The notice for next week’s Federal Energy Regulatory Commission (FERC) conference on the intersection of wholesale energy markets with state energy policies says that there is an “open question of how the competitive wholesale markets, particularly in states or regions that restructured their retail electricity service, can select resources of interest to state policy makers while preserving the benefits of regional markets.”

This is an intriguing understatement for a conference that provides at least a starting point for the hard discussion the energy sector must have about the need to catch wholesale market rules up with the reality of this country’s changing power generation mix.

How did we get here?

The states of wholesale energy market design and FERC, the federal agency that regulates that design, are in flux. Regional wholesale energy markets, intended to increase competition in the sale of energy and related services like capacity and reserves, were designed around the marginal cost of predictably dispatchable central station power plants with variable fuel costs.

During the several decades that most power plants exhibited these similar operating characteristics and natural gas prices were at least meaningful, coal and nuclear power plants proved successful in clearing markets to provide competitively priced energy. The last decade’s sustained plunge in natural gas prices, however, along with declining demand due to energy efficiency and an exponential increase in zero marginal cost wind and solar power plants coming online, and, to a lesser extent, the cost of environmental compliance for outdated fossil-fueled power plants, has dramatically altered the equation.

Coal and nuclear power plants that reliably cleared the markets have found themselves failing to recover costs, while natural gas rules the margin and wind and solar power and customers’ demand response contribute to lowering energy prices. The relatively rapid change has led to countless specific changes by regional market operators (buyer side mitigation battles, anyone?) trying to manage the transition as well as attempts by states like Maryland, New Jersey, and more recently, New York and Illinois, home to some of these failing power plants, to enact policies that protect their resources – with varying degrees of justified reliability and cost concerns.

Stepping back, it is fair to say that an increasingly severe disconnect exists between the services wholesale markets are designed to provide and the grid services necessary to reliably and cost-effectively support an electric grid increasingly powered by renewable energy resources. Determining and then monetizing the value of grid services necessary to support a renewables-dominated electric grid is critical to ensuring cost-effective reliability in our new world. (FERC and regional grid operators are by no means oblivious to this disconnect – next week’s conference is exhibit A, with B and C being efforts by regions like New England and PJM to get at the bigger market design issues, at least to the extent politically realistic.)

At the same time, pre- and post- presidential election events have FERC down to two commissioners, one short of quorum from a potential full slate of five. Acting Chairman LaFleur and Commissioner Honorable obviously recognize the urgency of the market reform need, but cannot act until at least one more Commissioner is appointed and confirmed.

It is at this crossroads from which the next stage of market reform must take form.  

Who’s In charge?

The conflict between state energy and environmental policies and FERC-jurisdictional markets are a large part of a bigger framework issue that has been playing out between FERC and the states over electric grid regulation, resulting in an unprecedented three cases at reaching the Supreme Court over jurisdiction under the Federal Power Act (and similar Natural Gas Act). The Supreme Court’s big three (so far) – Oneok, EPSA and Hughes – have resulted in a consistent recognition of the necessity of overlapping, neighborly authority over the same actors and resources in the electricity sector. The decisions also recognize that wholesale markets can’t prohibit qualified distributed resources from participating, and that states can continue to set their own energy policies so long as those policies do not require override of FERC-jurisdictional wholesale rates.

Nothing in these cases or the law prohibits states from pursuing their own energy and environmental policies. Despite politicking across the country on this front, Hughes provides basic legal parameters around which states can minimize their risk of getting caught in the net of jurisdictional growing pains related to a changing market place. Specific challenges will be sure to test the margins of these parameters in court, but careful policy design to, for example, require renewable energy procurement or establish a price on carbon, can ensure that state policies do not supplant FERC-approved wholesale rates.

So, what’s a FERC to do?

As we dive into what is sure to be two weedy days of wholesale market design, it is important to remember that none of the work FERC has done on price formation, breaking down barriers to distributed energy resource participation, or buyer-side mitigation, among several others, are unrelated. While conference participants will each come to the table with their own concerns and potential solutions will run the gamut from self-interested to bigger picture, the markets-policy technical conference provides a starting point to get at what is really a much larger wholesale market design affliction. I humbly recommend that those who will one day (hopefully soon-ish) make up a full slate of FERC commissioners keep a few points in mind:

• FERC’s obligation under the Federal Power Act is to ensure that the costs of wholesale energy are fair, and that the system operates reliably, in the face of a changing generation mix. Its obligation is not to pick winners and losers in competition of fuel sources – even when the economic winners are not the old guard. The fossil-fueled power industry long favored this “fuel neutrality” stance, although their views seem to be shifting as their resources are increasingly uneconomic in the marketplace.

• Markets are not an end unto themselves, but a means for expediting cost-effective outcomes in the wholesale sales of energy, capacity and ancillary services. There is nothing sacrosanct about the existing energy and capacity constructs that exist in the Eastern Interconnection RTOs. Recognizing the need for some level of market certainty, the solution to existing markets’ failure to protect a specific fuel diversity mix favored by economically interested market players is not to find ways for the market to prop up favored resources. The battle of the subsidies is simply unwinnable, no matter which resource choices one might subsidize or attempt to penalize for subsidization (“The fact of the matter is that all energy resources receive federal subsidies, and some resources have received subsidies for decades.”) Instead, FERC has an opportunity to step back and determine what market services are necessary and how to monetize those services as a means to reliably and cost effectively facilitate the sale and delivery of energy in this brave new world.

• To the extent the rationale for maintaining any specific market rules is providing the incentives necessary to maintain reliability, embracing the grid’s new reliability reality is critical. The market drivers behind increasing penetrations of renewable energy are not going anywhere, regardless of the current administration. Although to the average customer reliability will continue to mean ensuring the lights stay on, the nuances of grid reliability are not static. Reliability on a majority renewables grid involves different planning and operational considerations, and certainly metrics, than has been the case for ensuring reliability historically. All the experience in integrating high penetrations of renewables to date, and all the forward-looking studies, suggest that reliability in the new world is actually a quite manageable, if materially different, undertaking. Industry players who are losing on the economics should not be able to hide behind the guise of reliability and cost to obstruct forward progress (or relieve FERC of their statutory duty).

Recognizing that full-scale market reform may be politically impossible, the new FERC has the chance to take (what will never be perfectly competitive) markets and improve them, provide the incentives necessary to maintain reliability in the new world, and then get out of the way. The chance to improve wholesale energy market design represents a perhaps unique opportunity in our current divided political context for free market advocates, environmentalists, consumer interests and the states and federal government to find agreement.