Power repair misfits

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As Congress rushes to complete action on an energy bill, it needs to address the Federal Energy Regulatory Commission's proposal for a nationwide Standard Market Design (SMD). This proposal, virtually unknown outside the industry, is the most important item on the electricity policy agenda.

Although published more than a year ago, well before the recent Northeast blackout, proponents of this rulemaking now claim any delay in its implementation will interfere with FERC's ability to address reliability issues. In fact, the opposite is true. If adopted, SMD will make our electricity system more vulnerable to failure, because it is based on a fundamentally flawed premise -- that the government is better equipped than the private sector to fix markets when they are broken.

This was certainly not the case in California -- which adopted a plan approved by FERC before being put into place. Despite its obvious flaws, the California market design was allowed to persist until it virtually bankrupted all the utilities in the state. Even then, it was "fixed" in a way that shifted enormous costs to California's already overburdened taxpayers.

What happened in California should not have been surprising. Governmental processes are inherently cumbersome, self-protective and subject to manipulation by political and other forces. Any government-designed market, no matter how flawed, will have beneficiaries and vested interests who will be able to slow, and perhaps prevent entirely, the necessary fixes from being implemented.

Real markets, in contrast, typically self-correct rapidly once they process the relevant information, because private actors typically have sufficient incentives to deal honestly and forthrightly with each other. Despite any market imperfections that might have existed, there is little doubt California's crisis would have been over much more quickly and cost the state's consumers and taxpayers far less if its electricity markets had been completely unregulated.

While we do not now know precisely what caused the breakdown of the electricity grid on Aug. 14, it is unlikely that an electricity market designed by FERC is the answer. Here are just a few of the reasons to be concerned about what the FERC is proposing to do:

c FERC's new plan would place billions of dollars worth of transmission assets under the control of nonprofit, quasi-regulatory Regional Transmission Organizations. This separation of ownership from control of economic assets is virtually unheard of in our system. It is unclear what incentive structure will guide these entities, or to whom they will be accountable. But it is much more likely their decision-making will be guided by political than by economic-efficiency considerations.

c The proposal does little or nothing to improve the incentives for transmission investment. There are serious electricity bottlenecks in all parts of the country that remain neglected. At least part of the reason for this is the highly uncertain environment created by regulators, which is not conducive to investment. FERC's new plan, which relies on cumbersome transmission planning processes, would only exacerbate this situation.

c The Energy Department, which was initially a strong supporter of the FERC SMD proposal, was able to come up with only about a billion dollars of net benefits in its cost-benefit analysis. This is surely well within the margin of error for a $230 billion industry.

Congress should be extremely concerned about backing a proposal that can only be described as a risky regulatory experiment. If FERC goes forward with SMD, it will take years before the inevitable mistakes are corrected (if they ever are) and a stable set of rules emerges. The resulting confusion will yield a less -- not a more -- reliable electricity supply.

There is, however, reason to be optimistic. The Senate and the White House have apparently reached agreement on an amendment to the energy bill that would delay implementation of SMD until at least 2007. They now need to convince their colleagues in the House to come on board. Congress needs to tell FERC to go back to the more-modest, less-prescriptive course it was on before.

Thomas M. Lenard, an economist, is senior fellow and vice president for research at the Progress & Freedom Foundation.