Lessons Learned From Electricity Restructuring: Transition to	 
Competitive Markets Underway, but Full Benefits Will Take Time	 
and Effort to Achieve (17-DEC-02, GAO-03-271).			 
                                                                 
The electricity industry in the United States is undergoing major
change, the outcomes of which will affect every consumer. The	 
industry is restructuring from one where electricity prices are  
set by regulation to one in which competitive markets set the	 
price. GAO was asked to report on the extent to which federal and
state actions, to date, have achieved the goal of restructuring. 
GAO discusses lessons learned from efforts to date.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-271 					        
    ACCNO:   A05738						        
  TITLE:     Lessons Learned From Electricity Restructuring:	      
Transition to Competitive Markets Underway, but Full Benefits	 
Will Take Time and Effort to Achieve				 
     DATE:   12/17/2002 
  SUBJECT:   Electric energy					 
	     Energy industry					 
	     Energy marketing					 
	     Federal regulations				 
	     Independent regulatory commissions 		 
	     Prices and pricing 				 
	     Best practices					 

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GAO-03-271

Report to Congressional Requesters

United States General Accounting Office

GAO

December 2002 LESSONS LEARNED FROM ELECTRICITY RESTRUCTURING

Transition to Competitive Markets Underway, but Full Benefits Will Take
Time and Effort to Achieve

GAO- 03- 271

The goal of restructuring the electricity industry is to increase the
amount of competition in wholesale and retail electricity markets, which
is expected to lead to a range of benefits for electricity consumers.
These benefits include lower prices and access to a wider array of retail
services than were previously available. Increasing competition, however,
requires that structural changes be made to the electricity industry, such
as allowing a greater number of sellers and buyers of electricity to enter
the market.

The federal government has taken steps to bring about these changes by,
among other things, promoting and opening access to regional wholesale
markets and proposing to standardize a market design for these markets. In
addition, about one- half of the states have taken steps to introduce
competition in retail markets, including allowing customers to choose
their own electricity supplier.

It is not possible to determine the extent to which the goal of
restructuring* the development of competitive markets* has been achieved
to date. Our review of studies, our own analysis, and our evaluation of
monitoring activities of electricity markets indicate a mixed picture of
how much progress the industry has made in developing competitive markets
and the extent to which expected benefits have been achieved. While some
progress has been made in introducing competition, it has proven difficult
to measure the benefits of restructuring, and where measurement has been
possible, the extent to which expected benefits of restructuring have been
achieved is unclear. Recently, with the formation of its new Office of
Market Oversight and Investigations, the Federal Energy Regulatory
Commission has taken positive steps to look more broadly at the
performance of electricity markets.

On the basis of our review, we identified five key issues and lessons
learned that will require careful consideration as part of restructuring.
The solutions to these lessons may prove contentious and addressing them
will take time and effort. Unless addressed, the following four lessons
will limit competition and thereby diminish the ability of electricity
restructuring efforts to achieve their full expected benefits:

Different rules apply to the various regional electricity markets.

The Federal Energy Regulatory Commission has limited jurisdiction in
wholesale markets.

Wholesale and retail electricity markets have developed separately.

Generation and transmission siting decisions are subject to federal,
state, and local government jurisdiction.

In addition, a fifth lesson points out the need for better monitoring of
market performance to determine how well restructured markets are
functioning and the extent to which these markets provide consumer
benefits.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 271. To view the full report,
including the scope and methodology, click on the link above. For more
information, contact Jim Wells at (202) 512- 3841 or wellsj@ gao. gov.
Highlights of GAO- 03- 271, a report to the

Chairmen, Subcommittees on Government Efficiency, Financial Management and
Intergovernmental Relations and Energy Policy, Natural Resources and
Regulatory Affairs, House Committee on Government Reform

December 2002

LESSONS LEARNED FROM ELECTRICITY RESTRUCTURING

Transition to Competitive Markets Underway, but Full Benefits Will Take
Time and Effort to Achieve

The electricity industry in the United States is undergoing major change,
the outcomes of which will affect every consumer. The industry is
restructuring from one where electricity prices are set by regulation to
one in which competitive markets set the price. GAO was asked to report on
the extent to which federal and state actions, to date, have achieved the
goal of restructuring. GAO discusses lessons learned from efforts to date.

To help Congress ensure that the fullest benefits are achieved from
electricity restructuring, and to better understand what progress has been
made, GAO recommends that the Federal Energy Regulatory Commission (FERC)
(1) determine how restructured markets are performing across the country,
and (2) report annually to Congress and the states on the status of these
markets, including emerging issues and impediments to reaching its goal.

In commenting on the draft report, FERC agreed with GAO*s findings,
*lessons learned,* and the recommendation for annual reporting. However,
FERC said GAO*s recommendation to determine how restructured markets are
performing across the country is problematic because of the jurisdictional
division between states and FERC. GAO revised the recommendation to
clarify that it is not asking FERC to step outside of its jurisdictional
boundaries.

Page i GAO- 03- 271 Lessons Learned from Electricity Restructuring Letter
1

Executive Summary 3 Purpose 3 Background 4 Results in Brief 5 Principal
Findings 7 Agency Comments 11

Chapter 1 Introduction 13 The Electricity Industry Is An Important and
Complex Sector of the

U. S. Economy 13 The Development of a National Electricity Network 15
Federal and State Regulatory Framework Developed to Oversee

the Electricity Industry 16 Changing Nature of the Electricity Industry
Made Restructuring a

Possible and Attractive Option 17 Restructuring Occurs in a Legislative
and Regulatory Environment

Designed to Achieve Many Goals 19 Objectives, Scope, and Methodology 19

Chapter 2 Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers 21

To Meet the Goal of Increasing Competition Requires Structural Changes to
the Industry 21 Increased Competition Is Expected to Lead to a Range of
Benefits 24 Restructuring Expected to Occur While Maintaining or Improving

System Reliability 25 Conclusion 26

Chapter 3 Federal and State Efforts Are Underway to Develop Competitive
Markets 27

Federal Efforts Have Promoted Competition and Opened Access to Regional
Wholesale Markets 27 Some States Have Opened Retail Markets to New
Sellers, While

Others Have Not Pursued Restructuring Efforts 31 Conclusion 33 Contents

Page ii GAO- 03- 271 Lessons Learned from Electricity Restructuring
Chapter 4 The Extent to Which the Goal of Competitive

Electricity Markets Has Been Achieved Is Uncertain 34 Review of Studies
Indicates a Mixed Picture of Competition and

Uncertainty Regarding Benefits 34 GAO Evaluation Indicates Some Progress
Made in Developing

Competitive Markets but Questions Remain 35 Restructuring*s Impact on
Prices and Other Expected Benefits

Remains Unclear 39 Conclusion 43

Chapter 5 Lessons Learned from Electricity Restructuring and
Recommendations 44

Experience with Restructuring to Date Provides Five Lessons Learned 44
Conclusion 52 Recommendations for Executive Action 53 Agency Comments 53

Appendix I Scope and Methodology 57

Appendix II Related GAO Reports 59

Appendix III Comments from the Federal Energy Regulatory Commission 61

Appendix IV Bibliography of Selected Restructuring Studies 64

Appendix V GAO Contacts and Staff Acknowledgments 68

Table

Table 1: Status of RTOs Approved by FERC as of November 2002 29

Page iii GAO- 03- 271 Lessons Learned from Electricity Restructuring
Figures

Figure 1: Functions of the Electricity Industry 14 Figure 2: The Three
Major Interconnections in the Continental

United States 16 Figure 3: Average Electricity Prices, 1960- 1982 18
Figure 4: Status of State Electricity Restructuring Activity as of

November 2002 and Average Prices as of 1992 33 Figure 5: Generating
Capacity Added, 1995 through July 2002 38 Figure 6: Average Electricity
Prices, 1960- 2001 40 Figure 7: Overall U. S. Capacity Factor, 1949- 2001
43 Figure 8: Areas Served by Entities Subject to FERC Jurisdiction,

2002 46 Figure 9: Ownership of Large Transmission Lines by Entities

Subject to FERC Jurisdiction, 2002 47

Abbreviations

EPACT Energy Policy Act of 1992 ERCOT Electric Reliability Council of
Texas FERC Federal Energy Regulatory Commission ISO independent system
operator MW megawatt OASIS Open Access Same- Time Information System PJM
Pennsylvania, New Jersey, and Maryland independent

system operator PUHCA Public Utility Holding Company Act of 1935 RTO
regional transmission organization

Page 1 GAO- 03- 271 Lessons Learned from Electricity Restructuring

December 17, 2002 The Honorable Steve Horn, Chairman Subcommittee on
Government Efficiency, Financial Management and Intergovernmental
Relations Committee on Government Reform House of Representatives

The Honorable Doug Ose, Chairman Subcommittee on Energy Policy,

Natural Resources and Regulatory Affairs Committee on Government Reform
House of Representatives

As requested, we are reporting on efforts being taken to transition the
electricity industry from one in which monopoly utilities generate and
provide electricity to customers at regulated prices into one in which
private companies compete to sell electricity in a market- based system,
and the lessons learned from the experience to date. This report contains
recommendations to the Chairman, Federal Energy Regulatory Commission
(FERC), on (1) the need to develop a plan to collect and evaluate data and
information in order to monitor how electricity restructuring is
performing and to determine if the benefits of restructuring are being
achieved and (2) the need for FERC to report to Congress and the states
annually on, among other things, the progress being made in developing
competitive wholesale electricity markets.

As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the date of this letter. At that time, we will send copies to other
appropriate congressional committees as well as to the Chairman, FERC, and
the Director, Office of Management and Budget. We will also make copies
available to others upon request. In addition, the report will be
available at no charge on the GAO Web site at http:// www. gao. gov.

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 03- 271 Lessons Learned from Electricity Restructuring

If you or your staff have any questions concerning this report, please
call me at (202) 512- 3841. Key contributors to this report are listed in
appendix V.

Jim Wells Director, Natural Resources and Environment

Executive Summary Page 3 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

The electricity industry in the United States is undergoing major changes,
the outcomes of which will affect every consumer. The industry is in the
process of restructuring from one in which monopoly utilities generated
and provided electricity to consumers at regulated prices to one in which
numerous private companies are expected to compete to sell electricity in
wholesale and retail markets at prices determined by supply and demand
conditions. This restructuring effort, which began at the wholesale level
in 1992, has increasingly come under scrutiny as a result of volatile
prices, power shortages, and accusations of market manipulation. For
example, in 1998 the Midwest experienced a short- term spike in
electricity prices that resulted in the financial collapse of some
electricity trading companies and disruptions for some electricity
consumers. Further, in 2000, electricity markets in California experienced
a prolonged period of high prices and power shortages* even blackouts, in
some areas. GAO, academics, state government officials, and others have
found that market participants contributed to the crisis through their
efforts to raise prices. More recently, there have been accusations of
market manipulation, concerns over the accuracy of financial reporting,
widespread concern in the investment community over credit- worthiness of
some energy companies, and significant declines in financial market
valuation of several industry participants.

A number of studies and investigations are underway to respond to these
concerns. FERC has launched several efforts to examine the operation of
wholesale electricity markets and investigate complaints of market abuse
and mismanagement. Similarly, states have undertaken examinations of the
status of their efforts to promote competition in retail markets and
undertaken investigations of complaints of market abuses. Congress has
held hearings to investigate accusations of market abuses and to examine
electricity markets in general. In addition, in each of the past several
years, Congress has examined proposed legislation aimed at improving
federal oversight of electricity markets and related matters. As such,
Congress will continue to play an important role in restructuring the
electricity industry.

In light of the importance of restructuring to consumers throughout the
United States, and to assist Congress in evaluating the state of
electricity restructuring, the Chairmen of the Subcommittee on Government
Efficiency, Financial Management, and Intergovernmental Relations and the
Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs,
House Committee on Government Reform asked us to determine (1) the goals
of electricity market restructuring, (2) what actions federal and state
agencies have taken to restructure the electricity industry, (3) to what
extent these actions have achieved the goals of restructuring, and (4)
Executive Summary

Purpose

Executive Summary Page 4 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

what lessons can be learned from electricity restructuring efforts made to
date.

Electricity is central to the lives and livelihoods of all Americans.
Annual expenditures on electricity amount to about $224 billion, and
electricity provides the power to produce billions more in revenue in
other industries. The electricity industry is based on four distinct
functions: generation, transmission, distribution, and system operations.
Once electricity is generated* whether by burning fossil fuels, through
nuclear fission, or by harnessing wind, solar, or hydro energy* it is
typically sent through high- capacity, high- voltage transmission lines to
electricity distributors in local regions. Once there, electricity is
transformed into a lower voltage and sent through local distribution wires
for use by industrial plants, commercial businesses, and residential
consumers. Because electric energy is generated and consumed almost
instantaneously, the operation of an electric power system requires that a
system operator constantly coordinate the balance between the generation
and consumption of power. Absent such constant balancing, electrical
systems would be highly unreliable, with frequent and severe outages.

Historically, most utility companies built their own systems of power
plants and transmission and distribution lines to serve the needs of
consumers in their local areas. This arrangement occurred because
electricity service had long been considered a natural monopoly, wherein
it was believed to be most efficient for one company to serve the entire
needs of a local area. Over time, these individual company systems were
connected with adjacent companies* systems in order to improve reliability
and to facilitate trade across companies. In addition to these utilities,
federally owned utilities and power marketing administrations (such as the
Bonneville Power Administration, the Tennessee Valley Authority, and the
Western Area Power Administration), publicly owned utilities (such as
municipal authorities and public power districts), and cooperatively owned
utilities also participated in these electricity systems. These
interconnected systems ultimately evolved into three major networks: the
Western Interconnect, the Eastern Interconnect, and the Texas
Interconnect. Because utilities operated as monopolies, wholesale and
retail electricity pricing was regulated by FERC and the states,
respectively. Under the Federal Power Act of 1935, FERC is charged with
overseeing the rates, terms, and conditions of wholesale sales and
Background

Executive Summary Page 5 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

transmission of electricity in interstate commerce. FERC does not directly
regulate federally owned, publicly owned, or cooperatively owned
utilities. 1 States retained regulatory authority over retail sales of
electricity, electricity generation, construction of transmission lines,
and intrastate transmission and distribution.

Throughout the 1970s and 1980s, a number of events occurred in the
electricity industry* including rising electricity prices and advances in
generating technologies* that began to encourage a shift towards a more
competitive marketplace for wholesale power. In addition, many economists
and public policy analysts had long advocated the advantages of
competition over regulation and promoted the idea that competition could
drive down costs and prices by reducing inefficiencies, as well as spur
new technological innovations. Further, these advocates of competition
claimed that actions by legislators and regulators to deregulate airlines,
railroads, trucks, and barges had led to lower prices, better service, and
improved safety. These factors encouraged legislators and regulators to
examine the possibility of restructuring the electricity industry.

Based on an extensive review of laws, federal regulations, and relevant
literature, the goal of restructuring the electricity industry is to
increase the amount of competition in wholesale and retail electricity
markets. Increasing the amount of competition requires structural changes
to the electricity industry, such as allowing a greater number of sellers
and buyers of electricity to enter the market. Competition is expected to
produce benefits for consumers, including lower prices and access to a
wider array of retail services, by increasing the efficiency of wholesale
electricity generation and by encouraging innovations in retail
electricity services. Such efficiency gains and new services are expected
to occur as a result of increased incentives for electricity suppliers to
provide better service at lower prices.

1 Federally owned electricity- producing entities, such as the Tennessee
Valley Authority and the Bonneville Power Administration, are subject to
Department of Energy and congressional oversight. Because publicly owned
utilities, such as municipal systems, are owned by the people they serve,
they are generally overseen by the city council or elected/ appointed
members of an operating board. Similarly, since cooperatives are also
owned by the people they serve, they are generally overseen by a board of
directors, or the equivalent, elected by the customers/ owners. In their
comments to a draft of this report, FERC pointed out that additional
oversight of cooperatives may be provided by the Rural Utilities Service
or by FERC. Results in Brief

Executive Summary Page 6 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

Over the past 10 years, the federal government has taken a series of steps
that have opened wholesale markets to competition, and nearly half the
states have taken various steps toward introducing competition in retail
markets. Federal efforts by FERC to promote competition have opened access
to regional wholesale electricity markets. More recently, FERC has
proposed to standardize a market design for all jurisdictional electric
transmission providers. Twenty- four states and the District of Columbia
have promoted competition in retail electricity markets in a variety of
ways, such as allowing customers to choose a retail electricity supplier,
while 26 states have not pursued restructuring efforts and continue to
require retail customers to purchase electricity from the traditional
utility operating in the customer*s geographic region. More recently, a
number of states have delayed or postponed their efforts to restructure.

It is not possible to fully determine the extent to which the development
of competitive markets* the goal of restructuring* has been achieved to
date. Our review of relevant studies indicates a mixed assessment of how
far along the industry is in developing competitive markets and the extent
to which expected benefits have been achieved. Most studies found that
some progress has been made in introducing competition in wholesale
electricity markets, but it has proven difficult to measure the benefits
of restructuring for retail customers. Where measurement has been
possible, there is disagreement about the extent to which expected
benefits of restructuring have been achieved. Our own evaluation of the
performance of restructuring was also inconclusive. With respect to the
goal of increasing competition, restructuring efforts by the federal
government and the states have broadened electricity markets by making
them more regional and allowing new generation companies to participate.
However, questions remain regarding the competitiveness of these markets.
In addition, the extent to which restructuring has led to expected
benefits is uncertain, in part because restructuring is in the early
stages of development.

In determining the goals of electricity restructuring, reviewing actions
the federal and state agencies have taken to restructure the industry, and
determining whether those actions have achieved the goal of increased
competition and the expected benefits of restructuring, we have identified
five lessons learned from experience to date that relate to the structure
of electricity markets and market oversight. These lessons involve (1) the
existence of different rules in electricity systems, (2) FERC*s limited
jurisdiction in wholesale markets, (3) the separate development of
wholesale and retail electricity markets, (4) federal, state, and local
decisions on siting new power plants and the transmission infrastructure,

Executive Summary Page 7 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

and (5) the importance of better monitoring of restructuring. With regard
to monitoring, FERC has recently taken positive steps to look more broadly
at the performance of electricity markets through the formation of its new
Office of Market Oversight and Investigation. While these efforts may
improve the situation, GAO is making recommendations to FERC to better
monitor and report to Congress regarding the status of restructuring
efforts.

In commenting on the draft report, FERC agreed with GAO*s findings,
*lessons learned,* and the recommendation to report annually to Congress
and the states. However, FERC said GAO*s recommendation to determine how
restructured markets are performing across the country was more
problematic because of the jurisdictional division between states and
FERC. In response, GAO has revised the recommendation to clarify that GAO
is not asking FERC to step outside its jurisdictional boundaries.

Based on an extensive review of laws, federal regulations, and relevant
literature, the goal of restructuring the electricity industry is to
increase the amount of competition in wholesale and retail electricity
markets. Increasing competition requires structural changes to the
electricity industry, such as increasing the number of buyers and sellers
of electricity, improving the availability and accuracy of price
information, and allowing private companies to enter into competition with
existing utilities freely and fairly. Economists and other policy analysts
expect competition to lead to a range of benefits for consumers of
electricity, including lower prices and access to a wider array of retail
services than have been previously available. Based in part on success in
other industries that have been restructured, competition is expected to
achieve these benefits through improvements in the efficiency of wholesale
electricity generation as well as innovations in retail electricity
services. Generally, competition is expected to lead to greater efficiency
and more innovations by improving the incentives for electricity suppliers
to provide better and less expensive electricity service. Because of the
importance of the electricity industry to the lives of all Americans, it
is essential that any restructuring that does occur does not cause a
deterioration in the reliability of the electricity system. Principal
Findings

Goal of Restructuring Is to Increase Competition in Order to Provide
Benefits to Consumers

Executive Summary Page 8 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

The federal government has taken a series of actions over the past decade
that have promoted competition in wholesale electricity markets. The
Energy Policy Act of 1992 (EPACT) (1) authorized FERC to require
utilities, on a case- by- case basis, to provide other wholesale buyers
and sellers access to their transmission lines and (2) created a new class
of generators to further compete with traditional utilities. Beginning in
1996, FERC has issued a series of regulations to open up the transmission
system to competitive generators of electricity and to promote the
development of regional transmission organizations that can operate the
transmission system more efficiently and reliably than traditional
utilities. More recently, FERC has proposed mandating a standard market
design for all jurisdictional electric transmission providers to allow
sellers to transact easily across transmission boundaries and to allow
customers to receive the benefits of lower cost and more reliable
electricity supply.

To date, 24 states and the District of Columbia have enacted legislation
and/ or issued regulatory orders to restructure their retail electricity
markets. Of these, 17 states and the District of Columbia continue to be
active in implementing retail access, thereby allowing customers to choose
their own electricity supplier. However, most of these states have fixed
retail electricity prices at (or below) the regulated rate in place before
the onset of retail competition and continue to allow customers who do not
select an alternative service provider or whose competitive supplier has
stopped offering service to be served by their traditional utility. The
remaining 26 states have not enacted legislation and/ or issued regulatory
orders to implement retail access, and they continue to require retail
customers to purchase electricity from their traditional utility at
regulated rates.

It is not currently possible to fully determine the extent to which the
goal of developing competitive markets has been achieved. Our review of
studies related to measuring the performance of restructuring indicates a
mixed assessment of how far along the industry is in developing
competitive markets and the extent to which expected benefits have been
achieved. While most studies found progress has been made in introducing
competition in wholesale electricity markets, results at the retail level
have been difficult to measure. Where measurement has been possible, there
is disagreement about the extent to which the expected benefits of
restructuring have been achieved. Our own evaluation indicates that
federal and state restructuring efforts have broadened wholesale
electricity markets by making them more regional and allowing new
generation companies to participate. For example, several new regional
Federal and Some State

Efforts Underway to Develop Competitive Markets

The Extent to Which Markets Are Competitive Is Uncertain

Executive Summary Page 9 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

markets have emerged where buyers and sellers bid to buy and sell
wholesale electricity. While it appears that markets are broadening, we
could not determine, based on existing studies or our evaluation of
available data, the extent to which the expected benefits of increased
competition have been achieved. For example, while consumer prices have
generally fallen since restructuring began* and more so in states that are
restructuring than in nonrestructured states* the falling prices continue
a trend that began prior to restructuring, making it difficult to
determine the precise role restructuring has played in causing the price
reductions.

We identified five lessons learned from experience to date regarding the
structure of electricity markets and the need to monitor market
performance. Collectively, these lessons demonstrate potential limitations
to developing a national competitive electricity market and the expected
benefits of restructuring, as well as the importance of information in
monitoring restructuring progress.

Different rules in electricity systems limit the ability to achieve
benefits from competition.

In its effort to promote competitive wholesale markets, FERC historically
has approved a wide range of specific rules that govern the operation of
individual transmission system operators and centralized wholesale markets
under FERC*s jurisdiction. Today, these different rules and operations in
regional electricity systems and wholesale markets make it more costly for
participants in different electricity markets to buy and sell from each
other across electricity systems. This, in turn, limits the degree of
competition and the expected benefits of restructuring.

FERC*s limited jurisdiction in wholesale markets limits the ability to
achieve benefits from competition.

FERC does not have regulatory authority over all entities in wholesale
electricity markets, with large areas of the country operating primarily
outside the scope of FERC*s authority. Therefore, FERC has been unable to
prescribe the same operating standards and access to markets for these
entities as it has with entities subject to its jurisdiction. This
situation limits the development of competitive wholesale markets by
limiting the degree to which market participants can make electricity
transactions across these jurisdictions. This, in turn, limits the ability
of restructuring Lessons Learned from

Electricity Restructuring

Executive Summary Page 10 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

efforts to achieve a truly national competitive electricity system and
ultimately limits the expected benefits of restructuring.

Separate development of wholesale and retail electricity markets limits
the ability to achieve benefits from competition.

Federal and state actions to restructure wholesale and retail markets
have, for the most part, been undertaken separately. Federal actions have
focused on promoting wholesale competition by increasing the direct
interaction of buyers and sellers to determine price. However, most state
actions at the retail level* to freeze prices or continue price regulation
in areas not undertaking retail restructuring* have had the effect of
limiting the degree to which retail consumers respond to changes in
underlying wholesale prices. As a result, these actions place limits on
the extent to which fully competitive markets can develop and, thus, will
limit the expected benefits of restructuring.

Federal, state, and local decisions on siting new power plants and
transmission lines limit the ability to achieve benefits from competition.

While restructuring has opened access to wholesale electricity markets,
new market entry* through building new generating or transmission
facilities* remains subject to federal, state, and local siting decisions.
For example, state decisions on how and when to site new generation and
transmission will, to a great extent, determine the availability of and
access to new electricity supplies and, therefore, will affect the
competitiveness of wholesale electricity markets. As a result, state
actions that serve to delay or prevent the addition of new power plants or
power lines have the effect of limiting market entry and, consequently,
may limit FERC*s ability to achieve a national market for competitive
electricity and thus the expected benefits of restructuring.

Better monitoring of market performance is needed to determine how well
restructured markets are performing and the extent to which expected
benefits of competition are achieved.

To date, monitoring of restructuring efforts has not been comprehensive
enough to fully assess how well restructured markets are performing nor
the extent to which expected benefits of competition have occurred.
Limitations in the authority to collect data and incomplete monitoring
efforts by regulatory and monitoring entities have precluded a
comprehensive effort to determine how far along the road to greater

Executive Summary Page 11 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

competition we have come, and what remains to be done. To move forward, it
is essential that FERC and other regulatory bodies and market monitors
carefully watch for signs of problems and have the ability to make needed
adjustments, such as recognizing potential barriers to needed investments
in new generating or transmission facilities and acting to address them in
a timely fashion.

Recommendations

To help ensure that the fullest benefits possible are achieved from
electricity restructuring, and to better understand what progress has been
made, GAO is recommending that the Chairman, FERC,

1. determine how restructured wholesale electricity markets are performing
by developing and implementing a plan to collect necessary data and
perform evaluative analysis. These data should be sufficient to allow
evaluation of the competitiveness of these markets (including, but not
limited to, the extent of market power, efficiency of the industry, and
ease of market entry) and the expected benefits to retail consumers (such
as lower retail prices and the availability of new products). Where
possible and appropriate, FERC should work in concert with state and
regional entities to take advantage of their knowledge, expertise, and
access to important data relevant to the impacts of restructuring on
consumers.

2. report annually to Congress and the states on the status of
restructuring efforts, identify emerging issues and impediments to
reaching FERC*s goal of achieving national competitive wholesale
electricity markets, and make recommendations to Congress and the states
for changes that will improve the functioning of these markets.

We provided FERC with a draft of this report for review and comment. FERC
agreed with the report*s principal findings and *lessons learned.* In
addition, FERC agreed with GAO*s recommendation that FERC should report
annually to Congress on the status of restructuring, noting that it plans
to do so in spring 2003. However, FERC said that GAO*s recommendation
directing it to determine, in concert with the states and regional
entities, how both wholesale and retail markets are performing is more
problematic. FERC was concerned about this recommendation because of the
jurisdictional division between states and FERC* states have jurisdiction
over retail and FERC over wholesale electricity markets. Agency Comments

Executive Summary Page 12 GAO- 03- 271 Lessons Learned from Electricity
Restructuring

In addition, FERC stated that it does not have the resources or expertise
to evaluate retail markets.

In response to FERC*s concern, we clarified that we are not recommending
that FERC step outside its jurisdictional boundaries or attempt to assume
responsibility for the status and effectiveness of retail restructuring
efforts. Further, we revised the language of our recommendation to state
that FERC should evaluate the impacts of restructuring efforts in
wholesale markets on retail electricity consumers. With regard to the
issue of resources and expertise, we believe that FERC can supplement its
own assets by drawing from many sources, including other federal agencies,
expert panels, state agencies, and regional market monitoring entities.

FERC*s written comments are presented in appendix III. Our evaluation of
FERC*s written comments are contained at the end of chapter 5. In
addition, FERC provided us with some technical changes, which we
incorporated into the report as appropriate.

Chapter 1: Introduction Page 13 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

The electricity industry is an important and complex sector of our economy
that is central to the lives of Americans. Historically, the U. S.
electricity industry developed into a structure of localized monopoly
utilities. Each of these monopoly utilities generated electricity to serve
consumers in its local area. Within this localized structure, there was
limited interaction among different utilities across wide geographic
regions. Because of the complex nature of the electricity industry and its
historical development, both federal and state entities are involved in
overseeing and regulating the industry. Throughout the 1970s and 1980s, a
number of events occurred in the electricity industry that began to
encourage a shift toward more competitive electricity markets.

Electricity is central to the lives and livelihoods of all Americans.
Annual expenditures on electricity amount to about $224 billion, and
electricity is an important input to production in many industries. For
example, industrial customers* including companies engaged in
manufacturing and assembling products* rely on electricity to power
computers, tools, and machinery, as well as for lighting, heating, and
cooling their plants and buildings. Similarly, commercial customers*
including shopping malls, office buildings, individual stores, and
financial and stock markets* also depend heavily on electricity for their
day- to- day operations. In addition, residential customers rely on
electricity for heating and cooling, lighting, cooking, and cleaning.
Finally, with the expansion of Internet usage and the importance of
information technologies for commerce, electricity has assumed an even
greater role in the daily lives of Americans. As a result, the cost and
availability of electricity have implications for the entire economy.

The electricity industry is based on four distinct functions: generation,
transmission, distribution, and system operations. (See figure 1.) Once
electricity is generated* whether by burning fossil fuels, through nuclear
fission, or by harnessing wind, solar, or hydro energy* it is sent through
high- voltage, high- capacity transmission lines to electricity
distributors in local regions. Once there, electricity is transformed into
a lower voltage and sent through local distribution wires for end- use by
industrial plants, commercial businesses, and residential consumers.
Chapter 1: Introduction

The Electricity Industry Is An Important and Complex Sector of the U. S.
Economy

Chapter 1: Introduction Page 14 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

Figure 1: Functions of the Electricity Industry

Source: GAO.

A unique feature of the electricity industry is that electricity is
consumed at almost the very instant that it is produced. As electricity is
produced, it leaves the generating plant, and travels at the speed of
light through transmission and distribution wires to the point of use,
where it is immediately consumed. In addition, electricity cannot be
easily or inexpensively stored and, as a result, must be produced in near-
exact quantities to those being consumed. Because electric energy is
generated

Chapter 1: Introduction Page 15 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

and consumed almost instantaneously, the operation of an electric power
system requires that a system operator balance the generation and
consumption of power. The system operator monitors generation and
consumption from a centralized location using computerized systems and
sends minute- by- minute signals to generators reflecting changes in the
demand for electricity. The generators then make the necessary changes in
generation in order to maintain the transmission system safely and
reliably. Absent such continuous balancing, electrical systems would be
highly unreliable, with frequent and severe outages.

Historically, the electric industry developed initially as a loosely
connected structure of individual monopoly utility companies, each
building power plants and transmission and distribution lines to serve the
exclusive needs of all the consumers in their local areas. Such monopoly
utility companies were typically owned by shareholders and were referred
to as investor- owned utilities. In addition to these investor- owned
utilities, several types of publicly owned utilities, including rural
cooperatives, municipal authorities, state authorities, public power
districts, and irrigation districts, also began to sell electricity. About
one- third of these publicly owned utilities are owned collectively by
their customers and generally operate as not- for- profit entities.
Further, nine federally owned entities, including the Tennessee Valley
Authority and the Bonneville Power Administration, also generate and sell
electricity* primarily to cooperatives, municipalities, and other
companies that resell it to retail consumers.

Over time, the transmission and distribution systems owned by private,
public, and federal utilities became interconnected with one another in
order to improve reliability and to facilitate trade across companies.
These interconnected systems ultimately evolved into three major networks:
the Western Interconnect, the Eastern Interconnect, and the Texas
Interconnect. Figure 2 shows the division of the country into the three
major interconnected systems. The Development of a

National Electricity Network

Chapter 1: Introduction Page 16 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

Figure 2: The Three Major Interconnections in the Continental United
States

Source: Energy Information Administration.

Because the utilities operated as monopolies, wholesale and retail
electricity pricing was regulated by the federal government and the
states. The Public Utility Holding Company Act of 1935 (PUHCA) and the
Federal Power Act of 1935 established the basic framework for electric
utility regulation. PUHCA, which required federal regulation of these
companies, was enacted to eliminate unfair practices by large holding
companies that owned electricity and natural gas companies in several
states. The Federal Power Act created the Federal Power Commission* a
predecessor to FERC* and charged it with overseeing the rates, terms, and
conditions of wholesale sales and transmission of electric energy in
interstate commerce. FERC, established in 1977, approved interstate
wholesale rates based on the utilities* costs of production plus a fair
rate of return on the utilities* investment. States retained regulatory
authority over retail sales of electricity, electricity generation,
construction of transmission lines within their state*s boundaries, and
intrastate transmission and distribution. Generally, states set retail
rates based on the utility*s cost of production plus a rate of return.

In addition to federal and state regulation, some industry participants
have also self- regulated in part by their voluntary participation in the
North American Electric Reliability Council (NERC), an organization of
Federal and State

Regulatory Framework Developed to Oversee the Electricity Industry

Chapter 1: Introduction Page 17 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

electricity industry entities that develops and maintains standards for
operating the electricity systems in the United States. The need for such
an organization to help coordinate operations of individual utilities
became apparent as the transmission and distribution systems of the
individual utilities became connected. Because small changes in supply and
demand in one network can affect neighboring networks, it is necessary
that all parties coordinate their operations. When coordination fails, the
reliability of the system is in jeopardy, as was the case when blackouts
occurred in the Northeast in 1965. NERC was formed in response to these
blackouts and continues to play a role in facilitating coordination
between different utilities* systems.

Throughout the 1970s and 1980s, a number of events occurred in the
electricity industry that began to encourage a shift towards more
competitive electricity markets. These events included rising electricity
prices charged by utilities, changes in the technology of electricity
generation, and a shift in regulatory thinking in the United States and
other countries around the world that had begun to move toward the use of
markets rather than governments to make decisions about investments to
meet many public needs.

Between 1970 and 1982, average residential and industrial electricity
prices increased by 37 percent and 124 percent respectively, after
adjusting for inflation. As seen in figure 3, this sharp increase reversed
a downward trend in prices over the previous decade. 1 These price
increases were in part the result of investment decisions made by
utilities and approved by state regulators to build numerous large- scale,
costly electric power plants. These plants were built on the assumption
that demand for electricity would increase steadily in the future.
However, demand did not rise as quickly as anticipated, in part because of
slower- than- expected economic growth. Regulators allowed companies to
recover the high costs of building these new power plants through higher
electricity rates.

1 Prices are reported in cents per kilowatt- hour. A watt is a unit of
electrical power. A kilowatt is 1,000 watts. One kilowatt used for one
hour equals 1 kilowatt- hour. Changing Nature of

the Electricity Industry Made Restructuring a Possible and Attractive
Option

Chapter 1: Introduction Page 18 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

Figure 3: Average Electricity Prices, 1960- 1982

Source: GAO analysis of data provided by the Energy Information
Administration.

In addition to rising electricity prices, significant technological
changes in both generation and transmission were occurring, which improved
the efficiency of natural gas- fired power plants. These technological
improvements made it possible to build smaller, more efficient plants,
capable of producing electricity at lower cost than the prices charged by
many of the existing utilities. In addition, advances in transmission
capabilities also allowed electricity to be moved over longer distances,
making it more readily available to a wider range of customers. As a
result, electricity customers, particularly large industrial users, saw
their electricity prices rising, while advances in technology promised
lowerpriced power, and they began to exert pressure on legislators and
regulators to allow them to gain access to electricity at lower prices.
Restructuring the industry to introduce competition was seen as a way to
achieve this aim.

More generally, the evolution of regulatory thinking in the United States
and other countries around the world shifted toward the use of markets
rather than governments to make decisions about investments to meet many
public needs. Economists and public policy analysts, believing in the
advantages of competition over regulation, promoted the idea that markets

Chapter 1: Introduction Page 19 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

could drive down costs and prices by reducing inefficiencies and providing
better incentives for companies to develop new innovations. Legislators
and regulators passed laws and implemented rules that promoted competition
across the U. S. economy. For example, during the 1970s and 1980s Congress
passed laws deregulating the airline, railroad freight shipping, trucking,
and barge shipping industries. Over the same period, several other
countries* including New Zealand, Norway, Sweden, and the United Kingdom*
restructured their electricity industries to introduce competition. Citing
successes from other deregulation or restructuring efforts, many experts,
industry participants, and other interested parties began to call for
restructuring of the U. S. electricity industry.

Today, restructuring of the electricity industry is occurring within the
context of a myriad of federal and state laws and regulations related to
such issues as clean air, clean water, fish and wildlife management,
recreational uses of waterways and parks, irrigation, flood control, and
citizens* health and rights. Responsibility for implementing and enforcing
these laws and regulations is distributed across a wide range of federal,
state, and local agencies. The result is a natural tension between
achieving the goals of restructuring the electricity industry and other
existing laws and regulations.

The Chairmen of the Subcommittee on Government Efficiency, Financial
Management and Intergovernmental Relations and the Subcommittee on Energy
Policy, Natural Resources and Regulatory Affairs, House Committee on
Government Reform, asked us to determine (1) the goals of electricity
market restructuring, (2) what actions federal and state agencies have
taken to restructure the electricity industry, (3) to what extent these
actions have achieved the goals of restructuring, and (4) what lessons
have been learned from electricity restructuring efforts made to date.

To answer these questions, we collected views of stakeholders and industry
experts, including market participants; trade associations; and federal,
state, and regional market monitors. We also reviewed relevant studies of
restructuring, including reports by market monitors, trade associations,
consumer interest groups, academics, and consultants. In addition, we
conducted our own evaluation of data provided by the Energy Information
Administration, FERC, and private sources. We conducted our work from
November 2001 through November 2002 in accordance with Restructuring
Occurs

in a Legislative and Regulatory Environment Designed to Achieve Many Goals

Objectives, Scope, and Methodology

Chapter 1: Introduction Page 20 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

generally accepted government auditing standards. For a more detailed
description of our methodology, see appendix I.

Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers

Page 21 GAO- 03- 271 Lessons Learned from Electricity Restructuring

The goal of restructuring the electricity industry is to increase the
amount of competition in wholesale and retail electricity markets, which
is expected to lead to a range of benefits for electricity consumers,
including lower prices and access to a wider array of retail services than
were previously available. Increasing the amount of competition requires
structural changes within the electricity industry, such as allowing a
greater number of sellers and buyers of electricity to enter the market.
Competition is expected to produce benefits for consumers by increasing
the efficiency of wholesale electricity generation and by encouraging
innovations in retail electricity services. Such efficiency gains are
expected to occur as a result of improved incentives for electricity
suppliers to provide better service at lower prices. Further,
restructuring is expected to occur while maintaining or enhancing the
reliability of the electricity system to consumers.

Based on an extensive review of laws, federal regulations, other relevant
literature, and discussions with numerous industry experts, there is a
consensus that the goal of restructuring the electricity industry is to
increase the intensity of competition in wholesale and retail electricity
markets. Increasing competition requires that a number of conditions be
met, including (1) increases in the number of buyers and sellers, (2)
sufficient public information about electricity prices to enable buyers
and sellers to make informed decisions, and (3) the ability of sellers to
enter and exit markets in response to market information. Meeting these
conditions will require that the traditional system of regulated local
monopolies, which generated and provided electricity to retail consumers
at regulated prices, be replaced by a market- based competitive system in
which sellers and buyers interact to determine the price of electricity.

More buyers and sellers of wholesale electricity are needed to ensure that
no single entity has the ability to influence the price of electricity in
its favor. Under the regulated environment that preceded restructuring,
utilities held local monopoly positions that encompassed generation,
transmission, and distribution of electricity to consumers in each
utility*s area of control. While trading of wholesale electricity between
separate utilities occurred prior to restructuring, this took place
primarily between the existing monopoly utilities, thereby limiting the
number of participants in the wholesale markets. Therefore, in order to
increase the number of sellers, it is necessary for the monopoly owners of
transmission and distribution systems* the wires that deliver electricity
from generators to final customers* to provide access to these systems to
new market Chapter 2: Goal of Restructuring Is to

Increase Competition in Order to Provide Benefits to Consumers

To Meet the Goal of Increasing Competition Requires Structural Changes to
the Industry

Competition Requires an Increased Number of Buyers and Sellers.

Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers

Page 22 GAO- 03- 271 Lessons Learned from Electricity Restructuring

participants. Specifically, new sellers of wholesale electricity will have
to be able to buy access to the transmission system at nondiscriminatory
rates in order to sell wholesale electricity to buyers.

In addition, greater numbers of retail sellers are also needed to offer
the many retail customers a choice of electricity provider and to
encourage competition among those providers. Under the regulated retail
environment, utilities were the sole suppliers of retail electricity to
final consumers. Even if numerous wholesale sellers emerge, without
changes in the structure of the retail side of the market, there will be
few buyers* each utility will still be the sole provider of electricity to
consumers in its area of control, and therefore the only buyer of
wholesale electricity. Therefore, in order to increase the number of new
buyers in the wholesale market, it may be necessary to make changes in the
retail structure to allow more buyers to compete for electricity in the
wholesale market. New buyers of wholesale electricity could either be
private companies that would buy wholesale electricity and compete to sell
it to retail consumers, or, in some cases, final consumers themselves may
be able to purchase directly from wholesale suppliers. As in the wholesale
market, retail competition will require that new participants have
nondiscriminatory access to transmission and distribution systems. Changes
in regulation will also be needed to allow consumers to deal directly with
wholesale sellers or to allow competition among retail providers of
electricity.

In order for buyers and sellers of wholesale electricity to make informed
decisions, they must have access to sufficient information about relevant
prices, including prices of electricity at locations near them and prices
of transmission and other charges required to make transactions.
Wellfunctioning competition requires that no single buyer or seller has
better information about available prices of electricity than any other
market participant. If such an information advantage exists, then those
entities with superior information may be able to take advantage of other
participants, thereby leading to undesirable outcomes, such as higher
prices than would exist under competitive conditions. In addition to price
information, experts have said that there must be adequate information
about the volumes of trades, and a general increase in the volume of
electricity traded. In most commodity markets, such information is readily
and publicly available. However, it is less prevalent in the electricity
market, and experts generally agree that structural changes are required
to Adequate market

information is needed.

Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers

Page 23 GAO- 03- 271 Lessons Learned from Electricity Restructuring

make information more available. Specifically, experts point to a lack of
sufficient numbers of transactions in some electricity markets to generate
reliable information about prices and other market information. 1 In
addition, there is concern that even in markets with many transactions,
price and other relevant market data are not made publicly available.
Academics and consumer advocates have stated that a lack of public data
limits the ability of nonstakeholders to evaluate restructuring and has a
detrimental effect on consumer confidence in the restructuring process.

One of the foundations of a competitive market is the ability of market
participants to freely enter and exit the electricity industry in response
to information about opportunities in that and other industries. For
example, if wholesale electricity prices in one region are high compared
to other regions* leading to higher than normal profits for electricity
sellers* this would indicate that new investment in either generation or
transmission capacity is warranted. Similarly, if there were too much
generation in a particular area, leading to prices too low to support
normal profits, companies may wish to exit that area by shutting down
power plants to avoid losing money. Under competitive conditions, where
all participants have the same ability to enter or exit the industry,
private companies can be expected to make new investments or to withdraw
from a region, depending on market conditions. As a result, it is expected
that restructuring will lead to more consistent prices across regions than
under the previous regulated environment. More investment will be
attracted to high- price regions, thereby causing prices there to fall
relative to lowerprice regions, while more trade between regions will also
have the effect of bringing regional prices closer together. For potential
participants to have freedom to enter and exit electricity markets, they
must be able to gain access to existing power lines and associated
facilities under terms that are consistent with their competitors.
Therefore, owners of power lines must be required to provide access to new
entrants at terms that do not discriminate compared to existing market
participants.

1 For electricity markets to be efficient and for market participants to
have confidence in the prices, there must be sufficient liquidity, meaning
that there must be many trades taking place between knowledgeable buyers
and sellers. Freedom to enter and exit

the electricity industry is needed.

Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers

Page 24 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Increasing competition is expected to lead to benefits for consumers of
electricity. In particular, experts believe that competition in wholesale
markets will provide a way to reduce prices by improving the efficiency of
producing and delivering electricity. Proponents of restructuring have
stated that regulated companies and regulators made poor investment
decisions that raised the average cost of electricity for consumers. These
investments led to excess investment in electricity generation capacity,
in part because utilities and regulators overestimated demand growth. Once
this excess capacity was built, electricity prices had to rise to cover
the costs to the utilities, even when generating units sat idle. In
addition, economists and other industry experts argued that monopoly
utilities had poor incentives to keep overall costs down because they were
able to pass on all approved costs to consumers in their regulated rates.
The experts also argued that regulation slowed the pace of technological
innovation, because even if new cheaper generating units could be built,
the regulators were still bound to allow the utilities to recover their
investment costs for older more expensive generating units. Therefore, by
introducing competition among wholesale suppliers of electricity, experts
expect new, lower- cost generating plants to be built by nonutility
companies, leading to greater efficiency in producing electricity and
ultimately causing prices to fall. As an additional benefit, many newer
generating plants are much less polluting than the older existing plants.
Therefore, investment in new generating plants may facilitate improvements
in air quality, if electricity produced by these cleaner- burning
generators displaces electricity from older dirtier plants.

Restructuring of retail electricity markets is expected to (1) provide a
mechanism for transferring the lower costs achieved through wholesale
competition to consumers, (2) improve customer service, and (3) lead to
the introduction of new products and services. Under the old regulatory
environment, it was argued that monopoly utilities did not have sufficient
incentives to continually seek ways to provide better and cheaper
electricity and services to consumers. Introducing competition among
retail electricity suppliers is expected to allow retail customers to
choose a supplier on the basis of prices, products, and service. As a
result, retail suppliers will have an incentive to offer electricity and
services at prices consumers are willing to pay. Also, in order to compete
for customers, retail suppliers are expected to develop and introduce new
products and services.

Taken together, wholesale and retail competition could also provide a
mechanism by which the financial risks associated with building new
electricity generating plants can be transferred from consumers to private
Increased

Competition Is Expected to Lead to a Range of Benefits

Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers

Page 25 GAO- 03- 271 Lessons Learned from Electricity Restructuring

companies and their shareholders. In the old regulatory environment,
utilities built the bulk of new generating plants after first identifying
an expected need for the new plants and after gaining approval from state
regulators. Once approved and built, the cost of building and operating
the new generators was passed on to consumers, because the utilities were
allowed to capture these costs in the prices set by the regulators.
Therefore, consumers bore the financial risk associated with investments
made by utilities. In a competitive environment, owners of new generating
capacity are not guaranteed recovery of their costs; therefore, they bear
the risks of their decisions to build. In this environment, consumer
prices are determined more by current market conditions than by historical
investment decisions made by utilities and approved by regulators. For
this reason, it is argued, technological innovations that lead to lower
electricity costs will be adopted faster, leading to lower consumer
prices.

Because reliability of the electricity system is so important to the
economy, safety, and security of the country, it is essential that any
restructuring that occurs does so without adversely affecting reliability.
Historically, reliability has been maintained largely by utilities owning
enough generating capacity to serve even the highest demand for
electricity under conditions in which some of the capacity may be
inoperable. As a result, some power plants operated only a few hours per
year. Under restructuring, the total capacity required to maintain
reliability could be reduced for three reasons. First, restructuring is
expected to broaden electricity markets, which will allow individual local
areas to draw electricity from power plants across a wider region, thereby
reducing the amount of capacity the local area must own to meet its
demand. Because different localities will have their highest demands at
different times, idle power plants in one locality could serve other
localities experiencing high demand and this reduces the total generating
capacity necessary to maintain a reliable supply. Second, under
restructuring, some consumers will have enhanced incentives to conserve
power during peak demand periods when electricity prices are high. Such
incentives will reduce the total consumption of electricity during the
highest demand periods, thereby reducing the total capacity required to
maintain reliability. Third, some consumers may enter contracts that allow
the system operator to shut off their power in times of electricity
shortage to Restructuring

Expected to Occur While Maintaining or Improving System Reliability

Chapter 2: Goal of Restructuring Is to Increase Competition in Order to
Provide Benefits to Consumers

Page 26 GAO- 03- 271 Lessons Learned from Electricity Restructuring

avoid more general supply disruptions. In return, these consumers would be
compensated for the disruption. 2

Developing competitive wholesale and retail electricity markets will not
be easy. Among other things, it will require the creation of an
environment that encourages new participants and the development of
adequate and reliable information in order for these participants to make
informed investment decisions, while maintaining reliability of the
electricity system. In addition, restructuring is occurring within the
context of other federal and state laws and regulations, including those
related to clean air, clean water, and endangered species. Therefore, in
developing competitive markets, it will take time to deal with these
issues in a way that instills confidence in both market participants and
consumers.

2 Such contracts can and do also exist under the old regulated
environment, but the incentives for such contracts are greater when
electricity prices reflect the current levels of supply and demand, as
would be the case under full restructuring, than when prices are generally
fixed across most periods, as has generally been the case in the regulated
environment. Conclusion

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 27 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Federal efforts to promote competition have focused on promoting and
opening access to regional wholesale electricity markets, including FERC*s
most recent proposal to create a standard market design for all electric
transmission providers. Twenty- four states and the District of Columbia
have enacted legislation and/ or issued regulatory orders to allow
customers to choose their retail electricity supplier. The remaining 26
states have not taken such actions and continue to require retail
customers to purchase electricity from their traditional utility.

The federal government has taken a series of actions over the past decade
that has promoted competition in wholesale electricity markets. 1 The
Energy Policy Act of 1992 (EPACT) allowed some nonutility companies to
participate in wholesale markets without owning their own transmission
lines, an opportunity that was previously limited. 2 EPACT also authorized
FERC to require utilities, on a case- by- case basis, to provide other
wholesale buyers and sellers access to their transmission lines. By making
it easier for nonutility generators to enter the wholesale market for
electricity, EPACT not only expanded competition, but also facilitated the
shift in how electricity prices were set, since utilities could purchase
electricity from nonutility wholesale generators and pay market- based
prices, traditional cost- of- service prices, or a combination of both.

In April 1996, to remedy claims of undue discrimination in access to the
transmission system, FERC issued Orders 888 and 889, opening the
transmission systems of investor- owned utilities to all qualified
wholesale buyers and sellers of electricity. Commonly known as the *open
access rule,* Order 888 required that transmission line owners offer
transmission services to other transmission users under comparable terms
and conditions that they provide for themselves. The vertically integrated
nature of utilities in the past had not allowed independent electricity
suppliers equal access to transmission systems. In promulgating the
regulation, FERC found that by limiting the extent to which independent
electricity suppliers could provide service to electricity customers,
growth of competitive electricity generation markets had been hindered.
Order 888 also required utilities to separate their generation and
transmission

1 Restructuring is not currently planned to introduce competition to the
transmission or distribution of electricity. 2 Prior to EPACT, this
ability was limited to a small group of companies that generally produced
electricity through cogeneration processes and/ or the use of renewable
energy. Chapter 3: Federal and State Efforts Are

Underway to Develop Competitive Markets Federal Efforts Have Promoted
Competition and Opened Access to Regional Wholesale Markets

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 28 GAO- 03- 271 Lessons Learned from Electricity Restructuring

businesses* a process referred to as unbundling* to prevent discriminatory
practices in providing transmission services, such as denying competitors
equal access to transmission lines. This unbundling was accomplished by
requiring utilities to separate their transmission service functions from
other business activities. Order 888 also encouraged utilities to form
independent system operators (ISO), 3 to which they could transfer
operating control (but not ownership) of their transmission facilities,
thereby satisfying the unbundling requirement contained in the order.
Since Order 888 was issued, six ISOs have been formed and are operating,
each with its own set of operating rules. 4

FERC also found that to effectively ensure nondiscriminatory access to the
transmission system, up- to- date information about transmission must be
unrestricted and public to all transmission users. To meet this need, FERC
issued Order 889, which required all privately owned utilities to
participate in the Open Access Same- Time Information System (OASIS).
OASIS is an interactive Internet- based database containing information on
available transmission capacity, capacity reservations, and transmission
prices. By providing timely access to all qualified users regarding
transmission market information, the goal of OASIS was to facilitate the
functioning of competitive electricity markets.

After passage of Orders 888 and 889, FERC found evidence that the
traditional management of the transmission system was still inadequate to
support the open access and efficient and reliable operation needed for
the continued development of competitive electricity markets, and that
continued discrimination in the provision of transmission services by
vertically integrated utilities may also be impeding fully competitive
electricity markets. In December 1999, FERC issued Order 2000, which

3 An ISO is an entity encouraged by FERC to manage the transmission system
as the electric industry in the United States is restructured. An ISO is
to control the power system or grid without special interest, and is to
own no generation, transmission, or load. Therefore, the ISO is intended
to run the system fairly, for the benefit of all market participants.

4 These ISOs are California ISO; ISO New England; Midwest ISO; New York
ISO; Pennsylvania, New Jersey, and Maryland Interconnect (PJM); and
Electric Reliability Council of Texas (ERCOT) ISO. ERCOT established an
ISO in 1996 to satisfy the requirements of the Public Utility Commission
of Texas for deregulating the wholesale electricity market in the state.
The wholesale market in the ERCOT region is basically isolated from other
U. S. markets because its transmission system has only minor
interconnections to other U. S. transmission systems. FERC has limited
jurisdiction over the region because the ERCOT market is essentially
intrastate.

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 29 GAO- 03- 271 Lessons Learned from Electricity Restructuring

encouraged all privately owned utilities to voluntarily place their
transmission facilities under the control of a broader market entity
called a regional transmission organization (RTO). As a result, ISOs
created under Order 888 would be supplanted by larger RTOs, which together
would cover the entire nation. The rationale behind FERC*s approach to
forming RTOs was that the nation*s transmission systems should be brought
under regional control in order to eliminate the remaining discriminatory
practices in use, better meet the increasing demands placed on the
transmission system, improve management of system congestion and
reliability, and achieve fully competitive wholesale power markets. Order
2000 did not specifically require RTO participation; however, if a utility
opts not to join an RTO, it is required to explain why it is not doing so.

Since issuing Order 2000, FERC has approved one organization as an RTO and
conditionally approved three with the provision that to receive full
approval they take significant actions to further conform to RTO
requirements described in Order 2000. These organizations operate in 21
states and the District of Columbia, and in Manitoba, Canada. (See table 1
for RTO approval decisions by FERC.)

Table 1: Status of RTOs Approved by FERC as of November 2002 Organization
Approval Conditional

approval a Area of operation b

GridFlorida X Florida GridSouth X North Carolina, South Carolina Midwest
ISO X Illinois, Indiana, Iowa, Kentucky, Michigan,

Minnesota, Missouri, Montana, North Dakota, Ohio, South Dakota, Virginia,
Wisconsin, and Manitoba (Canada) PJM X Delaware, District of Columbia, New
Jersey,

Maryland, Ohio, Pennsylvania, Virginia, West Virginia

Source: FERC. a Certain organizations that have received conditional FERC
approval are not yet operational as

RTOs, in part because FERC has overlapping jurisdiction with certain state
regulatory authorities on the formation of RTOs and because some states
are still in the process of reviewing RTO participation for their
utilities. b Includes all or parts of listed states.

Despite these efforts, FERC has acknowledged that significant impediments
remain to competitive wholesale markets. For example, according to FERC,
recent events such as the collapse of Enron and the California electricity
crisis reveal the need for clear, stable market rules

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 30 GAO- 03- 271 Lessons Learned from Electricity Restructuring

and overdue infrastructure investment in the U. S. wholesale electricity
industry. As a result, in July 2002, FERC issued a notice of proposed
rulemaking to provide a standard market design for all electric
transmission providers. FERC*s fundamental goal in this initiative is to
create *seamless* wholesale electricity markets, nationwide, that allow
sellers to transact easily across transmission boundaries and allow
customers to receive the benefits of a lower- cost and more reliable
electricity supply. Accordingly, FERC*s standard market design proposal
contains a wide range of rules to standardize the structure and operation
of wholesale electricity markets and transmission services. Among other
things, it (1) describes the rules for how a portion of the nation*s
electricity will be exchanged in organized markets, (2) defines a new
transmission service, (3) establishes a congestion management system to
ensure that the transmission system is managed effectively and that users
recognize the true value of their actions, (4) lays out new rules to
assure that all transmission owners and operators recover their costs, (5)
establishes new market power mitigation and monitoring requirements, and
(6) sets out long- term planning and resource adequacy requirements.

To date, the proposed standard market design rule has generated
significant comments from numerous organizations reflecting concerns and
reservations about the scope and details of the proposal. For example, the
Chairman, FERC, has noted that one of the most widely voiced concerns
about FERC*s proposal is that it could cause low- cost states* electricity
prices to rise as competition allows sellers of electric power in these
states to sell to states with higher prices. In addition, others have
stated that the western U. S. market has unique characteristics that may
not readily lend itself to FERC*s proposed standard market design. In
response to these and other comments and concerns, FERC has extended the
comment period to January 10, 2003, for all interested parties to file
comments on certain features of its proposal. In addition, FERC has
invited interested parties to comment on more than 70 specific issues
described in its proposal and has convened a series of conferences to
address its proposal. FERC estimates that a final rule could be published
during the summer of 2003.

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 31 GAO- 03- 271 Lessons Learned from Electricity Restructuring

To date, 24 states and the District of Columbia have enacted legislation
and/ or issued regulatory orders to open their retail markets to
competition by implementing retail access, thereby allowing customers to
choose their own electricity suppliers. 5 Of these, 17 states and the
District of Columbia continue to be active in implementing retail access.
6 Under retail access, the local distribution utility continues to provide
transmission and distribution services. State restructuring legislation or
regulatory orders have either required or encouraged utilities to divest
generation assets, in part to encourage competition among generating
companies. In addition, in some states, metering and billing are subject
to competition, while in others these services are combined with
distribution services.

Most of the 17 states that have begun to open their retail markets to
competition have simultaneously frozen retail electricity prices at (or
below) the regulated rate in place before the onset of retail competition.
For example, in Michigan, the two largest utilities agreed to provide a 5
percent rate reduction to all residential customers. The reduction began
in June 2001 and will extend through December 2003* after which the
utilities may still not increase rates until either December 2013 or until
the Michigan Public Service Commission determines that certain conditions
are met. In addition, most of these states usually allow customers who
choose not to select an alternative service provider or whose competitive
supplier has stopped offering service to continue to be served by their
local distribution utility.

The remaining seven states that have enacted legislation and/ or issued
regulatory orders have either delayed or suspended implementation of
retail access. Six of these states* Arkansas, Montana, Nevada, New Mexico,
Oklahoma, and West Virginia* have delayed implementation of retail access
by, for example, choosing a new date to move forward. One state,
California, suspended its retail- access program in September 2001

5 These states are Arizona, Arkansas, California, Connecticut, Delaware,
Illinois, Maine, Maryland, Massachusetts, Michigan, Montana, Nevada, New
Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon,
Pennsylvania, Rhode Island, Texas, Virginia, and West Virginia.

6 These states are Arizona, Connecticut, Delaware, Illinois, Maine,
Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York,
Ohio, Oregon, Pennsylvania, Rhode Island, Texas, and Virginia. Note:
Retail access in these states is either currently available or will soon
be available; each state*s retail access schedule varies according to its
legislative mandates or regulatory orders. In Oregon, for example, no
customers are currently participating in the state*s retail access
program, but the law allows nonresidential customers access. Some States
Have

Opened Retail Markets to New Sellers, While Others Have Not Pursued
Restructuring Efforts

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 32 GAO- 03- 271 Lessons Learned from Electricity Restructuring

after experiencing a prolonged period of high prices and power shortages
but has not repealed its overall plans to restructure.

The remaining 26 states have not enacted legislation or issued regulatory
orders to implement retail access, and they continue to require retail
customers to purchase electricity from their traditional utility. 7 Of
these states, 8 continue to study the issue of restructuring, while 18
have decided that electricity restructuring is not in their best interest
at this time and are not actively considering it, according to a recent
report by the National Regulatory Research Institute. These states see
little benefit from opening their electric industries to competition
anytime soon, since most of these states have relatively low electric
rates compared with the rest of the nation. In contrast, states that have
opened their retail electricity markets to competition, such as
Pennsylvania, New York, and most of New England, have historically had
higher than average U. S. retail electricity prices. Figure 4 shows the
status of state electricity restructuring activity as of November 2002, as
well as average retail electricity prices in 1992, when widespread
wholesale restructuring began with the passage of EPACT.

7 These states are Alabama, Alaska, Colorado, Florida, Georgia, Hawaii,
Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Minnesota, Mississippi,
Missouri, Nebraska, North Carolina, North Dakota, South Carolina, South
Dakota, Tennessee, Utah, Vermont, Washington, Wisconsin, and Wyoming.

Chapter 3: Federal and State Efforts Are Underway to Develop Competitive
Markets

Page 33 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Figure 4: Status of State Electricity Restructuring Activity as of
November 2002 and Average Prices as of 1992 a

Source: Energy Information Agency. a Average prices are in units of cents
per kilowatthour, in 1992 dollars.

b States that took legislative and/ or regulatory action have some degree
of shading. States not taking such actions are shown in white.

Despite FERC*s efforts, significant impediments remain to the development
of competitive wholesale markets. FERC*s efforts to develop regional
transmission organizations and standardize rules between them are in the
early stages of development, with a number of contentious issues to still
be resolved. Further, while nearly half of the states moved forward to
restructure their retail markets, some states* when faced with the
uncertainties that accompany restructuring* decided to delay or suspend
their efforts. Continuing to address these restructuring issues will take
considerable time and effort on the part of FERC and the states.
Conclusion

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 34 GAO- 03- 271 Lessons Learned from Electricity Restructuring

It is not possible to determine fully the extent to which the development
of competitive markets* the goal of restructuring* has been achieved to
date. Our review of studies related to measuring the performance of
restructuring indicates a mixed assessment of how far along the industry
is in developing competitive markets and the extent to which expected
benefits have been achieved. While most studies found progress has been
made in introducing competition in wholesale electricity markets, results
at the retail level have been difficult to measure, and, where measurement
has been possible, there is disagreement about the extent to which
expected benefits of restructuring have been achieved. Our own evaluation
of the performance of restructuring was also inconclusive. With respect to
the goal of increasing competition, restructuring efforts by the federal
government and the states have broadened electricity markets by making
them more regional and allowing new generation companies to participate.
However, we could not determine the extent to which expected consumer
benefits have been achieved, in part because restructuring is in its early
stages, but also because of a lack of data necessary to measure key
benefits.

In our review of more than 30 studies that examined the performance of the
electricity industry since restructuring began, we found general agreement
that some progress has been made in developing more competitive wholesale
electricity markets. 1 For example, the development of ISOs and the
beginning of RTO formation is cited as having caused greater numbers of
sellers and buyers to have access to electricity over wider geographic
regions than was previously possible. Some of these studies also conclude
that this increase in competition has led to lower prices for retail
electricity customers. However, other studies dispute the claim that
retail electricity customers are better off under restructuring and point
to episodes of high prices, including the crisis of 2000 and 2001 in
California and the West, as evidence that flaws in restructuring have led
to undesirable outcomes. A number of studies also pointed to continuing
problems with the scope of restructuring, including the fact that most
retail electricity customers are insulated from changes in wholesale
prices. As such, these customers typically pay a fixed price, regardless
of changes in the underlying cost of acquiring the electricity in
wholesale markets. Therefore, these customers do not respond to periods of
high wholesale prices by reducing their consumption of electricity as they
might if they

1 A bibliography of studies can be found in appendix IV. Chapter 4: The
Extent to Which the Goal of

Competitive Electricity Markets Has Been Achieved Is Uncertain

Review of Studies Indicates a Mixed Picture of Competition and Uncertainty
Regarding Benefits

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 35 GAO- 03- 271 Lessons Learned from Electricity Restructuring

had to pay those higher prices directly. As we recently reported, there is
general agreement among economists and other experts that the absence of
price- responsive customers may enable electricity sellers to charge
higher than competitive prices. 2

The combined efforts of the federal government and some states have
broadened electricity markets, expanding their scope in many cases from a
local to a regional focus. Along with this broadening of the markets have
come increases in the number of buyers and sellers entering the wholesale
electricity markets. Broader markets may also be improving the
availability and quality of electricity pricing information, but there are
indications, such as a lack of transparent electricity transactions, that
the industry is still lacking in this area. There has also been a great
deal of investment in new power plants, indicating that entry into the
industry has occurred.

Early restructuring efforts have led the electricity industry to
experience a significant change in the way power is sold across state
lines. Four ISOs* California, PJM, New York, and New England* currently
operate centralized power markets in which electricity suppliers and
buyers submit bids to sell and buy power. Sellers from across these
regions and states compete together in these centralized markets,
expanding the geographic scope of the markets. In addition to operating
power markets, the ISOs manage the generation and transmission of
electricity to maintain reliability of the system.

In addition to the introduction of more regional wholesale electricity
markets, private electricity trading hubs have emerged, expanding the
scope of markets even further and improving the ability of buyers and
sellers to manage risk. Specifically, these trading hubs provide a market
for buying and selling electricity, as well as for trading electricity
futures and various derivatives outside centralized regional wholesale
markets. 3 Simply put, a trading hub is a location on the power grid
representing a delivery point where ownership of electric power changes
hands, although

2 U. S. General Accounting Office, Restructured Electricity Markets:
California Market Design Enabled Exercise of Market Power, GAO- 02- 828
(Washington, D. C.: June 21, 2002). 3 Derivatives are financial products*
for example, options, futures, and other contracts* the value of which is
derived from underlying instruments, such as company stocks, electricity
and natural gas commodities, or other financial instruments. GAO
Evaluation

Indicates Some Progress Made in Developing Competitive Markets but
Questions Remain

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 36 GAO- 03- 271 Lessons Learned from Electricity Restructuring

the actual trades may take place in numerous locations. The emergence of
trading hubs is an important development in the process of developing
competitive electricity markets because hubs provide market participants a
way to trade a standardized increment of electricity. However, of the 10
major hubs that have been developed to date, only a few account for the
bulk of power trading. Furthermore, there are indications that the future
is somewhat cloudy. For example, the New York Mercantile Exchange recently
announced that it was discontinuing trading of electricity futures, citing
a lack of trading volume. It remains unclear whether these types of hubs
will reemerge and become viable in the future electricity industry
environment.

Similarly, development of Internet- based trading systems, such as
EnronOnline, Dynegydirect, and Intercontinental Exchange, has further
changed the ways in which electric power is sold. Such systems provide an
additional market for both physical energy (electricity and natural gas
products) and energy derivatives to be bought and sold. Experts say that
in other commodity markets the existence of multiple markets has resulted
in improvements in the quality and availability of price information.
Recently, in the electricity industry, there have been accusations that
large market participants who had superior market information manipulated
these systems, and some companies such as Enron have stopped such
Internet- based trading.

Increases in the number of wholesale electricity sellers* one of the key
structural changes required to implement competition* has accompanied the
opening of regional wholesale electricity markets, trading hubs, and
Internet- based trading systems. The introduction of ISOs and RTOs has
allowed more market participants to compete effectively and allowed all
the suppliers in the region to compete in a broader marketplace. In
addition, since 1992 FERC has granted authority to 850 companies to charge
*market- based* rates, which enables them to participate in competitive
wholesale markets. FERC*s approval to charge market- based rates enables
these companies to participate as sellers in the various wholesale markets
that have emerged. If these companies are not granted authority to charge
market- based rates they can only sell power in interstate wholesale
markets at regulated rates, based on their costs, which must also be
approved by FERC.

In addition to an increase in the number of wholesale sellers, some states
are witnessing an increase in the number of retail sellers who are
competing with utilities to sell electricity to consumers. For example,
one study, conducted by the National Regulatory Research Institute, found
that

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 37 GAO- 03- 271 Lessons Learned from Electricity Restructuring

in the 18 states that have operated restructured retail markets, there
were 75 companies competing with these states* utilities to sell
electricity to retail customers. These companies must either buy their
electricity from the wholesale markets or generate it themselves, and when
they buy electricity from the wholesale market, this increases the number
of wholesale buyers as well, another key structural change needed to
implement competition. In providing technical comments on a draft of this
report, FERC stated that most states that have implemented retail
competition fear that too few new retailers have entered the market to
support effective retail competition.

There have also been improvements in the availability and reliability of
price and other market information* another requirement of competitive
markets. Increased numbers of transactions, whether executed through
institutions such as ISOs or RTOs, through private trading hubs, or
through other types of transactions, provide a critical means of
developing price information and making it available. While the
development of broader electricity markets has contributed to the
availability and quality of price data, there are indications that the
electricity industry is still in the early stages of development in this
area. For example, in a recent FERC conference on market monitoring,
several conference participants stated that there is still not enough
trading in many markets across the country to ensure confidence that the
prices observed in those markets are accurately representative of the
prices at which electricity is generally trading there. In addition,
recent concerns by FERC and others that some market participants may have
misreported price information used in various publications have raised
questions about the reliability of publicly available information.

Another indication of the emergence of competition is that new suppliers
are able to enter the market. In recent years, there has been a large
increase in the amount of new generating capacity that has been built.
Specifically, from 1995 through July 2002 there has been about 175,000
megawatts (MW) of new generating capacity built in the United States, with
most of this capacity added since 1998. 4 These new generating plants
added about 23 percent to the total generating capacity that existed in
1995. In addition, nonutility companies own most of the new generating
capacity built in recent years, which has served to increase in the number

4 A megawatt is a measure of electric power equal to 1,000, 000 watts. One
megawatt of generating capacity can serve the needs of about 750 homes.

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 38 GAO- 03- 271 Lessons Learned from Electricity Restructuring

and capabilities of these new types of electricity sellers in wholesale
markets. Specifically, nonutilities accounted for about 148,000 MWs of
generating capacity, or about 85 percent of the 175,000 MWs added from
1995 through July 2002. Investor- owned utilities (IOUs) accounted for the
remaining 15 percent. Figure 5 shows the new investments in generating
capacity from 1995 through July 2002.

Figure 5: Generating Capacity Added, 1995 through July 2002

Source: GAO analysis of PowerDAT data provided by Platt*s/ RDI. a 2002
reflects data through July.

The growth rate of generating capacity over these years has been far
higher than the average growth rate of demand, meaning that new generating
plants will likely displace some generation from existing facilities. This
is especially likely because most of the new generating units burn natural
gas and employ technology that is currently less costly per unit of
electricity generated than many older generating plants, making the former
more economically competitive and able to sell power profitably at lower
prices. Any displacement of older plants powered by fossil fuel by power
plants that burn natural gas would have a positive effect on air quality
because, in addition to running at lower cost, the newer plants create far
fewer emissions per unit of electricity generated than the older

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 39 GAO- 03- 271 Lessons Learned from Electricity Restructuring

plants. However, over the past year, a large number of proposed power
plants have been canceled, in part as a result of poor market conditions,
including tighter credit requirements from banks and investors, slower
economic activity, and the financial difficulties of several large energy
companies.

Available data and information do not allow a determination of the extent
to which restructuring efforts to date have led to the expected benefits
for consumers of lower electricity prices and a wider array of services.
While electricity prices have generally fallen since restructuring began
in the 1990s, it is not clear how much of the decline was attributable to,
or simply coincided with, restructuring efforts. Further, periods of
higher prices have also occurred in some places and during some periods of
time. Similarly, new electricity products have emerged, both in
restructuring and nonrestructured states, making it difficult to conclude
that these new products are the direct result of restructuring efforts. In
addition, while operating efficiency for power plants appears to have
increased since restructuring began, this is a continuation of a trend
that began prior to restructuring, and it is therefore not clear how much
of the improvement can be attributed to, or is simply coincident with,
restructuring.

Throughout the 1990s* the period during which restructuring began at the
national level and expanded to individual states* average retail prices
for electricity fell, after adjusting for inflation. Specifically, from
1990 through 1999, average retail prices for residential customers fell by
about 14 percent, and prices for industrial customers fell by about 23
percent. However, in 2000, retail prices for industrial customers rose,
and, in 2001, prices rose for both industrial and residential customers.
Over the entire period from 1990 through 2001, retail residential and
industrial prices fell by about 13 and 15 percent, respectively. As shown
in figure 6, the decrease in prices throughout the 1990s continues a trend
that began in 1983. Restructuring*s

Impact on Prices and Other Expected Benefits Remains Unclear

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 40 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Figure 6: Average Electricity Prices, 1960- 2001

Source: GAO analysis of data provided by the Energy Information
Administration.

To try to determine the effect of restructuring efforts on retail prices,
we examined these price changes in the context of state restructuring
status, distinguishing between (1) states that implemented restructuring
plans, (2) states that made restructuring plans but delayed their
implementation, and (3) states that did not develop restructuring plans. 5
In addition, we focused on the years from 1997 through 2001, which
encompass the period during which individual states began restructuring
their retail markets. In so doing, we found that those states that
implemented some restructuring efforts generally experienced decreases in
residential retail prices while

5 For the purpose of this analysis, we modified the Energy Information
Administration*s classification of states* restructuring status as of
November 2002 by grouping California, which is currently listed as
*suspended,* with the 17 *active* states. We did this because California
had an active retail access program from April 1998 until September 2001.
Using this modified classification, 18 states and the District of Columbia
have implemented restructuring plans, 6 states made restructuring plans
but delayed their implementation, and 26 states did not develop
restructuring plans. All prices have been adjusted for inflation and are
expressed in terms of 2001 dollars. In addition, the average prices we
report are a simple average across states, as opposed to an average
weighted by the volumes of electricity consumed in each state.

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 41 GAO- 03- 271 Lessons Learned from Electricity Restructuring

prices generally increased in states that did not implement restructuring
during the same period. For example, over the entire 4- year period,
average residential prices fell by about 4 percent in states that
implemented restructuring, but rose by 4 percent in states that delayed
and by 3 percent in states that made no restructuring plans. Over the same
4- year period, overall retail prices for industrial customers generally
rose, but we found that the price increases were generally smaller for
states that implemented some restructuring efforts compared to states that
either delayed or made no restructuring plans. Specifically, we found that
on average, restructuring states witnessed almost no change in average
retail industrial prices over the entire four year period from 1997
through 2001, while states that delayed their restructuring plans or did
nothing had 24 and 5 percent price increases, respectively. As discussed
previously in this report, residential retail prices rose in 2001, and
industrial retail prices rose in both 2000 and 2001. 6

While restructuring may have contributed to the overall reduction in
retail prices in the 1990s, and may account in part for the greater
decreases in restructuring states in the period from 1997 through 2001,
there are other factors that could have affected prices. For these and
other reasons, we were unable to determine the effect of restructuring on
retail prices. For example, this period also witnessed reductions in the
prices of natural gas, coal, and other fuels used to generate electricity,
as well as the introduction of cost- saving technologies at new and
existing power plants, all of which may have led to price reductions. We
also found that states that restructured generally reduced and froze
retail prices at the time they restructured in the expectation that
restructuring would lead to lower prices overall and to ensure that their
retail customers benefited immediately. Therefore, the greater price
reductions observed in these restructured states may reflect state
regulator*s expectations, rather than what restructuring actually
achieved.

Expert opinion is also mixed on the impact of restructuring on retail
prices. Some experts attribute lower retail prices in part to
restructuring and increased competition in wholesale and retail markets,
while others, citing periods of higher prices, point to flawed
restructuring as the cause,

6 The data used in figure 6 differ from those used in the calculations of
prices from 1997 through 2001. The data used to generate the figure
include prices from utilities, as well as energy service providers selling
to retail customers, while the data used to calculate changes from 1997
through 2001 only reflect utility prices* state- by- state data for energy
service providers were not available.

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 42 GAO- 03- 271 Lessons Learned from Electricity Restructuring

claiming that the electricity industry cannot be made to behave
competitively. Still others have stated that flaws in restructuring
efforts, including frozen retail rates that made it difficult for new
sellers to compete with existing utilities, have reduced what impact
restructuring could have had on lowering retail prices. Finally, because
electricity frequently crosses state borders as generators in one state
sell to buyers in another, prices in any single state will often affect
prices in adjacent states. This further complicates the picture, making it
difficult to sort out the effect of restructuring on overall retail
electricity prices.

Another expected benefit of restructuring, new electricity products, has
become available in recent years, but new products have occurred in both
restructured and nonrestructured states. These products include green
power (electricity produced by renewable resources), electricity sold at a
price that varies according to time of use or market conditions, and
energy service contracts that provide additional services to consumers,
such as energy audits or energy efficiency improvements. For example, in
several states, green power has emerged as a product for which consumers
are willing to pay more. One recent study found that in 18 states that had
actively pursued retail restructuring, companies were offering their
customers 49 different ways to buy electricity generated by renewable
sources. New products are also emerging in nonrestructured states. For
example, in Colorado* a state that has not restructured* the local
monopoly utility has also offered to sell electricity generated by
renewable sources to its customers. Because new products have emerged in
both restructured and nonrestructured states, and because there is no
central source of data on the development of new products, we were unable
to determine what effect restructuring has had on the development of these
products.

While it appears that there have been efficiency gains in the operation of
electricity generating plants, another expected benefit of restructuring,
we find that it is not possible to determine whether restructuring caused
or simply coincided with these gains. In promoting restructuring, experts
believed it would improve efficiency by, among other things, reducing the
amount of excess generating capacity required to maintain a reliable
electricity system. Throughout the 1990s, power plants did experience
increases in their intensity of use* reducing excess capacity during these
years. However, this was a continuation of a trend that began in 1983,
prior to restructuring. In addition, the upward trend in intensity of
power plant use was reversed in 2000 and 2001. Some experts attribute part
of the overall efficiency gains to restructuring, stating that increased
competition improves incentives for using existing power plants more
intensively. They

Chapter 4: The Extent to Which the Goal of Competitive Electricity Markets
Has Been Achieved Is Uncertain

Page 43 GAO- 03- 271 Lessons Learned from Electricity Restructuring

also attribute the fall in intensity of power plant use in 2000 and 2001
in part to the large number of new plants that began operation during
those years and to the fact that overall demand grew more slowly than
expected. Overall, due to data limitations, we were unable to determine
the impact of restructuring on the efficiency of power plant operations.
Figure 7 shows the average capacity factor for power plants from 1949
through 2001. The capacity factor for generating plants shown in the
figure measures the proportion of total generating capacity that is
actually produced during each year.

Figure 7: Overall U. S. Capacity Factor, 1949- 2001

Source: GAO analysis of data provided by the Energy Information
Administration.

Competitive electricity markets are clearly in the early stages of
development. While restructuring efforts have broadened electricity
markets and increased the number of market participants (both buyers and
sellers), the extent to which expected benefits have been achieved is
uncertain. Because the development of competitive markets and the expected
benefits from competition are central to restructuring efforts,
understanding how far along the road to greater competition we have come
and what remains to be done in moving forward is important. Conclusion

Chapter 5: Lessons Learned from Electricity Restructuring and
Recommendations

Page 44 GAO- 03- 271 Lessons Learned from Electricity Restructuring

In determining the goals of electricity restructuring, reviewing actions
that federal and state agencies have taken to restructure the industry,
and determining whether those actions have achieved the goal of increased
competition and the expected benefits of restructuring, we have identified
key lessons learned from experience to date that relate to the structure
of electricity markets and market oversight. The lessons presented here
point out potential limitations to the extent of competition in
electricity markets and to the expected benefits of restructuring. In
addition, we discuss the need for improved monitoring of restructured
electricity markets.

In its effort to promote competitive wholesale markets, FERC has
historically approved a wide range of specific rules that govern the
operation of individual transmission system operators and centralized
wholesale markets under its jurisdiction. FERC has acknowledged the lack
of a single set of rules for transmission access or wholesale market
operations. Furthermore, FERC has stated that the absence of consistent
rules has permitted (1) rules that can be used to discriminate and lead to
increased transmission costs and system reliability problems and (2)
various design flaws in wholesale markets and transmission services that
have created operational problems within and between wholesale markets.
For example, a variety of inconsistent rules governing the operation of
power plants in PJM, New York ISO, and ISO New England have made it more
costly for participants in these electricity markets to buy and sell from
each other. Overall, the presence of different rules and operations limits
the extent of possible competition between these markets. Limiting the
extent of competition between wholesale markets will, in turn, limit the
expected benefits from restructuring.

Recently, FERC*s proposed standard market design rulemaking was developed
largely to address the variations in rules and operating procedures for
the wholesale markets and transmission services. Through its proposal,
FERC plans to bring a level of standardization to market rules and
procedures that will remedy these problems and provide a level playing
field for all entities that seek to participate in wholesale electricity
markets. Chapter 5: Lessons Learned from Electricity

Restructuring and Recommendations Experience with Restructuring to Date
Provides Five Lessons Learned

Different rules in electricity systems limit the ability to achieve
benefits from competition

Chapter 5: Lessons Learned from Electricity Restructuring and
Recommendations

Page 45 GAO- 03- 271 Lessons Learned from Electricity Restructuring

FERC does not have regulatory authority over all entities in wholesale
electricity markets. Specifically, FERC does not have jurisdiction over
power sales by federally owned entities (e. g., the Bonneville Power
Administration, the Tennessee Valley Authority, and the Western Area Power
Administration), publicly owned utilities, or most cooperatively owned
utilities. For example, the electricity needs of Nebraska are entirely
served by municipal, cooperative, and other suppliers not explicitly
subject to FERC oversight. As a result, a patchwork of rules has developed
governing both restructured and nonrestructured jurisdictions, with large
areas of the country operating primarily outside the scope of FERC*s
authority.

While many of these nonjurisdictional entities are smaller than many
investor- owned utilities, taken together they serve large areas of the
country and provide service to about 25 percent of the nation*s demand for
electricity. As shown in figure 8, the areas served by entities not under
FERC jurisdiction cover a wide area, especially in the Southeast, Midwest,
and West. FERC*s limited jurisdiction

in wholesale markets limits the ability to achieve benefits from
competition

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Page 46 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Figure 8: Areas Served by Entities Subject to FERC Jurisdiction, 2002

Source: GAO analysis of PowerMap data provided by Platt*s/ RDI. Notes:
Areas served by entities generally not subject to FERC jurisdiction
include areas served by publicly owned entities such as municipal
utilities, cooperative utilities, and others.

Data on service territories include some overlaps, indicating that some
areas are served by both entities subject to FERC jurisdiction and
entities not generally subject to FERC jurisdiction, particularly some
areas in Pennsylvania, Michigan, Wisconsin, and Iowa. Data reflected above
depict those areas of overlap as not generally subject to FERC
jurisdiction.

Unshaded portions of the map indicate either that no electric service is
provided or the service area is very small.

In addition to covering wide areas of the country, these nonjurisdictional
entities also own about 30 percent of the transmission lines nationwide.
FERC has only limited jurisdiction over the transmission services of such
entities. As shown in figure 9, the lines owned by nonjurisdictional
entities are prominent in the West and South, including lines owned by
federal

Chapter 5: Lessons Learned from Electricity Restructuring and
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Page 47 GAO- 03- 271 Lessons Learned from Electricity Restructuring

entities such as the Bonneville Power Administration, the Western Area
Power Administration, and the Tennessee Valley Authority. Many of the
lines owned by these nonjurisdictional entities are high- voltage
transmission lines, capable of carrying large volumes of electricity over
long distances. These types of lines may offer opportunities to facilitate
transactions between regions.

Figure 9: Ownership of Large Transmission Lines by Entities Subject to
FERC Jurisdiction, 2002

Source: GAO analysis of PowerMap data provided by Platt*s/ RDI. Notes:
Data for transmission lines reflect primary ownership* some lines may have
multiple owners. Federal entities include the Bonneville Power
Administration, the Tennessee Valley Authority, the Western Area Power
Administration and others.

Chapter 5: Lessons Learned from Electricity Restructuring and
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Page 48 GAO- 03- 271 Lessons Learned from Electricity Restructuring

High voltage transmission lines are generally capable of moving higher
volumes of electricity over greater distances with fewer losses, than
lower voltage lines.

As a result of the lack of jurisdiction across wide regions of the country
and over significant transmission lines connecting some areas of the
country, FERC has not been able to prescribe the same standards of open
access to the transmission system. This situation, by limiting the degree
to which market participants can make electricity transactions across
these jurisdictions, will limit the ability of restructuring efforts to
achieve a truly national competitive electricity system and, ultimately,
will reduce the potential benefits expected from restructuring.

FERC*s proposed standard market design rulemaking does not address the
issue of its jurisdiction and authority regarding federally owned
entities, cooperatives, and municipalities. Nonetheless, there have been
several legislative proposals in the 107th Congress to address FERC*s
limited jurisdiction, though none has been enacted.

Federal and state governments each have regulatory authority for
overseeing the electricity industry* federal over wholesale and state over
retail markets. As a result, the actions taken to restructure wholesale
and retail markets have, for the most part, been undertaken separately.
For example, to promote competition in wholesale markets, FERC has taken
actions to allow prices to be established by direct interaction between
buyers and sellers. However, most state actions at the retail level have
in fact served to freeze retail prices, thereby limiting the degree to
which buyers can respond to changes in underlying wholesale prices.
Specifically, states have imposed frozen retail prices in restructured
markets or continued to regulate prices in areas not undertaking retail
restructuring, both of which limit the ability of consumers to respond to
changes in wholesale prices. There is general agreement among industry
experts that the absence of a significant demand response has a negative
impact on the functioning of wholesale electricity markets, causing prices
to be higher and more volatile and facilitating the exercise of market
power by electricity sellers. As a result, these state actions place
limits on the extent to which competitive markets can develop and, thus,
reduce the potential benefits expected from restructuring.

Because FERC does not generally have authority over retail electricity
markets, FERC*s standard market design proposed rulemaking does not
directly address the issue of making electricity consumers responsive to
prices. However, the proposed rulemaking does reference and comment
Separate development of

wholesale and retail electricity markets limits the ability to achieve
benefits from competition

Chapter 5: Lessons Learned from Electricity Restructuring and
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Page 49 GAO- 03- 271 Lessons Learned from Electricity Restructuring

on the value and need for a better link between supply (wholesale) and
demand (retail) to help create improved supply planning and a more
efficient competitive environment. Further, according to FERC, the
proposed rulemaking would require market operators to receive demand
reduction bids if states allow retail customers to make such bids.

Federal, state and local entities all have authority over key decisions
that affect new investment in generation and transmission facilities.
Decisions made by private investors on how and when to site new generation
facilities will influence the availability of new electricity supplies.
Further, although transmission increasingly serves regional needs, state
and local governments make many of the decisions on whether and where to
site new lines. Therefore, the investments necessary to maintain adequate
supplies of electricity and a reliable electricity system are critically
dependent on how federal, state, and local regulatory bodies exercise
their authority over these new investments. For example, adding a
transmission line that crosses several state boundaries and passes through
federal lands requires multiple permits and approval processes involving
numerous regulatory entities charged with, among other things,
environmental protection and land use planning issues. Similarly,
investments in new generating facilities, while typically involving a
single state, generally require approval from multiple regulatory entities
to address state and local environmental, zoning, and energy policy
issues.

While recognizing the importance of the regulatory approval process, many
market participants have stated that the lack of a unified and consistent
regulatory environment across states creates a potential barrier to
investment that leads to uneven and, in some cases, insufficient
investment in new generating or transmission facilities. For example, as
we have previously reported, states* power plant siting decisions affect
companies* perceived risk of entering a given market, which may, in turn,
result in more or less investment. 1 As restructuring creates markets that
are more regional in scope, less than needed investment in new plants in
one state may have implications for neighboring states* resulting in the
need for additional plants to be built in adjacent states or contributing
to higher market prices. As a result, state actions that serve to delay or

1 U. S. General Accounting Office, Restructured Electricity Markets: Three
States* Experiences in Adding Generating Capacity, GAO- 02- 427
(Washington, D. C.: May 24, 2002). Federal, state, and local

decisions on siting new power plants and transmission lines limit the
ability to achieve benefits from competition

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Page 50 GAO- 03- 271 Lessons Learned from Electricity Restructuring

prevent additions of new power plants or power lines could limit FERC*s
ability to achieve a national market for competitive electricity and,
thus, limit the expected benefits of restructuring.

FERC*s standard market design proposal does not directly address the
siting processes for electricity power plants or for transmission lines.
However, the standard market design proposal does encourage regional
cooperation and state and federal collaboration on generation and
transmission system planning.

FERC, the states, and other market monitors are not fully monitoring the
overall performance of all wholesale and retail markets nor collecting
sufficient data to do so. As a result, cross- regional comparison of the
performance of markets is generally not possible. FERC has recently
proposed changes to the design of electricity markets, which include plans
to improve monitoring efforts.

Until recently, FERC has not actively monitored market performance in a
general sense. As reported earlier this year, FERC*s previous efforts to
directly oversee the market have been incomplete or ineffective. 2
Specifically, FERC staff told us that in the past their monitoring efforts
were largely undertaken on a case- by- case basis in response to specific
problems. For example, FERC has been actively investigating several
complaints of market manipulation and violations of market rules over the
past year, many stemming from the western U. S. electricity crisis that
began in 2000. Further, FERC has limited authority to compel market
participants to provide proprietary data needed for more comprehensive
monitoring. For example, FERC has identified difficulties in getting data
on individual power plant operations that it needs in order to evaluate
the functioning of the transmission system. Senior FERC officials told us
that, in general, FERC*s authority to collect data from market
participants is predicated on developing a specific legal argument that
the data support a specific investigation, rather than for more general
monitoring of market performance. In some cases, according to FERC, this
is due to the requirements of the Paperwork Reduction Act.

2 U. S. General Accounting Office, Energy Markets: Concerted Actions
Needed for FERC to Confront Challenges that Impede Effective Oversight,
GAO- 02- 656 (Washington, D. C.: June 14, 2002). Better monitoring of

market performance is needed to determine how well restructured markets
are performing and the extent to which expected benefits of competition
have occurred

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State efforts to monitor the electricity industry have declined since the
mid- 1990s. According to experts, the ability of state public utility
commissions to monitor restructured electricity markets is limited because
oversight has shifted from the states to FERC. They further stated that
state commission access to data from market participants is more limited
under restructuring than under the previous regulated environment in which
they had authority over setting electricity rates for the utilities in
their states and, therefore, access to most of the relevant industry data.
In addition, a survey of public utility commissions, currently in process
by the National Regulatory Research Institute, indicates that only 23 of
the 40 states that responded had a formal standard on electricity
reliability and service quality.

As required by FERC, all ISOs or RTOs currently operating wholesale
electricity markets have market- monitoring units that evaluate the
conduct of their participants and some measures of market performance.
However, the primary focus of the monitors has been to identify and
mitigate the exercise of market power by electricity sellers, rather than
measuring how well their overall design is working or whether these
markets are delivering benefits to consumers. Market monitors we spoke
with said that their efforts to evaluate market power have generally
focused on comparing estimates of the costs of producing electricity to
the prices received from the market. In most specific cases of day- to-
day monitoring, monitors share their results in nonpublic reports with the
management of the ISO and sometimes with FERC. In addition, the market
monitors develop periodic reports, which evaluate the performance of their
markets and are often made public. However, the authority and scope of
each of these market monitors to collect data from market participants is
limited by the boundaries of their individual markets. As a result,
investigations undertaken by these entities are inherently limited because
some key information may not be reviewed if it involves transactions with
entities located outside the monitors* jurisdiction or involves
transactions about which the monitor has no detailed information. In
addition, because several of the market monitors rely on different methods
to evaluate market power, there is a lack of uniformity in what data are
collected, how they are analyzed, and what is reported, making cross-
market comparisons difficult.

Recently, with the formation of FERC*s new Office of Market Oversight and
Investigations, FERC has begun to look more broadly at the performance of
electricity markets and is in the process of studying what measures of
market performance to evaluate on a regular basis. As part of this effort,
the Office of Market Oversight and Investigations has begun to

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Page 52 GAO- 03- 271 Lessons Learned from Electricity Restructuring

produce weekly reports on market conditions for the commissioners and
staff, although at this point the reports offer only limited coverage. In
addition, FERC*s efforts to implement its proposed standard market design
may improve market monitoring by standardizing the markets and improving
the ability to make cross- market comparisons. As part of its proposed
standard market design, FERC intends for each region to set up market
monitoring units that would report to FERC regularly. FERC would also
require that some of the data collected by the regional market monitors
follow comparable protocols to facilitate cross- market comparisons. Using
these reports and data received from the market monitors and other
sources, FERC intends to regularly monitor electricity markets and take
corrective actions in the event that problems emerge in wholesale
electricity markets.

While FERC*s recent efforts may improve the situation, key issues remain
unresolved, and, unless addressed, will prevent full and consistent
monitoring of restructured markets from going forward. Among the issues
identified by recent participants in a FERC sponsored conference on market
monitoring are (1) the lack of consistency in what data are collected and
what evaluations are made, which makes cross- market comparisons
difficult; (2) the unavailability of data needed by the public and
researchers to evaluate restructuring; (3) the unavailability of key data
to market monitors, such as information about bilateral trades between
buyers and sellers outside the ISO- run markets; and (4) concern and
reluctance on the part of market participants that the proprietary data
they provide to market monitors may be revealed in such a way that it
impedes their ability to compete effectively. As a result, no entity can
currently conduct a comprehensive evaluation of restructuring across
different states and electricity markets to determine how restructuring is
doing with respect to overall performance and the delivery of consumer
benefits.

Because the transition to greater competition will take considerable time,
it is possible that bad outcomes for consumers, such as rising retail
prices in the aftermath of the electricity crisis in the western United
States from summer 2000 to spring 2001, could occur again. It is
essential, therefore, that FERC and other regulatory bodies or independent
monitors carefully watch for signs of problems and be able to make needed
adjustments in a timely fashion. Further, better monitoring of electricity
markets would also help to ensure that the goal of increasing competition
in electricity markets and the expected benefits associated with this
greater competition are achieved. Without a concerted effort to improve
monitoring of wholesale markets and their impact on consumers, FERC
Conclusion

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Page 53 GAO- 03- 271 Lessons Learned from Electricity Restructuring

will lack key information needed to make informed regulatory decisions and
to report to Congress about the status and progress of restructuring.

To help Congress ensure that the fullest benefits possible are achieved
from electricity restructuring, and to better understand what progress has
been made, GAO is recommending that the Chairman, FERC,

1. determine how restructured wholesale electricity markets are performing
by developing and implementing a plan to collect necessary data and
perform evaluative analysis. These data should be sufficient to allow
evaluation of the competitiveness of these markets (including, but not
limited to, the extent of market power, efficiency of the industry, and
ease of market entry) and the expected benefits to retail consumers (such
as lower retail prices and the availability of new products). Where
possible and appropriate, FERC should work in concert with state and
regional entities to take advantage of their knowledge, expertise, and
access to important data relevant to the impacts of restructuring on
consumers.

2. report annually to Congress and the states on the status of
restructuring efforts, identify emerging issues and impediments to
reaching FERC*s goal of achieving national competitive wholesale
electricity markets, and make appropriate recommendations to Congress and
the states for changes to improve the functioning of these markets.

In its written comments, FERC agreed with our report*s *lessons learned*
and principal findings. In addition, FERC agreed with our second
recommendation that FERC should report annually to Congress on the status
of restructuring, noting that it plans to do so in spring 2003. However,
FERC said that our recommendation directing it to determine, in concert
with the states and regional entities, how both wholesale and retail
markets are performing is more problematic. While FERC agreed that it
should evaluate and report on wholesale markets under its jurisdiction, it
stated two reasons for its concern about evaluating retail markets in
concert with state entities. First, because retail markets are under state
jurisdiction, while FERC oversees wholesale markets, FERC is sensitive to
this division of jurisdiction and is hesitant to monitor the status and
effectiveness of retail competition unless Congress specifically directs
it to do so. Secondly, FERC states that it does not currently have the
expertise or resources to evaluate the multiplicity of retail markets.
Recommendations for

Executive Action Agency Comments

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Page 54 GAO- 03- 271 Lessons Learned from Electricity Restructuring

We are sensitive to the separation of jurisdiction over retail and
wholesale electricity markets. For this reason, we are not recommending
that FERC step outside its jurisdictional boundaries or attempt to assume
responsibility for the status and effectiveness of retail restructuring
efforts. However, we believe that in order for FERC to fully evaluate and
understand the effectiveness of its actions to implement competition in
wholesale markets, it must examine the status of restructuring in
wholesale markets as well as the impact of this restructuring on consumers
of electricity. FERC*s Order 888, issued April 24, 1996, points out that
FERC*s actions are ** designed to remove impediments to competition in the
wholesale bulk power marketplace and to bring more efficient, lower cost
power to the nation*s electricity consumers.* Because lower electricity
prices to consumers are an expected benefit from more competitive
wholesale markets, we believe it is reasonable that FERC, Congress, and
the states should know if lower prices are occurring as the basis for
possible future policy actions.

With regard to the issue of resources and expertise, we believe that FERC
can supplement its own assets by drawing from many sources to assist it in
evaluating retail impacts. Among these sources are (1) other federal
agencies* including the Energy Information Administration* and private
companies that collect data on consumer electricity prices and other
related information; (2) market monitoring units of regional or state
independent system operators or other entities that operate wholesale
electricity markets; (3) expert panels, such as the panels recently
brought together to assist FERC with its market monitoring plans in FERC*s
proposed standard market design; and (4) state agencies that have
historically tracked consumer issues as part of their oversight over
retail electricity markets* as we previously reported, there is precedent
for FERC obtaining input on its studies from state public utility
commissions. 3 We also believe that FERC is in a unique position to be
able to make a nationwide assessment of restructuring because, as the
primary federal agency responsible for overseeing wholesale electricity
markets, it is the only entity that currently has access to key
information from all its jurisdictional markets and market participants.
In addition, in the process of formulating its proposed standard market
design, FERC has consulted with state and regional entities, in part to
formulate plans to monitor the

3 U. S. General Accounting Office, Energy Markets: Concerted Actions
Needed for FERC to Confront Challenges that Impede Effective Oversight,
GAO- 02- 656 (Washington, D. C.: June 14, 2002). See page 43 for reference
to obtaining input from state public utility commissions for FERC studies.

Chapter 5: Lessons Learned from Electricity Restructuring and
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Page 55 GAO- 03- 271 Lessons Learned from Electricity Restructuring

performance of markets under the standard design. We believe that such
coordination between FERC, the states, and regional entities is necessary
and should extend to evaluating the impacts of wholesale restructuring on
consumers.

In order to make it clear that we are not asking FERC to overstep its
jurisdictional boundaries, we have revised the language of our
recommendation to state that we recommend FERC evaluate the impacts of
restructuring efforts in the wholesale markets on retail electricity
consumers. However, because of the importance of state and regional
involvement in restructuring of the electricity industry more generally,
we continue to encourage FERC, where possible and appropriate, to work in
concert with state and regional entities to develop this analysis.

In a related comment, FERC also noted that while the report distinguishes
between wholesale and retail markets, it does not recognize or clearly
articulate the significant differences between the two markets and the
impacts of and motivations for competition at each level.

We agree that there are significant differences between retail and
wholesale markets, but we believe the report appropriately reflects these
differences and therefore we made no change in response to this comment.
More importantly, retail and wholesale markets are closely linked through
the actions of buyers and sellers; for this reason, an evaluation of one
of these markets without considering its effect on the other market is
incomplete and could be misleading. For example, federal actions to
restructure wholesale electricity markets are expected to ultimately
reduce electricity prices for retail consumers through improvements in
efficiency brought on by restructuring. It is equally true that actions at
the retail level have an impact on the functioning of competitive
wholesale markets. For example, as we previously reported, there is wide
agreement among industry experts and academics that the absence of
consumer response to sharply higher prices in western wholesale
electricity markets was a contributing factor to the financial and

Chapter 5: Lessons Learned from Electricity Restructuring and
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Page 56 GAO- 03- 271 Lessons Learned from Electricity Restructuring

energy crisis in the West during 2000 and 2001. 4 These examples
illustrate the need for FERC to make a periodic nationwide assessment of
restructuring that includes an evaluation of the impacts of wholesale
restructuring on expected retail consumer benefits.

4 U. S. General Accounting Office, Restructured Electricity Markets:
California Market Design Enabled Exercise of Market Power, GAO- 02- 828
(Washington, D. C.: June 21, 2002).

Appendix I: Scope and Methodology Page 57 GAO- 03- 271 Lessons Learned
from Electricity Restructuring

To address the objectives overall, we interviewed and obtained
documentation from a wide range of stakeholders to the issue including
federal and state government officials, industry officials, academic
experts, and various other special interest groups and organizations. We
interviewed officials at FERC, the Department of Energy*s Energy
Information Agency, the Congressional Research Service, the Maryland
Energy Administration, the California Energy Commission, the Western
Interstate Energy Board, and the National Association of Regulatory
Utility Commissioners. Of particular note, we interviewed representatives
from the existing ISOs in the United States to understand the structure
and performance of their markets. These ISOs include California ISO, ISO
New England, Midwest ISO, New York ISO, PJM ISO, and the Electric
Reliability Council of Texas. We also talked with representatives of
organizations that are in the process of creating ISOs to run their
wholesale electricity markets, including Regional Transmission Operator
West and the Southeastern Transmission System. We also interviewed noted
economists. In addition, we talked to the Edison Electric Institute, the
Electric Power Supply Association, the National Energy Marketers
Association, the Electricity Consumers Resource Council, and the Consumer
Energy Council of America, and Public Citizen. We also spoke with
representatives from a number of research organizations, including EPRI,
the National Regulatory Research Institute, the Tellus Institute,
Resources for the Future, and the Regulatory Assistance Project.

In addition to gathering the views of experts and stakeholders, we
reviewed numerous appropriate documents from outside sources, including
academic books and articles on restructuring and reports from the Energy
Information Administration, the North American Electric Reliability
Council, the Congressional Research Service, the Congressional Budget
Office, various ISOs, and electricity industry experts. Furthermore, we
reviewed prior GAO work on the electricity industry.

To better understand the basis for and nature of electricity restructuring
in the world community, specifically, we interviewed selected
representatives and reviewed readily available reports and information on
the restructuring experiences of several foreign countries, including the
Great Britain, Norway, Sweden, Australia, and New Zealand.

To develop an understanding of the goals and guiding principles of
restructuring, we conducted legislative and regulatory searches as well as
an extensive literature search, supplemented by interviews with government
and industry officials, experts, ISO officials, and other stakeholders. We
reviewed information on federal legislation, FERC Appendix I: Scope and
Methodology

Appendix I: Scope and Methodology Page 58 GAO- 03- 271 Lessons Learned
from Electricity Restructuring

orders, FERC proceedings and other documents related to restructuring, and
court orders related to FERC regulations. This included reviews of FERC*s
notice of proposed rulemaking on standard market design, staff research
papers, congressional testimony by FERC Chairman Pat Wood, and speeches by
other FERC officials.

To identify actions that federal and state agencies have taken to
restructure the electricity industry, we reviewed documents related to
federal and state restructuring laws and regulations. We also interviewed
numerous officials from federal and state regulatory agencies and the
staff of all the ISOs.

To determine to what extent federal and state actions achieved the goals
of restructuring, we reviewed numerous studies of restructuring; collected
views of experts and market participants and interviewed officials from
FERC, state regulatory agencies, and trade groups, as well as the staff of
the ISOs. In addition, we collected publicly available data, including
wholesale and retail electricity prices, generating capacity, electricity
consumption, investment in new generating plants, and information about
the transmission system. We evaluated this data to try to determine
whether statistical methods could be used to estimate the extent to which
restructuring has achieved expected consumer benefits. However, we found
that the publicly available data were generally insufficient to allow such
statistical methods to be used in light of the transitional nature of
restructuring. For example, we were unable to collect comprehensive data
on the operations of electricity generating plants, and these data are
necessary to determine how the efficiency of operations may vary according
to the restructuring status of the states in which these generating plants
are situated. Because we had to rely, instead, on more aggregated and less
comprehensive data, we were unable to determine whether generating plants
in restructured markets operate more efficiently than do plants in regions
that are still regulated traditionally.

We conducted our work from November 2001 through November 2002 in
accordance with generally accepted government auditing standards.

Appendix II: Related GAO Reports Page 59 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

Restructured Electricity Markets: California Market Design Enabled
Exercise of Market Power. GAO- 02- 828. Washington, D. C.: June 21, 2002.

Energy Markets: Concerted Actions Needed by FERC to Confront Challenges
That Impede Effective Oversight. GAO- 02- 656. Washington, D. C.: June 14,
2002.

Air Pollution: Emissions from Older Electricity Generating Units. GAO02-
709. Washington, D. C.: June 12, 2002.

Tennessee Valley Authority: Information on Benchmarking and Electricity
Rates. GAO- 02- 636. Washington, D. C.: May 30, 2002.

Restructured Electricity Markets: Three States* Experiences in Adding
Generating Capacity. GAO- 02- 427. Washington, D. C.: May 24, 2002.

Air Quality: TVA Plans to Reduce Air Emissions Further, but Could Do More
to Reduce Power Demand. GAO- 02- 301. Washington, D. C.: March 8, 2002

Energy Markets: Results of Studies Assessing High Electricity Prices in
California. GAO- 01- 857. Washington, D. C.: June 29, 2001.

California Electricity Market: Outlook for Summer 2001. GAO- 01- 870R.
Washington, D. C.: June 29, 2001.

California Electricity Market Options for 2001: Military Generation and
Private Backup Possibilities. GAO- 01- 865R. Washington, D. C.: June 29,
2001.

Federal Power: The Evolution of Preference in Marketing Federal Power.

GAO- 01- 373. Washington, D. C.: February 8, 2001.

Power Marketing Administrations: Their Ratesetting Practices Compared With
Those of Nonfederal Utilities. GAO/ AIMD- 00- 114. Washington, D. C.:
March 30, 2000.

Federal Power: The Role of the Power Marketing Administrations in a
Restructured Electricity Industry. GAO/ T- RCED/ AIMD- 99- 229.
Washington, D. C.: June 24, 1999.

Federal Power: Regional Effects of Changes in PMAs* Rates. GAO/ RCED99-
15. Washington, D. C.: November 16, 1998. Appendix II: Related GAO Reports

Appendix II: Related GAO Reports Page 60 GAO- 03- 271 Lessons Learned from
Electricity Restructuring

Federal Power: Options for Selected Power Marketing Administrations* Role
in a Changing Electricity Industry. GAO/ RCED- 98- 43. Washington, D. C.:
March 6, 1998.

Federal Power: Issues Related to the Divestiture of Federal Hydropower
Resources. GAO/ RCED- 97- 48. Washington, D. C.: March 31, 1997.

Power Marketing Administrations: Cost Recovery, Financing, and Comparison
to Nonfederal Utilities. GAO- AIMD- 96- 145. Washington, D. C.: September
19, 1996.

Appendix III: Comments from the Federal Energy Regulatory Commission

Page 61 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Appendix III: Comments from the Federal Energy Regulatory Commission

Appendix III: Comments from the Federal Energy Regulatory Commission

Page 62 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Appendix III: Comments from the Federal Energy Regulatory Commission

Page 63 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Appendix IV: Bibliography of Selected Restructuring Studies

Page 64 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Alexander, Barbara R. *Part One: An Analysis of Residential Energy Markets
in Georgia, Massachusetts, Ohio, New York and Texas.* National Center for
Appropriate Technology, August 2002.

Borenstein, Severin, and James Bushnell. *Electricity Restructuring:
Deregulation or Reregulation?* (unpublished). February 2000.

Borenstein, Severin. *The Trouble with Electricity Markets (and some
solutions)* (unpublished). January, 2001.

Brennan, Timothy J. *The California Electricity Experience 2000- 01:
Education or Diversion?* Resources for the Future, October 2001.

Brown, Matthew H. *Part Two: An Analysis of Opt- Out Aggregation in
Massachusetts and Ohio.* National Center for Appropriate Technology,
August 2002.

California Independent System Operator. *Background Paper: Comparison of
Capacity Obligations and Markets.* Draft prepared by Power Economics,
Inc., March 15, 2002.

Citizens for Pennsylvania*s Future. *Electricity Competition: The Story
Behind the Headlines A 50- state Report.* Harrisburg, PA: August 2002.

Congressional Budget Office. *Causes and Lessons of the California
Electricity Crisis.* Washington D. C.: September 2001.

Cooper, Mark N. *All Pain, No Gain: Restructuring and Deregulation in the
Interstate Electricity Market.* Consumer Federation of America,
Washington, D. C.: September 2002.

Cooper, Mark N. *U. S. Capitalism and the Public Interest: Restoring the
Balance in Electricity and Telecommunications.* Consumer Federation of
America. Washington, D. C.: August 2002.

Deregulation of Network Industries: What*s Next. Peltzman, Sam and
Clifford Winston, editors. AEI- Brookings Joint Center For Regulatory
Studies. 2000.

Electricity Advisory Board. *Competitive Wholesale Electricity Generation:
A Report of the Benefits, Regulatory Uncertainty, and Remedies to
Encourage Full Realization Across All Markets.* Electric Resources,
Capitalization Concerns Subcommittee. September 2002. Appendix IV:
Bibliography of Selected

Restructuring Studies

Appendix IV: Bibliography of Selected Restructuring Studies

Page 65 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Electricity Advisory Board. *Transmission Grid Solutions Report,*
Subcommittee on Transmission Grid Solutions. September 2002.

Electricity Consumers Resource Council. *Preventing Market Failures on the
Road to Competition: Analysis and Recommendations of Electricity Consumers
Resource Council, a Special Report.* Washington, D. C.: May 2001.

Federal Trade Commission. *Competition and Consumer Protection
Perspectives on Electric Power Regulatory Reform: Focus on Retail
Competition.* Washington, D. C.: September 2001.

Harvard Electricity Policy Group. *Reshaping the Electricity Industry: A
Public Policy Debate.* Harvard University, June 2001.

Heffner, Grayson C., and Charles A. Goldman. *Demand Responsive Programs*
An Emerging Resource for Competitive Markets?* Environmental Energy
Technologies Division of Lawrence Berkeley National Laboratory, August
2001.

Hirst, Eric. *Barriers to Price- Responsive Demand in Wholesale
Electricity Markets.* Prepared for Edison Electric Institute, June 2002.

Hirst, Eric. *The California Electricity Crisis Lessons for Other States*
(unpublished). July 10, 2001.

Hirst, Eric. *The Financial and Physical Insurance Benefits of
PriceResponsive Demand.* February 2002.

Hogan, William W. *Electricity Market Restructuring: Reforms of Reforms.*
Paper presented at annual conference of Center for Research in Regulated
Industries, Rutgers University: May 23- 25, 2001.

Hogan, William W. *Regional Transmission Organizations: Millennium Order
on Designing Market Institutions for Electric Network Systems*
(unpublished). May 2000.

Hunt, Sally. Making Competition Work in Electricity. New York: John Wiley
& Sons, 2002.

Joskow, Paul L. *Lessons Learned from Electricity Liberalization in the UK
and U. S.* Presentation at Conference Towards a European Market of

Appendix IV: Bibliography of Selected Restructuring Studies

Page 66 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Electricity at the SSPA- Italian Advanced School of Public Administration,
Rome, Italy. June 24, 2002.

King, Chris S. *The Economics of Real- Time and Time- of- Use Pricing for
Residential Customers.* American Energy Institute, June 2001.

Lee, Stephen T. *Lessons Learned from the California Power Crisis.* EPRI,
Palo Alto, CA. November 1, 2001.

Mattoon, Richard. *The Electricity System at the Crossroads- Policy
Choices and Pitfalls.* Economic Perspective, 1Q/ 2002.

Moore, Adrian T. and Lynne Kiesling. *Powering Up California: Policy
Alternatives for the California Energy Crisis.* Policy Study No. 280,
Reason Public Policy Institute, Los Angeles, CA: February 2001.

Morey, Matthew J. *Ensuring Sufficient Generating Capacity, During the
Transition to Competitive Electricity Markets.* Prepared for Edison
Electric Institute, Washington, D. C.: November 2001.

Moss, Diana. *Promoting Competition in the U. S. Electricity Industry:
Policy Issues and Recommendations.* The American Antitrust Institute,
Washington, D. C.: December 18, 2001.

Pricing in Competitive Electricity Markets. Faruqui, Ahmad and Kelly
Eakin, editors. Kluwer Academic Publishers. 2000.

Rose, Kenneth and Venkata Bujimalla. *2002 Performance Review of Electric
Power Markets.* National Regulatory Research Institute, Columbus, OH.:
August 30, 2002.

Rowe, John W., Peter Thornton, and Janet Bieniak Szcypinski. *Competition
Without Chaos.* Joint Center for Regulatory Studies, Working Paper 01- 07,
June 2001.

State Corporation Commission (of Virginia). *Part III- Recommendations to
Facilitate Effective Competition in the Commonwealth.* August 2002.

Stoft, Steven. Power System Economics: Designing Markets for Electricity.
IEEE/ Wiley, 2002.

Sweeney, James, L. *The California Electricity Crisis: Lessons for the
Future.* The Bridge, Volume 32, Number 2. Summer 2002.

Appendix IV: Bibliography of Selected Restructuring Studies

Page 67 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Weston, Frederick, and Jim Lazar. *Framing Paper #3: Metering and Retail
Pricing.* Produced for New England Demand Response Initiative by The
Regulatory Assistance Project, May 1, 2002.

Wolak, Frank A. *Designing a Competitive Electricity Market that Benefits
Consumers* (unpublished). October 15, 2001.

Wolfram, Catherine D. *Electricity Markets: Should the Rest of the World
Adopt the UK Reforms?* (unpublished) September 1999.

Appendix V: GAO Contacts and Staff Acknowledgments

Page 68 GAO- 03- 271 Lessons Learned from Electricity Restructuring

Jim Wells (202) 512- 3841 Dan Haas (202) 512- 9828

In addition to the individuals named above, Mike Gilbert, Jason Holliday,
Rich Iager, Randy Jones, Jon Ludwigson, Jonathan McMurray, Frank Rusco,
and Barbara Timmerman made key contributions to this report. Important
contributions were also made by Kim Wheeler- Raheb, and Venkareddy
Chennareddy. Appendix V: GAO Contacts and Staff

Acknowledgments GAO Contacts Acknowledgments

(360151)

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