Electricity Markets: FERC's Role in Protecting Consumers	 
(06-JUN-03, GAO-03-726R).					 
                                                                 
The electricity industry is currently undergoing a restructuring,
evolving from an industry characterized by monopoly utilities	 
that provide consumers with electricity at regulated rates to a  
competitive industry in which prices are largely determined by	 
supply and demand. The Federal Energy Regulatory Commission	 
(FERC) has been engaged in this restructuring effort and is	 
currently working, among other things, to foster competitive	 
wholesale energy markets across the nation while protecting	 
consumers against abuses of market power. At the retail level,	 
about half the states have pursued restructuring their retail	 
electricity markets in order to allow consumers such as 	 
residential, commercial, and industrial customers to choose their
electricity suppliers. Proponents of electricity restructuring	 
believe that it will ultimately provide consumers with lower	 
electricity prices, more services, and technological innovation. 
However, opponents cite extremely high prices and market	 
manipulation in California as evidence that, without more	 
stringent oversight, restructuring may leave consumers vulnerable
to higher prices, market manipulation, and less reliable service.
In light of ongoing electricity restructuring efforts, Congress  
asked us to describe FERC's role in protecting electricity	 
consumers.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-726R					        
    ACCNO:   A07109						        
  TITLE:     Electricity Markets: FERC's Role in Protecting Consumers 
     DATE:   06/06/2003 
  SUBJECT:   Electric energy					 
	     Electric utilities 				 
	     Competition					 
	     Consumer protection				 
	     Monopolies 					 

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GAO-03-726R

Page 1 GAO- 03- 726R FERC Consumer Protection June 6, 2003 Congressional
Requesters:

Subject: Electricity Markets: FERC*s Role in Protecting Consumers The
electricity industry is currently undergoing a restructuring, evolving
from an industry characterized by monopoly utilities that provide
consumers with electricity at regulated rates to a competitive industry in
which prices are largely determined by supply and demand. The Federal
Energy Regulatory Commission (FERC) has been engaged in this restructuring
effort and is currently working, among other things, to foster competitive
wholesale energy markets across the nation while protecting consumers
against abuses of market power. At the retail level, about half the states
have pursued restructuring their retail electricity markets in order to
allow consumers such as residential, commercial, and industrial customers
to choose their electricity suppliers. Proponents of electricity
restructuring believe that it will ultimately provide

consumers with lower electricity prices, more services, and technological
innovation. However, opponents cite extremely high prices and market
manipulation in California as evidence that, without more stringent
oversight, restructuring may leave consumers vulnerable to higher prices,
market manipulation, and less reliable service.

In light of ongoing electricity restructuring efforts, you asked us to
describe FERC*s role in protecting electricity consumers. This report does
not evaluate FERC*s success in serving this role, but does provide
examples of how FERC has acted previously to protect consumers. GAO plans
to issue a report in the summer 2003 on the progress FERC has made so far
in preparing itself to monitor competitive energy markets. A complete list
of the requesters appears at the end of this report.

Results in Brief

FERC*s role in protecting electricity consumers is to ensure that prices
in the wholesale electricity market are just and reasonable.
Traditionally, FERC has ensured rates are just and reasonable in the
wholesale market by regulating them based on a utility*s costs of service
plus a regulated return on the utility*s investment. However, with the
advent of greater competition in the electricity industry, FERC believes
the best ways to ensure wholesale prices are just and reasonable today is
by (1) fostering competitive regional wholesale markets that have balanced
market rules (i. e., rules that encourage efficient behavior and
infrastructure development and deter abusive behavior), (2) continuously
monitoring these markets for anticompetitive behavior, and (3) enforcing
or correcting market rules as needed. As part of these efforts, FERC
oversees the interstate transmission system to ensure it remains open
without discrimination to all buyers and sellers of electricity. This
oversight also works to protect consumers by ensuring companies that
generate electricity will be able to transmit their power without
disruptions or inefficiencies. United States General Accounting Office
Washington, DC 20548

Page 2 GAO- 03- 726R FERC Consumer Protection FERC has limits on where and
how it can protect consumers. For example, FERC does not oversee wholesale
electricity sales and transmission in areas where it generally lacks

jurisdiction, such as the areas served by federally owned utilities
including the Tennessee Valley Authority and the Department of Energy*s
four federal Power Marketing Administrations, publicly owned (municipal)
utilities, and most cooperative utilities. In addition, states, rather
than FERC, have authority over the retail electricity rates paid by
customers, the local distribution of electricity, and the construction and
siting of power plants and transmission lines within their boundaries.
Background

Established in 1977 as the successor to the Federal Power Commission
(FPC), FERC is the principal federal agency that regulates the electricity
industry. An independent agency, FERC obtains much of its legal authority
over electricity from three sources: the Federal Power Act of 1935, which
created the FPC and charged it with overseeing the rates, terms, and
conditions of wholesale sales and transmission of electric energy in
interstate commerce; the Public Utility Regulatory Policies Act of 1978,
which opened the door for competition in the U. S. electricity supply
market by allowing nonutility generators that met criteria set by FERC to
enter the wholesale market; and the Energy Policy Act of 1992, which
created a new class of electricity supplier* the exempt wholesale
generator* and led to FERC Order No. 888, which opened up the national
transmission system to wholesale suppliers. In fiscal year 2002, FERC had
a budget of about $191 million and funding for about 1,200 full- time
staff.

The electricity industry is based on four distinct functions: generation,
transmission, distribution, and system operations. (See fig. 1.) Once
electricity is generated, 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.

Page 3 GAO- 03- 726R FERC Consumer Protection Figure 1: Functions of the
Electricity Industry

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. Because electric energy is generated 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- byminute

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.

Since the early 1900s, electric utilities have been largely considered
natural monopolies because they have high fixed costs (the costs of large-
scale power plants, transmission lines, and distribution wires) and can
lower their production costs as they increase the volume of electricity
they generate. At that time, large, centralized power plants were seen as
the most efficient and inexpensive way to produce and distribute
electricity to retail customers. As a result, utilities obtained exclusive
service territories in exchange for the regulation of their retail

Page 4 GAO- 03- 726R FERC Consumer Protection rates and terms of service
by state public utility commissions. Wholesale electricity generated and
transmitted for the interstate market came (and still resides) under
FERC*s jurisdiction.

Technological advances, such as the development of smaller, less costly
generation units, and the passage of the Public Utility Regulatory
Policies Act of 1978 created opportunities for companies other than
utilities to generate and sell electricity in the wholesale market. The
Energy Policy Act of 1992 gave FERC the authority, on a case- by- case
basis, to require utilities to provide nonutility generators with access
to the utility*s interstate transmission lines. Subsequent FERC orders
advanced this principle, requiring most utilities to provide nonutility
generators access to their interstate transmission lines on a
nondiscriminatory basis. Several states have restructured their intrastate
market to allow retail customers to choose their electricity provider
while retaining their utility*s traditional distribution services. As we
reported in December 2002, 24 states and the District of Columbia had
enacted legislation or issued regulations opening their retail markets to
competition. 1 Of those, 17 states and the District of Columbia were
implementing programs that enable retail customers to choose their
electricity supplier.

FERC*s Role is to Protect Consumers through the Wholesale Markets

FERC*s role with respect to protecting electricity customers is to ensure
that prices in the wholesale electricity market are just and reasonable
and to oversee the interstate transmission of electricity. 2
Traditionally, FERC approved its regulated rates for wholesale electricity
based on a utility*s cost to generate and transmit the power, plus a rate
of return on investment. Opponents of cost- based rate regulation contend
that it is less efficient than market pricing and results in, among other
things, over investment in a utility. In light of the advances in
technology, the introduction of nonutility power generators, and the
nation*s general shift in policy over the past three decades away from
government regulation and toward markets, FERC now believes that the best
way of achieving just and reasonable rates is to

 foster competitive regional wholesale markets that have balanced market
rules (i. e., rules that encourage efficient behavior and infrastructure
development and deter abusive behavior),

 continuously monitor these markets for anticompetitive behavior, and 
enforce or correct market rules as needed. Under this approach, FERC*s
first goal is to advance the development of competitive wholesale markets
by implementing clear and balanced market rules and regulations on sales
and transmission. According to FERC, establishing balanced market rules up
front encourages efficient behavior and infrastructure development and
deters abusive behavior in the market. More specifically, following Order
No. 888, FERC approved the creation of independent system operators for
New England, the Mid- Atlantic states, New York, and California to operate

1 U. S. General Accounting Office, Lessons Learned from Electricity
Restructuring: Transition to Competitive Markets Underway, but Full
Benefits Will Take Time and Effort to Achieve, GAO- 03- 271 (Washington,
D. C.: Dec. 17, 2002).

2 Although FERC has authority to oversee the interstate transmission
system, the North American Electric Reliability Council (NERC) makes sure
the interconnections among transmission systems work reliably by
developing and monitoring standards of operation.

Page 5 GAO- 03- 726R FERC Consumer Protection wholesale energy markets and
transmission systems within their regions. Then, in December 1999, FERC
issued Order 2000, which 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). RTOs are intended to
bring the nation*s transmission systems under regional control in order to
increase access for all suppliers, improve management of system congestion
and reliability, and achieve fully competitive wholesale power markets.
Since issuing Order 2000, FERC has approved the creation of two RTOs* the
Midwest Independent Transmission System Operator, Inc. (Midwest ISO) and
the PJM Interconnection. Five others are in various stages of the approval
process* GridFlorida, GridSouth, RTO West, WestConnect, and SeTrans 3 .
Additionally, in July 2002, FERC issued a Notice of Proposed Rulemaking to
establish a standard market design for all jurisdictional electric
transmission providers. In FERC*s view, the proposal will enable sellers
to transact for electricity more easily across transmission boundaries,
thus potentially bringing more sources of electricity to consumers and
allowing them to receive the benefits of lower- cost and more reliable
electricity supply. Since 1992, FERC has granted authority to more than
850 companies to charge market prices for their electricity, provided that
the companies comply with market rules and charge wholesale prices that
are just and reasonable.

Second, according to FERC, it will also monitor these markets and thereby
protect consumers by proactively identifying market violations or
mismanagement. In order to better monitor markets for anticompetitive
behavior, in August 2002, FERC established the Office of Market Oversight
and Investigations (OMOI). The role of this office is to scrutinize
wholesale energy markets in order to identify issues before they develop
into major problems and to monitor the market to ensure that participants
play by the rules. In addition, to help monitor the markets, the Office of
Market Oversight and Investigation manages FERC*s Enforcement Hotline,
which is designed to provide industry participants and the public a way to
tell the commission their concerns or complaints about behavior in
electricity markets. In 2002, the Hotline handled 584 calls.

Finally, to enforce or correct market rules, FERC, through OMOI, is
conducting investigations that are either self- initiated or result from
Hotline complaints or other referrals by industry participants. According
to FERC, as of May 1, 2003, OMOI*s Divisions of Enforcement and
Operational Investigations were conducting 38 investigations related to
electricity matters such as generator practices, undue discrimination, or
market manipulation. Between June 2002 and midApril 2003, the division
resolved or terminated 18 investigations. Several of these investigations
led to enforcement actions that either provided payment of refunds, civil
penalties, or investigation costs or provided corrections to market rules
to help ensure generation can

adequately meet increased demand. 3 As we reported in December 2002,
Midwest ISO operates in Illinois, Indiana, Iowa, Kentucky, Michigan,
Minnesota, Missouri, Montana, North Dakota, Ohio, South Dakota, Virginia,
Wisconsin, and Manitoba (Canada). PJM operates in Delaware, the District
of Columbia, New Jersey, Maryland, Ohio, Pennsylvania, Virginia, and West
Virginia. GridFlorida operates in Florida. GridSouth operates in North
Carolina and South Carolina. According to FERC, RTO West operates in
Washington state, Idaho, Montana, Oregon, Nevada, Wyoming, Utah, and a
small part of northern California. WestConnect operates in Arizona,
Colorado, New Mexico, and Utah. SeTrans operates in Alabama, Arkansas,
Florida, Georgia, Louisiana, Mississippi, South Carolina, and Texas.

Page 6 GAO- 03- 726R FERC Consumer Protection Portions of the Wholesale
Market are Not Subject to FERC Jurisdiction

Some entities in the wholesale electricity market operate outside FERC*s
statutory jurisdiction. These entities include the Tennessee Valley
Authority and the Department of Energy*s four Power Marketing
Administrations. 4 In addition, the Federal Power Act of 1935 excludes
publicly owned utilities, such as municipal utilities, public power
districts, and irrigation districts, as well as most cooperatively owned
utilities from FERC*s jurisdiction. Publicly owned utilities are usually
nonprofit and are regulated by the government organization that owns them,
while electric cooperatives are owned by and provide service primarily to
their members. Most cooperatives do not sell electricity on the wholesale
market or transmit electricity interstate.

Figure 2: Jurisdictional Territories of FERC and Power Entities Not
Subject to FERC, 2002

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. Portions of the map without shading indicate either that no
electric service is provided or the service area is very small. 4 The
Power Marketing Administrations are Bonneville, Western Area,
Southeastern, and Southwestern.

Page 7 GAO- 03- 726R FERC Consumer Protection As shown in figure 2, power
entities generally operating outside FERC*s jurisdiction represent a
significant share of the electricity market. Together, they currently
provide service for about 25

percent of the nation*s consumption of electricity and constitute an even
larger portion of the electricity market in some areas. For example, in
Nebraska, municipal utilities, cooperatives, and other suppliers not
explicitly subject to FERC*s jurisdiction provide almost all of the
state*s

electricity. Many of the entities operating outside FERC*s jurisdiction
reside in the Southeast, Midwest, and West. In addition, municipal
utilities, cooperatives, and federally- owned power entities own about 30
percent of the nation*s transmission system. Lines owned by
nonjurisdictional entities are prominent in the South and West. States
Regulate Retail Electricity Markets Although FERC has regulatory authority
over most of the interstate wholesale market in electricity, states have
authority over the retail electricity and distribution markets and thus

regulate the retail rates paid by residential, commercial, and many
industrial customers. 5 In a majority of states, public utility
commissions set consumers* retail rates based on a utility*s cost of
service plus a rate of return on investment. As we reported in December
2002, 24 states have enacted legislation or regulations to open their
retail electricity markets to competition.

Seventeen of those states and the District of Columbia have implemented
programs enabling residential, commercial, and industrial customers to
choose their electricity provider. However, of these 17 states, most have
frozen their retail electricity prices at levels equal to or less than the
retail cost- of- service rates that were in place at the outset of
competition.

In addition to setting rates in the retail electricity market, states have
the authority to approve the construction and siting of power plants and
transmission lines. To be built, these facilities usually require the
approval of the state*s public utility commission as well as the consent
of other state and local government agencies on environmental, zoning, and
energy policy issues. Although transmission lines increasingly serve
regional needs and can cross state boundaries, state and local governments
make many of the decisions on whether and where to site new lines and thus
potentially have significant impact on the transmission system*s
reliability and the amount of electricity it can deliver to consumers.
Agency Comments

We provided FERC with a draft of this report for its review and comment.
In general, FERC*s Chairman agreed with our report and its depiction of
the commission*s role in protecting electricity customers. The Chairman
suggested technical and editorial changes that we included as appropriate.

5 Wholesale energy trades within a state-- for example, when a
municipality purchases power from a generator in the same state-- are
regulated by the state*s public utility commission. In addition, FERC has
no jurisdiction over the wholesale market in Hawaii and Alaska because,
being geographically separated from the contiguous U. S., these states
have no interstate trade in electricity. Similarly, FERC has no
jurisdiction over wholesale electricity trades in much of Texas because
the state has few connections with the two major interstate grid systems
in the United States, the Eastern and Western Interconnect.

Page 8 GAO- 03- 726R FERC Consumer Protection Scope and Methodology

To obtain information on the ways in which FERC can protect consumers, we
reviewed industry reports, academic literature, and discussed the issue
with officials from FERC*s Office of Markets, Tariffs, and Rates and
Office of Market Oversight and Investigations. To obtain information on
FERC*s jurisdiction, we reviewed applicable statutes and federal rules. To
identify areas of consumer protection and concerns, we reviewed industry
publications and interviewed officials with consumer advocacy groups. In
addition, we spoke to officials with the National Association of
Regulatory Utility Commissioners and the Electricity Consumers Resource
Council.

We performed our work between November 2002 and May 2003 in accordance
with generally accepted government auditing standards.

- - - - - As agreed with your offices, unless you publicly announce its
contents earlier, we plan no further distribution of this report until
seven days from the date of this letter. At that time, we will send copies
to 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.

If you or your staff have any questions about this report, please contact
me at (202) 512- 3841. Key contributors to this report include Dan Haas,
Daren Sweeney, Randy Jones, Carol Kolarik, Jon Ludwigson, Frank Rusco,
Jonathan McMurray, and Barbara Timmerman.

Jim Wells Director, Natural Resources

and Environment

Page 9 GAO- 03- 726R FERC Consumer Protection List of Congressional
Requesters The Honorable Robert E. Andrews United States House of
Representatives

The Honorable Brian Baird United States House of Representatives

The Honorable Tammy Baldwin United States House of Representatives

The Honorable Shelley Berkley United States House of Representatives

The Honorable John Conyers, Jr. United States House of Representatives

The Honorable Peter DeFazio United States House of Representatives

The Honorable Sam Farr United States House of Representatives

The Honorable Bob Filner United States House of Representatives

The Honorable Michael M. Honda United States House of Representatives

The Honorable Dennis J. Kucinich United States House of Representatives

The Honorable Tom Lantos United States House of Representatives

The Honorable Barbara Lee United States House of Representatives

The Honorable Carolyn Maloney United States House of Representatives

The Honorable Karen McCarthy United States House of Representatives

The Honorable James P. McGovern United States House of Representatives

The Honorable George Miller United States House of Representatives

Page 10 GAO- 03- 726R FERC Consumer Protection The Honorable Bill
Pascrell, Jr. United States House of Representatives

The Honorable Bernard Sanders United States House of Representatives

The Honorable Hilda L. Solis United States House of Representatives

The Honorable Fortney Pete Stark United States House of Representatives

The Honorable Tom Udall United States House of Representatives

The Honorable Maxine Waters United States House of Representatives

The Honorable Robert Wexler United States House of Representatives

Page 11 GAO- 03- 726R FERC Consumer Protection

Enclosure I: Comments from the Federal Energy Regulatory Commission

Enclosure I: Comments From the Federal Energy Regulatory Commission Page
12 GAO- 03- 726R FERC Consumer Protection (360279)

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