Matt King is the director, markets & analytics, and John Chiles is a principal in transmission services at GDS Associates.
Recent opinion pieces have discussed the health and value of regional transmission organizations. One piece suggested that RTOs are sick and dying and should possibly be transitioned to one or more different types of organizations. A responsive piece argued that while imperfect, RTOs nonetheless provide great benefits. So, which is correct? Our view is both, at least to some degree, are correct.
As laid out in Federal Energy Regulatory Commission Order No. 2000, RTOs were envisioned around the turn of the century to bring efficiency and lower costs while maintaining reliable service. RTOs have gone about pursuing this goal by administering open access transmission service/interconnection and providing for centralized economic dispatch over a large geography.
Our view is that this fundamental RTO function does provide great benefit, is performed on a day-to-day basis with little objection, and is largely taken for granted. In this sense, the other functions that RTOs perform can be viewed as extensions to this fundamental function. However, areas that deviate from the RTO’s core purpose are laden with dysfunction and those are where the problems lie.
This has been most recently evidenced by the Midcontinent Independent System Operator and the PJM Interconnection delaying their respective capacity auctions. The regulatory and market uncertainty that exists is massive and unfortunate. Although transmission planning and interconnection queue logjams are also major issue areas for the same reasons (and are connected to resource adequacy outcomes), the struggle and dysfunction at RTOs has primarily occurred in the resource adequacy/capacity market venue.
The cause of RTO struggles
Why are RTOs struggling? In short, the cause is the valuation of new entrants in the transition of the generation fleet, growing reliance of the economy and country on electric reliability, and the stress of extreme weather. These factors are impacting RTOs today, and the RTOs are expecting greater impacts in the future.
Whereas the resource transition could formerly be viewed as a problem to be dealt with in the future, extreme weather events in the past several years have motivated RTOs to act in significant ways now. This can be well understood since RTOs are tasked with reliably operating the grid (and given what happened in the Electric Reliability Council of Texas footprint in February 2021, which led to the firing of its CEO, resignation of its board, numerous lawsuits, and criticism from the Texas governor).
As an aside, it’s worth noting that, in the aftermath of the February 2021 event, there was a shallow narrative in various industry settings that RTO areas were uniquely susceptible, but the extreme weather last Christmas, which caused load shed in the Tennessee Valley Authority area and Duke Energy (in the Carolinas), revealed that these are industry-wide challenges.
Why are capacity markets the primary setting for those struggles? To put it briefly, capacity markets are designed to determine the question of “how many” resources are needed (reserve margin modeling) and how resources should be counted as capacity (accreditation). Both are directly related to reliability events triggered by extreme weather (and infrastructure failures) and addressing future concerns around maintaining reliability during the ongoing resource transition.
So why then are RTOs struggling to make effective changes? We offer several possibilities. First and foremost, RTOs were not designed to manage a massive transition of the country’s generation fleet, although it appears they are increasingly expanding into this role. RTOs may be struggling simply because they are not-for-profit, stakeholder-driven organizations designed for a different purpose. Further, there may be a void of who should manage this transition (at least at the federal level) and as a result, RTOs are “filling the vacuum” based on their geographical scope and requirement to operate their systems reliably.
Although a federal carbon policy of some sort has been considered an inevitability, the apt question appears to be more of an “if” than a “when” at this point. Most recently in the Inflation Reduction Act, Congress stood firm on limiting its climate policy to indirect measures including research and development, tax incentives, and industrial policy. The Environmental Protection Agency also continues to promulgate stricter regulations on traditional generation.
Because of the lack of a direct federal policy, the resource transition is more bottom-up and driven by the goals and mandates of localities, states and corporations. This can lead to some genuine lack of clarity around how fast the resource transition should/will occur. In our experience, a lack of clear direction can frustrate RTO stakeholder processes. The state-mandated and federally-incentivized transition can also be viewed as in conflict with the RTOs’ fundamental role of achieving efficiency.
RTO-administered wholesale markets based on short-run marginal prices without direct federal policy lack the means to marry the environmental goals of the resource transition with its fundamental role of lowest reasonable cost. This void extends from the RTOs to their regulator, FERC. As a case in point, FERC required PJM to expand its Minimum Offer Price Rule, or MOPR, to counter the state subsidies (upsetting many) and then later a reconstituted FERC decided to largely reverse that decision. The result is not a definitive resolution as much as it is a rejection of the expanded MOPR.
A similar lens through which to view the struggle is the jurisdictional limitations of FERC and the RTOs. FERC oversees the RTO electric wholesale markets, but states maintain interests in resource planning because of their duty to ratepayers — an overlap that is evident in the MOPR example (PJM is a multi-state RTO which further complicates things). But jurisdictional limitations extend to other areas. For example, FERC and the RTOs do not have oversight of natural gas production or markets, but natural gas availability and deliverability concerns continue to play a significant role in recent electric reliability events, as most recently evidenced in December.
Potential policy solutions that could help resolve issues that the RTOs are facing include:
- Enactment of federal policy that harmonizes state and corporate environmental goals with federal markets and provides clear industry direction and pace of transition. However, after recent passage of the IRA, further energy legislation directed at such goals may not be a congressional priority for the foreseeable future.
- Guidance from FERC on key resource adequacy issues related to demand (risk modeling) and supply (accreditation). Such a posture from FERC would represent a shift from its recent practice of reviewing relevant RTO proposals on a case-by-case and regional basis.
- Further improvements to winterization (and other relevant) standards from the North American Electric Reliability Corp. Thus far, NERC’s action in this area has been moderate and implementation timeframes can be lengthy.
- Significant natural gas supply and coordination improvements resulting from the ongoing North American Energy Standards Board Gas-Electric Harmonization Forum process. Past harmonization efforts have failed to fully mitigate problems, but recent winter events may drive better solutions.
- Interconnection queue reform that allows for timely and efficient entry of new resources. Despite reform efforts, interconnection queues continue to become more clogged. But allowing for substantial annual resource additions would help mediate RTO resource adequacy concerns.
We expect RTOs will continue to grapple with managing the resource transition. RTOs will continue to use “markets” as their primary tool to incent desired reliability outcomes. Absent a significant shift in federal policy, RTO adjustments may continue to struggle to effectively address reliability concerns for the reasons laid out above. RTOs provide great value in operating the electric system every day, but they struggle with their role in the massive undertaking and challenge of managing a wholesale overhaul of that system.