ISO MARKET SURVEILLANCE COMMITTEE OPINION ON FIRM TRANSMISSION RIGHTS PROPOSALS

The Market Surveillance Committee (Frank Wolak and Carl Shapiro), and its advisors (Robert Wilson, and James Bushnell) have analyzed the current two proposals for the creation of firm transmission rights (FTRs) for the California electricity market.
  
It is the opinion of the Committee that the issuance of a set of FTRs with an aggregate capacity equal to 100% of the current physical capacity of the system could potentially lead to several serious, negative consequences to electricity consumers in California.  The committee is particularly concerned about the allocation of FTRs that include a scheduling priority to be invoked when the ISO adjustment markets do not clear.  There is concern that an issuance of such rights equivalent to 100% of transmission system capacity could eliminate the incentive of rights holders to participate in ISO congestion protocols and weaken the ability of the ISO to oversee the reliable operation of the transmission resources under its jurisdiction.  Several negative consequences may ensue from a marginalization of the ISO’s role in congestion management:

1.	The transparency of transmission prices could be seriously reduced or eliminated.  The lack of a transparent and reliable price signal for transmission congestion could undermine the ability of both producers and consumers to effectively participate in a regional market.  Without clear signals about the costs of moving power throughout the California grid, decisions about where to locate new generation or what transmission paths should be upgraded and when become extremely difficult to make.  Market participants will be forced to make decisions that affect congestion costs without a clear idea of what these costs are.

2.	The movement of the majority of transmission market transactions to secondary, and perhaps non-transparent markets may seriously impede the ability of the ISO and other institutions to monitor market abuses in transmission, energy, and ancillary service markets.  More importantly, the ISO would lose the ability to monitor FTRs holdings, and therefore find it significantly more difficult to detect the exercise of market power that arises from concentrated holdings of FTRs, until that market power has actually been used.  

3.	The potential lack of price-transparency and concentration of scheduling priorities may lead many non-rights holding consumers and producers to shift their scheduling decisions from day-ahead markets to real-time markets.  Significant differences between day-ahead schedules and real time operations would place increased strain on the ISO’s ability to maintain reliability in the real-time balancing of the system.

While it is not certain that all, or any, of these negative consequences may actually arise, there is sufficient concern to warrant a cautious approach to the issuance of FTRs in this market. The committee recommends an initial issuance of FTRs equal to no more than 1/3 of the aggregate capacity of the associated transmission interfaces. These rights would have a duration of one year.  If needed, to provide adequate incentive for the owners of existing transmission contracts (ETCs) to convert their rights and enter the ISO system, 100% of the capacity of these ETCs could be converted to FTRs upon entering the ISO system, if this initial level of FTRs is not found to cause serious market power and system reliability problems.  After this one year experiment, there should be a rigorous assessment of:  (1) the  performance of the market for evidence of market power or gaming, (2) the impact of the FTRs on congestion management, and (3) the need for additional FTRs or the need to continue with these experimental FTRs at all.

The MSC and its advisors see no significant economic benefit to California consumers from giving scheduling priority to holders of financial transmission rights.  Hedging inter-regional price differentials due to transmission constraints can be accomplished by purely financial transmission rights with no scheduling authority, if all scheduling coordinators submit incs and decs in accordance with the ISO’s congestion management protocols.  If  scheduling coordinators submit sufficient bids on all links, congestion will be cleared and there will there no need to impose the default usage charge, and use the scheduling priority.  Consequently, given the significant potential costs to the market and California consumers discussed above,  a very cautious policy towards FTRs seems prudent at this time.