Williams Comments to Senate Energy Committee Informational
Hearing on CAISO MD02 Proposal

-W. Kent Palmerton

Senator Bowen, members of the Committee, thank you for inviting me to speak this morning.

I have to tell you that I feel like I've been here before, on this same subject, in the same room, with many of the same players. Have you seen the movie Ground Hog Day? Actor Bill Murray, a weatherman on assignment to report on a famous ground hog and his shadow, wakes up day after day, after day to the same day until he finds….. The question begs asking, "What are we searching for?" What will it take to get us out of this cycle?

I submit to you, Senator Bowen, that we have another opportunity to get the Wholesale Market Design right this time. A number of ways have been proposed to get that job done. However, we shouldn't design away alone or in isolation. The CAISO may have a good start with their MD02 proposal, and as we speak, the CPUC is reviewing IOU procurement rights and obligations in an effort to get the State out of the energy procurement business. These are good starts, but the real action on Market Design is at FERC.

FERC is preparing a NOPR on Standard Wholesale Market Design and drawing national attention to this effort. A series of Technical Conferences are schedule this week. In addition, FERC Chairman Wood has made it a point to reach out to States and their Utility Commissions to solicit input to this FERC process - partly in response to earlier criticism that the FERC wasn't responsive to States interests. Furthermore, the FERC expects to tailor its "Standard" Market Structure to meet regional needs, with a serious emphasis on incorporating and I hope meeting regional stakeholders needs.

The State should not miss this opportunity to contribute to this over-reaching design effort to create a Wholesale Market Structure that will work for all market participants.

How do we get it right? There are a lot of options, and many may work, but only if they form a complete system. A system is, among other things, a complete set of relationships. Whether we prefer a strictly Bi-lateral market design or a fully optimized, centrally dispatched, nodal LMP model for the "market", we will be back here again if we don't fully specify our Electric Market System - from Wholesale Generation Obligations to Retail Rates. A word of caution, I don't mean fully describe each element, as in a command and control situation. Market relationships work, and they work well; we see this throughout our Nation's economy. I mean we must fully specify the relationships within the Electric Market System, make them compatible, comprehensive, and fully integrated. Furthermore, we need to be careful about the types of constraints we put on them so we don't get unintended consequences.

For example, in our haste to put the market together after AB 1890, the Legislature, CPUC, FERC and the CAISO all put constraints on certain market mechanisms or left some out altogether:

• The ability for IOU's for forward contract - Load got their "rate hedge" but Utilities were unable to hedge their wholesale cost exposure. The CPUC must allow appropriate Risk Management Methods to be employed by the IOUs. Furthermore, for any ACAP model to work, the CPUC must adopt workable prudence review standards.
   
• Transmission Rates, Firm Transmission Rights, and Transmission Expansion Mechanisms - for the most part, these elements were left unspecified and as such continue to plague our California markets. Furthermore, any Congestion Management methodology must be fully integrated with these "forgotten" transmission issues. Why? Because the Congestion Management system tells us the value of Transmission and therefore creates the primary incentive to expand the transmission system.
   
• Price Responsive Load - one of the basic tenants of any market is the ability of the demand side to be responsive to price, by its own choosing, i.e. to efficiently ration its consumption in return for some value or savings. Look what lower loads and more hydro energy have done to prices in California and elsewhere recently - lowered them. Some form of meaningful price response must be part of any new market design.
   
• Recovery of Fixed Costs - In a market environment of energy only prices and energy limited resources, Market Clearing Prices will reflect energy bids greater than "marginal costs" if there is not forward contracting, capacity payments or minimum load payments. Over some period, every generator "required by the market to serve load" must expect to recover its fixed costs or it should go out of business.
   
• Accurate representation of Physical Generation and Transmission Constraints - Intra-zonal congestion, infeasible dispatch instructions, unwarranted penalties and sanctions, and unrealistic operation expectations need to be addressed - especially if an optimal, security constrained dispatch, LMP market model is implemented as proposed by the CAISO. The CAISO must be able to accurately model and consider real generation and transmission constraints.

There is a lot of detail in the CAISO's proposal, but not nearly enough to understand how the entire "System" will perform. The devil is in the details. I would like to complement the CAISO staff for taking comments from their stakeholders and responding, in a major way, to delay the February 7, 2002 Board approval vote. However, as I said in my opening remarks, we should not miss out on this opportunity to participate and hopefully influence the ongoing market design efforts at the FERC.

FERC is responsive to California Wholesale Market Structure issues in at least three "venues", 1) In its National RTO Standard Market Structure development process, 2) By its agreement to accommodate regional differences to its Standard Market Structure, and 3) Through its contemporary orders to the CAISO to fix existing problems.

In each case, the State, the CPUC and all market participants need to show up at FERC and be counted. California has a lion's share of experience to offer. And in each case I think that we need to coordinate all our efforts, under each jurisdiction to make sure we "Fully Specify" all the relationships in whatever Wholesale Market Model we adopt on a National and Regional level.