So far all unregulated schemes result in boom/bust cycles analogous to pork bellies - high price spur investments that have a delay before coming to market. Once the investments become production, price tanks. Result - a period of shortage and high price followed by oversupply and unproductive investments. Society's resources are wasted and misallocated both ways.

We all know the failings of regulation first hand so it is no panacea. Like socialism, the benefits (profits) tend to get distributed based on political power rather than economic merit.

Ultimately, there is no substitute for citizens paying attention to the market throough their exercise of political power. "Free enterprise" will always seek exclusive market power in service of maximizing profits. Professional political players will always seek to maximize their political power by allocation of public goods under their control. There will ALWAYS be some fox wanting to watch the chicken coup for us.

I'm not yet convinced that capacity markets are required for effective operation of regional wholesale power markets. But if we are going to consider them in the context of FERC's standard market design, we at least ought to consider markets properly designed to provide the services that they are intended to provide.

Aggregated displaced capacity (or, groups of companies who reduce electrical consumption jointly) will provide a viable commercial alternative to renewable energy or new power plants. In fact, the environmental impact of large amounts of reduced demand is far better than either source of new electrical supply.

We refer to this option as the Orion Virtual Power Plant (TM). We estimate that over 21,000 MW could be displaced by industrial/commercial customers who simply replace their HID lighting with T8 fluorescent fixtures with reflector logic. In our estimation, 100,000 MW could be displaced with a robust plan for U.S. energy efficiency.

This energy efficient strategy would greatly improve electrical availability by using the never-regulated option of the U.S. business community to use less energy. Together, the end users can render the regulated vs deregulated energy debate less important and certainly less political.

There is also something very American about individuals and individual companies taking control and accepting responsibility for their actions.

I presented this commentary as the basis for discussion, rather than as the codification of a "final solution". However, any solution set that does not address the real option issues of electricity reliability and the corresponding free rider concerns is destined to create the "boom/bust" cycle.

In the past years a wide belief and convincement was diffused in Italy and also in Europe, on the possibility that the completion of the liberalization and privatization process of the energy sector would have allowed the reduction of the energy bills. This had been stated by the National Industry Association (Confindustria) at the Conference “Actions to compete”, held in Parma, Italy on 16 and 17 March 2001, by the Italy’s Bank Governor Antonio Fazio, by the Italian EU Commissioner for competition Mario Monti and by the Italy’s Energy Minister Antonio Marzano affirming : “The reduction of the electricity prices is one of the mayor objectives I intend to achieve”. The oil crisis in 2000/2001 and the subsequent energy crisis in California, with several “blackouts”, have raised doubts on the real benefits achievable through liberalization and privatization of the energy sector in our country. What happened in California has not due to the public or private ownership of the State energy system, but to other causes. In the industrial world today exist private electric system, like in Germany and in the United Kingdom, which operate well and others, like the French public monopoly EdF that function also very well and even better. The negative experiences in California and in Spain should lead us to ponder. But with the energy sector liberalization, the energy bills will not decrease. It is not a problem of competition, but of diversification of the energy sources. Should we generate electricity burning oil or natural gas, the energy sources more costly, whose price have doubled or even tripled in the past few years – when all the others Nations using nuclear and coal, generates electricity at a much lower cost - there is no difference where the ownership is a public monopoly or a private investor. What is really needed is “diversification” of the energy sources, rather than “liberalization” of the energy sector : use more coal and, in future, go back to nuclear energy. It is not worthwhile to remember that after the 1973 oil crisis (Kippur war), all the others industrial nations, but not Italy, have substituted oil with nuclear or coal in electricity generation, France from 45% to 2%, Germany from 23% to 1.5%, Sweden from 19% to 3%, Belgium from 78% to 15%. We instead have increased the hydrocarbons use in electricity production from 61% to 71% ! This is way our energy bills are double than in France, three times higher than in Sweden and 60% higher than the European average, with a major cost of about 8 billions Euro (see Table attached). Energy is a very peculiar good : it shall be generated at the same time is requested, it is difficult to storage, requires long time for the construction of plants and transport lines with relevant investment and delayed revenue. Not by chance the private entrepreneurs ante Enel did subdivide the national territory in zones of competence, avoiding to compete among themselves. According to the French Economy Minister Laurent Fabius, several privatizations of public companies have led the energy bills to higher prices and according to the NUS Consulting Group: +16.5% in Germany, + 7.5% in Denmark, + 5.6% in south Africa, +2.4% in Spain and 2.3% in Canada. Luigi Einaudi, formerly President of the Italian Republic, was used to say : “ The operation of public services by the State assures results, not always valuable in money, but unquestionable advantages for the civilization of the Nations”. We will need energy, a lot of energy in the future to come. According the World Energy Council (“Energy for Tomorrow’s World- Acting Now!, April 2000”), the World energy demand in the next 20 years shall increase by 50% and it states : “ Al the industrial Nations retain that the diversification of the energy sources means simply to use more coal and no one energy source shall be abandoned for arbitrary political reasons, in particular nuclear, which does not emit greenhouse gases”. And in addition : “Governments shall shape the energy sectors”. In other words : “ Market is an essential mechanism for promoting greater efficiency in the energy sector, but is not sufficient by itself”. The EU has proposed at the recent Johannesburg Summit, to increase the renewable energies contribution up to 15% by the year 2015, but this proposal had been rejected by US, because their elevated cost. In the mean time the EU Commission, with its deliberation of November 16th 2001, had rejected the EU Green Paper on “: Towards a European strategy for the security of energy supply”, which had considered nuclear energy :” costly, undesirable, and in doubts”. Almost no one has the courage to say that nuclear energy is the solution. Only Lester Turow, Nobel Prize and prestigious chief economist at the MIT in Boston has recently written on the magazine USA Today : “ In the case of electricity, we already have a technical

In other instances I have noted the need for renewables to promote their usage on a consistent valuation methodology. In many cases, the apparent advantage of nuclear and large coal units is based on the rolled in rate base payment of the fixed capital costs. This makes the return required for these investments lower than corporate based capital. In addition, I have argued that deregulation has a significant imbedded increase in capital costs for the entire industry. I have no problem with nuclear generation as long as the society makes the consensus decision to provide for a manner of disposing of wastes. If the society determines that nuclear waste is "unmanagable" then the increased costs should be accepted.

The premise of this article is that the "unquestionable advantages" need not be only available through a regulated market. However, absent an adequately desgined market, I would argue that deregulated electricity markets can very easily begin to resemble the market stability of the airline industry than the crude oil market. The issue is appropriate design - something lacking to date.

We currently have "distributed" generation in the wholesale market connected by the transmission network. It is the redispatch of this distributed generation which the FERC is relying on to allow the concept of transmission congestion charges to work. Redispatch can only occur on the constrained side of a path if sufficient generation capacity exists above load needs in the constrained area. My expected outcome of SMD will be to encourage further development of distributed generation to take advantage of LMP rather than significant transmission investment.

If shorter lead times for exercising the capacity option are of benefit, then the market should see the shortest lead time for construction of capacity as a good thing, with as minimal overcapacity added as necessary. Due to the lumpy nature of central station additions to take advantage of economies of scale, more capacity is typically added than is necessary. This adds a cost to the option price that must also be born by the consumer until the load grows into the capacity, as has been occuring over the past 20 years in the US. Oddly enough, the electric industry is going to be faced with overall higher reserve margin requirements (more generation capacity) due to increasingly smaller constrained load pockets, since reserves cannot be shared over an unreliable transmission system.

As the generation additions become more local, with the extreme being additions at the end user, the capacity option for electricity could be internalized in the end user's costs as it is for other infrastructure such as air conditioners for cooling, furnaces for heating, machinery for producing widgets, etc. This essentially places the capacity option lead time on the order of weeks or months instead of years, removes the boom/bust nature of the merchant/IPP approach and brings the issue of how much should the market invest (and hence charge the customer in the option) for reliability down to the end user decision level. It will be interesting to see how the end user distributed generation market develops over the next decade.

With the market forces moving the responsibility for capacity to more local levels, the FERC envisioned wholesale market will become nothing but an instantaneous energy clearing house for non-firm electricity transactions hedged by local generation.