In discussions about whether utilities should join such markets, some have asserted that there are no unbiased studies of their benefits. Others have questioned wholesale market benefits because retail electricity rates in some market regions are higher than other regions that are not part of these markets. However, these assertions do not address the academic studies showing that RTO markets have produced cost savings and how other costs utilities include in customer bills erode these savings. Further, comparing rates in different market and non-market regions is an inappropriate counterfactual.
This post will summarize key independent studies on wholesale market savings and how retail-level issues can offset these efficiency gains. In doing so, it clarifies that there are at least two separate questions relevant to considering options for enhancing electricity sector competition:
Whether utilities should participate in organized wholesale electricity markets, even if these markets are imperfect; and
How to structure utility incentives to ensure they cost-effectively serve customers. Conflating these two questions may lead us to miss the benefits of greater market efficiencies as well as the opportunities to diagnose and fix the real problems.
As an initial matter, it is important to clarify why commonly made rate comparisons across markets and non-markets regions are unsound.
First, electricity rates are determined through factors other than the presence of a market, such as fuel, land, tax, labor, and regulatory compliance costs. These tend to be higher in more populated areas, and market regions include the largest U.S. metropolitan centers. The appropriate comparison for studying the impact of markets is thus not between different regions with and without markets, but to compare how a given region would look like with and without markets.
Second, rates as a metric do not fully convey information important to assessing social welfare. Customers ultimately pay bills, and utilities with energy efficiency or low-income assistance programs can have higher rates but lower total bills. Further, energy burden, by comparing bills to income, can better distinguish between regions with high energy consumption due to greater wealth from communities where energy bills can compete with essential household budget items. Notably, energy burden is not more significant in market regions.
Independent retrospective studies find RTO cost savings to be substantial
RTO savings largely come from more efficient use of existing resource fleets and reduced need for additional resources. While the compounded savings from avoided investments are projected to be an order of magnitude greater than the production cost savings from efficient use of existing assets, most studies have focused on the latter.
RTO markets have reduced production costs by increasing trade, better coordinating power plants, and driving efficiency improvements at plants, according to the most cited literature surveyed by U.C. Davis and Dartmouth researchers. Recent academic studies have quantified efficiency gains from wholesale electric energy trading.
A University of Chicago researcher estimated that wholesale markets nationwide saved about $3 billion per year in production costs, based on data from 1999-2012. The savings accrued from greater use of lower-cost plants and increased trading among utilities. The author noted that while market power was a concern, this was far outweighed by market efficiency savings.
A Dartmouth study found that 19 Midwest utilities joining PJM in 2004 produced efficiency gains of over $160 million annually, exceeding the one-time $40 million implementation cost. These Midwestern utilities already had been trading bilaterally with their eastern neighbors. After joining PJM, the energy traded between them tripled, and production shifted to lower-cost facilities as the market identified new trading opportunities.
An Oberlin study examining Texas’ transition from a bilateral market to a centralized auction found improved market efficiency that dominated any change in market power incentives. Following the transition, production shifted to lower-cost generators, leading to annual cost savings of about $59 million.
Retail rate mechanisms can erode RTO cost savings in end-use customer bills
Even though RTO markets reduce wholesale rates, costs incurred through utility rate mechanisms that vary by state can offset these savings. These expenses determined through state-jurisdictional processes can be half or more of the total bill.