SAFIR WORKSHOP: MARKET DEVELOPMENT AND REGULATORY PROCESSES Craig Glazer Vice President—Governmental Policy PJM Interconnection, L.L.C. Washington, D.C USA August 3, 2002

…and Government …and Local Practices Physics Earn Trust Real Markets Real Information Real Time

HISTORY OF REGULATION IN THE UNITED STATES  Start of the Industry:  Competitive model with no regulation

THE BIRTH OF REGULATION  Products “affected with the public interest”  Treatises of Sir Matthew Hale—1670  Ferryboats, wharves etc.  Munn vs. Illinois  Two Part Test: Necessity and Monopoly

The Birth of Regulation  Public Utility Test:  Necessity: “When property devoted to a public use, the owner in effect grants to the public an interest in that use and must submit to be controlled by the public for the common good”

The Birth of Regulation  Public Utility Test:  Monopoly: “An enterprise which the public itself might undertake or whose owner relies on a public grant or franchise for the right to conduct business.”

Principles of Regulation  Grant of a Franchise  Substitute for Competition  Regulatory Compact

Key Elements of Regulation  Reasonable return on investment  Overall reasonableness standard  Review of service quality  Control over reliability  Eminent domain

Alternative Models  Cooperative movement  Municipal power  Power market agencies  Social compact regulation

Rights of a Public Utility  Reasonable return on investment  Exclusive franchise  Right of eminent domain  Right to operate under reasonable rules and regulations

Duties of a Public Utility  Universal service  Adequate service  Reasonable rates  No undue discrimination  No expansion or abandonment without approval  Duty to operate safely  Prudent financial operations and management

Regulatory Paradigm  Regulatory commissions move to judicial role from legislative role  Regulation of service quality and rates is pervasive  Regulation of capital structure  No pre-approvals  Control over corporate structure

Alternative Models  State-owned utilities  Cooperatives  Municipal utilities  Private systems  Driving force: introduction of hydro power

Movement Toward Competition  1970’s Prudence Reviews  1970’s Antitrust Reviews  Advent of nuclear power  Advent of cogeneration  Privatization Efforts in U.K.  Deregulation of airlines and trucking in U.S.  Telephony competition in U.S. and U.K.

Market Oriented Processes in U.S.  Structural: Energy Policy Act of 1992  Exempt wholesale generators  Open access transmission  Gas model  FERC Order 436—functional unbundling  FERC Order 636—pipelines out of merchant function

FERC ORDER 888  Movement toward open access transmission  Need for comparability  Mandated tariffs  Stranded costs  Handling of “native load”

Need for Development of Markets  Need for price transparency and introduction of new retail suppliers  PJM model to transform power pool into competitive model  Price spikes in U.S. In 1990’s

Regulatory Response  Creation of new institutions  Bedrock principles of independence and transparency  Operation of the electric grid  Movement toward transparent markets

Regulatory Role in Markets  Creation of institutions charged with responsibility  Establishment of standard market design  Market monitoring  Antitrust review  Planning new transmission

Regulatory Challenges in the New Market Era  Who orders construction of new facilities?  Energy security/ diversity issues?  Addressing native load responsibilities  Remedies for market power abuses: restating prices or punishing bad actors?  Allowing regional variations vs. mandating market design?  Providing flexibility for growth and development?

For More Information: Craig Glazer Vice President—Governmental Policy PJM Interconnection, L.L.C.