customers. The Chairman suggested technical and editorial changes that we included
as appropriate.

 Wholesale energy trades within a state--for example, when a municipality purchases power from a generator in the
same state--are regulated by the state’s public utility commission. In addition, FERC has no jurisdiction over the
wholesale market in Hawaii and Alaska because, being geographically separated from the contiguous U.S., these states
have no interstate trade in electricity. Similarly, FERC has no jurisdiction over wholesale electricity trades in much of
Texas because the state has few connections with the two major interstate grid systems in the United States, the
Eastern and Western Interconnect.

Page 7                                                                       GAO-03-726R FERC Consumer Protection
Scope and Methodology

To obtain information on the ways in which FERC can protect consumers, we reviewed industry
reports, academic literature, and discussed the issue with officials from FERC’s Office of
Markets, Tariffs, and Rates and Office of Market Oversight and Investigations. To obtain
information on FERC’s jurisdiction, we reviewed applicable statutes and federal rules. To
identify areas of consumer protection and concerns, we reviewed industry publications and
interviewed officials with consumer advocacy groups. In addition, we spoke to officials with the
National Association of Regulatory Utility Commissioners and the Electricity Consumers
Resource Council.

We performed our work between November 2002 and May 2003 in accordance with generally
accepted government auditing standards.

                                           -   -   -   -   -

As agreed with your offices, unless you publicly announce its contents earlier, we plan no further
distribution of this report until seven days from the date of this letter. At that time, we will send
copies to appropriate congressional committees as well as to the Chairman, FERC, and the
Director, Office of Management and Budget. We will also make copies available to others upon
request. In addition, the report will be available at no charge on the GAO Web site at

If you or your staff have any questions about this report, please contact me at (202) 512-3841. Key
contributors to this report include Dan Haas, Daren Sweeney, Randy Jones, Carol Kolarik, Jon
Ludwigson, Frank Rusco, Jonathan McMurray, and Barbara Timmerman.

Jim Wells
Director, Natural Resources
 and Environment

Page 8                                                          GAO-03-726R FERC Consumer Protection
List of Congressional Requesters

The Honorable Robert E. Andrews
United States House of Representatives

The Honorable Brian Baird
United States House of Representatives

The Honorable Tammy Baldwin
United States House of Representatives

The Honorable Shelley Berkley
United States House of Representatives

The Honorable John Conyers, Jr.
United States House of Representatives

The Honorable Peter DeFazio
United States House of Representatives

The Honorable Sam Farr
United States House of Representatives

The Honorable Bob Filner
United States House of Representatives

The Honorable Michael M. Honda
United States House of Representatives

The Honorable Dennis J. Kucinich
United States House of Representatives

The Honorable Tom Lantos
United States House of Representatives

The Honorable Barbara Lee
United States House of Representatives

The Honorable Carolyn Maloney
United States House of Representatives

The Honorable Karen McCarthy
United States House of Representatives

The Honorable James P. McGovern
United States House of Representatives

The Honorable George Miller
United States House of Representatives

Page 9                                   GAO-03-726R FERC Consumer Protection
The Honorable Bill Pascrell, Jr.
United States House of Representatives

The Honorable Bernard Sanders
United States House of Representatives

The Honorable Hilda L. Solis
United States House of Representatives

The Honorable Fortney Pete Stark
United States House of Representatives

The Honorable Tom Udall
United States House of Representatives

The Honorable Maxine Waters
United States House of Representatives

The Honorable Robert Wexler
United States House of Representatives

Page 10                                  GAO-03-726R FERC Consumer Protection
Enclosure I: Comments from the Federal
Energy Regulatory Commission

       Page 11          GAO-03-726R FERC Consumer Protection
           Enclosure I: Comments From the Federal Energy Regulatory Commission

           Page 12                                                 GAO-03-726R FERC Consumer Protection
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