FTC Staff Comment Before the Federal Energy Regulatory Commission Concerning Electricity Market Design and Structure

1 This comment represents the views of the staff of the Bureaus of Economics and Competition
and the Office of the General Counsel of the Federal Trade Commission. They are not necessarily the
views of the Federal Trade Commission or any individual Commissioner. The Commission has,
however, voted to authorize the staff to submit these comments.
Before the
United States of America
Federal Energy Regulatory Commission
Electricity Market Design and Structure: ) Docket RM01-12-000
Strawman Discussion Paper for Market )
Power Monitoring and Mitigation )
Comment of the Staff of the
Bureaus of Economics and Competition and the Office of the General Counsel
of the Federal Trade Commission1
April 3, 2002

1 This comment represents the views of the staff of the Bureaus of Economics and Competition
and the Office of the General Counsel of the Federal Trade Commission. They are not necessarily the
views of the Federal Trade Commission or any individual Commissioner. The Commission has,
however, voted to authorize the staff to submit these comments.
2 The discussion paper was released by FERC in conjunction with the Market Monitoring and
Mitigation Panel of its February 2002 technical conference on Market Structure and Design. These
comments also apply to the Market Power Monitoring and Mitigation section of the FERC Working
Paper on Standardized Transmission Service and Wholesale Electric Market Design released March
15, 2002.
Before the
United States of America
Federal Energy Regulatory Commission
Electricity Market Design and Structure: ) Docket RM01-12-000
Strawman Discussion Paper for Market )
Power Monitoring and Mitigation )
Comment of the Staff of the
Bureaus of Economics and Competition and the Office of the General Counsel
of the Federal Trade Commission1
I. Introduction and Summary
The staff of the Bureaus of Economics and Competition and the Office of the General Counsel
of the Federal Trade Commission (FTC or Commission) appreciates this opportunity to present its
views concerning the Federal Energy Regulatory Commission’s (FERC) strawman discussion paper on
market power monitoring and mitigation in wholesale electricity markets.2 The discussion paper
presents principles that may be used to guide FERC’s monitoring efforts and to form the basis for the
design of market power mitigation measures.
We agree with most of the principles and policy preferences expressed in the discussion paper.
One of the principles the Commission has articulated to ensure that consumers benefit from electricity

3 See Letter of the Federal Trade Commission to House Commerce Committee Chairman
Thomas Bliley, Analysis of H.R. 2944 (Jan 14. 2000) (Bliley Letter).
4 FTC Staff Report: Competition and Consumer Protection Perspectives on Electric Power
Regulatory Reform (Jul. 2000), available at <http://www.ftc.gov/be/v000009.htm>. This report
compiles previous comments that FTC Staff had provided to various state and federal agencies. For
example, FTC Staff has commented to FERC on electric power regulation in Docket No. RM99-2-
000 (regional transmission organizations) (Aug. 16, 1999); Docket EL99-57-000 (Entergy transco
proposal) (May 27, 1999); Docket RM98-4-000 (merger filing guidelines) (Sept. 11, 1998); Docket
2
restructuring is the need to reduce substantial and durable horizontal market power in electricity
markets.3 Our comment focuses on (1) clarifying the definition of market power, (2) advantages of
structural remedies compared to behavioral remedies for market power, (3) the special problem of load
pockets and the potential need for additional market power mitigation measures in those areas, and (4)
the importance of demand side participation in addressing horizontal market power concerns in electric
power markets.
The FTC is an independent administrative agency responsible for maintaining competition and
safeguarding the interests of consumers. In the electric power industry, the staff of the FTC often
analyzes regulatory or legislative proposals that may affect competition or the efficiency of resource
allocation in addition to its review of proposed mergers involving electric and gas utility companies. In
the course of this work, as well as in antitrust research, investigation, and litigation, the staff applies
established principles and recent developments in economic theory and empirical analysis to
competition issues. The Commission has issued two Staff Reports (July 2000 and September 2001) on
electric power industry restructuring issues at the wholesale and retail levels. The July 2000 FTC Staff
Report established a policy framework for increased competition in wholesale and retail electric power
markets.4 The September 2001 FTC Staff Report reviewed those features of state retail competition

No. PL98-5-000 (ISO Policy) (May 1, 1998); Docket Nos. ER97-237-000 and ER97-1079-000
(New England ISO) (Feb. 6, 1998); Docket No. RM96-6-000 (merger policy) (May 7, 1996);
Docket Nos. RM95-8-000 and RM94-7-001 (open access) (Aug. 7, 1995). The FTC staff
comments are available at <http://www.ftc.gov/be/advofile.htm>.
5 FTC Staff Report: Competition and Consumer Protection Perspectives on Electric Power
Regulatory Reform, Focus on Retail Competition (Sep. 2001), available at
<http://www.ftc.gov/reports/index.htm>.
6 FTC Staff Comment on Docket No. MR01-10-000 (Dec. 20, 2001).
7 FTC Staff Comment on Docket No. MR02-1-000 (Dec. 21, 2001).
8 FTC Staff Comment on Docket No. EL01-118-000 (Jan. 5, 2002).
9 Memorandum of Agreement Between the Federal Trade Commission and the Antitrust
Division of the U.S. Department of Justice Concerning Clearance Procedures for Investigations (Mar.
5, 2002), available at <http://www.ftc.gov/opa/2002/02/clearance/ftcdojagree.pdf>.
3
plans that have provided benefits to consumers and those that have not. It also provided
recommendations as to whether states had sufficient authority to implement successful retail competition
programs.5 Since the September 2001 FTC Staff Report, FTC staff has filed three comments with
FERC regarding standards of conduct for transmission providers,6 interconnection standards,7 and
market based rates.8
The FTC and the Antitrust Division of the United States Department of Justice recently entered
a Memorandum of Agreement Concerning Clearance Procedures for Investigations that allocates to the
FTC responsibility for handling antitrust investigations for the energy industry. The FTC will review
proposed mergers under Section 7 of the Clayton Act, and have a right of first refusal for non-merger
antitrust investigations, in the energy industry, which includes gas, electricity, coal, pipelines, petroleum,
and gas stations.9

10 Discussion Paper at 1.
11 Whether markets are competitive also will depend on seller concentration, the ability of
sellers to increase output, and entry conditions.
4
II. Principles Underlying the Market Power Discussion Paper
The purpose of FERC’s paper is to stimulate discussion that can guide the design of market
power monitoring efforts and market power mitigation measures in wholesale electricity markets. The
proposal recognizes that clarity in future regulation and mitigation policies is critical to well-functioning
wholesale electricity markets.
One of the underlying assumptions of the discussion paper is “that sufficient competition can
exist in generation supply as long as certain structural conditions are present.”10 In “well-developed”
markets FERC indicates that additional market power mitigation should be unnecessary. The
discussion paper does not specifically define “well-developed” markets, but it is our understanding that
elements of such markets may include elements likely to contribute to increased competition such as
price-responsive demand, an effective regional transmission organization that uses locational marginal
pricing or some other pricing system to address the problem of transmission congestion, and market
monitoring.11
The discussion paper also expresses a general preference for ex ante structural remedies to
market power, as exemplified by FERC’s efforts to encourage the establishment of regional
transmission organizations (RTOs) in all regions of the lower forty-eight states. The proposal
recognizes that ex ante structural analysis and remedies may be necessary in regions with no RTO and
that efforts to promote price-responsive demand should be a priority for all parties involved in

12 An offer cap requires that a seller of electricity bid into a wholesale market at no more than a
specified price, but the seller receives the market clearing price for any of its electricity that is
dispatched if the market clearing price exceeds the offer cap.
13 Discussion Paper at 7.
5
restructuring. For well-developed markets, the proposal suggests that intrusive regulation should be
unnecessary, although it indicates that behavioral regulation, such as offer caps,12 may still be
appropriate in certain circumstances.
The discussion paper explains that withholding of output should be the focus of ex post market
power assessments, and urges minimization of ex post refunds and similar forms of mitigation. The
discussion paper further seeks to distinguish high market prices due to scarcity from those due to
market power. It also directs any examination of market power to be focused on significant and
sustained exercises of market power as opposed to insubstantial and transient exercises of market
power.
We agree with the central observation in the discussion paper that ex ante clarity of the rules
that will govern wholesale electricity markets and mitigation policies is absolutely essential.13 Clarity of
any behavioral and structural mitigation policies that FERC may apply is critical for making long-term
investments in new generation and transmission, which — as the California experience has shown —
are essential for supply adequacy and well-functioning wholesale power markets. We continue to
foresee difficulties in delineating feasible behavioral remedies that will achieve this clarity in the eyes of
market participants. The preference for structural remedies expressed herein is based, in part, upon
our view that ex ante structural remedies are best able to pass this essential “regulatory clarity” test.
Although the discussion paper appropriately emphasizes ex ante structural remedies for market

14 We reiterate the concern highlighted previously that FERC may wish to establish a
benchmark concerning efficient operations of RTOs. Whenever a newly independent institution
emerges, there is a risk that independence will devolve into indifference to the quality of service, the
pace of innovation, and changes in customer preferences. RTOs are unlikely to be an exception. To
avoid traveling down such a path, FERC may wish to identify minimum efficiency incentives that will
characterize RTOs. For example, efficiency may be enhanced by providing a mechanism for displacing
management and the board of directors if either or both fail to operate and manage the RTO efficiently
or fail to respond to customer preferences. See FTC Staff Comment to FERC on Regional
Transmission Organizations, Docket No. RM99-2-000 (Aug. 16, 1999) at 28-30, available at
<http://www.ftc.gov/be/v990011.pdf>.
15 See, e.g., FTC Staff Comment to the Arkansas Public Service Commission, In the Matter of
a Generic Proceeding to Establish Filing Requirements and Guidelines Applicable to Market Power
Analysis, Docket No. 00-048-R (Apr. 13, 2000); FTC Staff Comment to FERC on Revised Filing
Requirements, Docket No. MR98-4-000 (Sep. 11, 1998).
16 A load pocket is refer to a geographic area within which at least some electricity must be
generated because transmission congestion prevents exclusive reliance on suppliers from outside the
area. An area may be a load pocket during some high demand hours but not be a load pocket during
other hours.
6
power rather than ex post penalties or behavioral rules, well-developed market institutions (such as
those FERC currently contemplates encouraging through its standard market design regulatory
proceeding14) alone may be insufficient to address all existing market power concerns in generation.15
This is, in part, because state and federal regulators assumed that rate and service regulation would
remain in place indefinitely and thus may have assumed there was no need for antitrust scrutiny of
mergers to restrain the growth of horizontal market power. Load pockets16 with concentrated
ownership of generation and entry impediments may be subject to significant market power problems
even if they have well-developed market institutions. Consequently, FERC may wish to monitor and
mitigate market power in load pockets differently in some respects from the manner in which it monitors
and mitigates market power in other areas of the country. We discuss this proposal below, and also

17 One additional concern we have is the discussion paper’s characterization of natural gas
pipelines as natural monopolies. This characterization may not fully describe the natural gas
transportation market in the United States. An industry is a natural monopoly if it is less expensive for a
single firm to serve the entire market. Empirical research employing data from the Texas intrastate gas
transmission industry has suggested that gas transmission is not inherently a natural monopoly in many
markets. See, e.g., Jerry Ellig and Michael Giberson, “Scale, Scope, and Regulation in the Texas Gas
Transmission Industry,” 5 J. of Reg. Econ. (Mar. 1993). Even in interstate transmission, most origin
and destination markets are served by multiple pipelines, and the number of competitors increases
further if one includes nearby potential competitors that could enter a market by constructing a spur
within two years. Edward Gallick, Competition in the Natural Gas Pipeline Industry (1993). Since
the mid-1980s, FERC itself has encouraged expansion of the interstate gas transmission network even
when such expansion leads to pipe-on-pipe competition. Regulatory scholars suggest that the facts of
these cases show that interstate gas transmission is moving away from a natural monopoly model. See,
e.g., Jerry Ellig, “Why Do Regulators Regulate? The Case of the Southern California Gas Market,” 7
J. of Reg. Econ. 293 (1995); Harry G. Broadman and Joseph P. Kalt, “How Natural is Monopoly?
The Case of Bypass in the Southern California Gas Market,” Yale J. on Reg. 447 (1989).
18 Discussion Paper at 1.
19 See § 0.1, Market Definition, Measurement and Concentration, United States Department
of Justice and Federal Trade Commission, Horizontal Merger Guidelines, issued Apr. 2, 1992, revised
Apr. 8, 1997.
20 Id.
7
offer suggestions relating to other issues in the discussion paper.17
III. Definition of Market Power
FERC has defined market power as “the ability to raise market price above the competitive
level.”18 As the term is used in antitrust and industrial organization economics, market power to a seller
“is the ability profitably to maintain prices above competitive levels for a significant period of time.”19
When a seller has market power, competition also may be reduced on dimensions other than prices,
such as product quality, service, or innovation.20 Two explanations of this definition are in order. First,

21 Id.
22 Over a longer time horizon, other actions by sellers may tend to preserve or enhance market
power. Firms with existing market power may have incentives, for example, to preserve transmission
bottlenecks, discourage real-time pricing and other forms of demand-side participation in markets, and
block or delay interconnection of new generators. Other techniques that raise the costs of other
suppliers may also allow a firm to exercise market power. In our December 20, 2001, comment on
standards of conduct for transmission providers, supra note 6, we described the potential
anticompetitive effects of raising fuel prices paid by other electric power suppliers that the FTC
examined in various recent investigations (e.g., the Matter of PacifiCorp and The Energy Group PLC).
23 To the extent that market monitoring of output withholding closes off one method of
exercising market power, suppliers may have incentives to exercise market power through other
techniques that are more difficult to detect and that may be more socially costly. Inducing transmission
congestion may be one such technique.
8
the focus on profitability refers to whether an “action is in the actor’s economic interest,”21 not whether
the individual act, in and of itself, is profitable. This broader focus is consistent with the basic
framework of economic analysis, which emphasizes profit maximization as the objective of private
firms. Second, in the context of electricity markets in which demand and supply conditions vary over
short periods of time, the “significant period of time” concept can reasonably be interpreted, for
example, as a set of demand and supply conditions that recur in a similar form over time, even when the
periods are not contiguous.
In electric power wholesale markets, a firm with market power may withhold generation that
otherwise would be supplied to the market. Reducing the quantity supplied may be accomplished
unilaterally or in coordination with other suppliers. Firms also could reduce supply to a market by
creating transmission congestion.22 Thus, a principal suggested clarification to the discussion paper is to
include monitoring to detect generation or transmission decisions that add to transmission congestion as
a means to exercise market power.23 In some circumstances, increased output by a generator may

24 See Bliley Letter, supra note 3, at 5
25 F. M. Scherer and D. Ross, Industrial Market Structure and Economic Performance 4-5 (3rd
Ed., Boston: Houghton Mifflin 1990). We focus on the concentration and entry aspects of the term
structural, rather than on the broader use that includes such issues as dispatch and bidding rules,
reliability rules, and retail pricing regulations.
9
create loop flows that, in turn, create transmission congestion and reduce the ability of generators in
other areas to sell into a load pocket. This may create or enhance market power for one or more
generators within the transmission constraint. Computer simulation modeling may be useful in
distinguishing output increases that serve primarily to create transmission constraints from those that
help meet demand in load pocket areas.
IV. The Advantages of Structural Remedies
The discussion paper explains the difficulties in performing ex ante structural analyses in light of
the complexities involved in defining relevant product and geographic markets. Despite these
difficulties, we continue to believe that ex ante structural analyses are vital to diagnose potential market
power problems.24 Moreover, structural analyses of wholesale electricity markets, as described below,
are critical to ensure that whatever remedies are adopted are narrowly tailored to the market power
problem that is being corrected.
The structure of a market refers to many features of the market such as the number and relative
sizes of independent suppliers in the market (concentration), product differentiation, entry conditions,
cost functions, and vertical integration.25 Prospects for the exercise of unilateral market power and/or
coordinated interaction are reduced when the number of actual and potential suppliers is sufficient to
provide the ability and incentives to undermine efforts of dominant suppliers to exercise market power.

26 FTC Staff Comment to the Arkansas Public Service Commission, Section IV, supra n. 14.
10
The probability that one or more suppliers will be pivotal is reduced when concentration is low or the
supply elasticity is high for other suppliers.
The structure of the market that provides supply to particular customers is unlikely to be static
because the geographic extent of the market varies as demand and supply conditions shift during the
day and across seasons of the year. Because demand and supply in any given period is largely
independent of demand and supply in other periods in electric power markets (in large part because
storing electric power is not widely practical with existing technologies), each such period of time
constitutes a separate product market with an associated geographic market. Further, at any given
period of time, different types of generators (baseload, mid-merit, or peaking generators) may be more
or less influential in determining the wholesale spot market price applicable to a geographic cluster of
customers. Within a specific time frame, the structure of ownership and control over a subcategory of
generators (for example, mid-merit generators) may be as telling as more general measures of market
concentration.26 Because the extent and shape of the relevant geographic market constantly changes, a
structural remedy that is sufficient to address market power concerns in one period of time may be
insufficient in other periods of time.
The goal for ex ante structural remedies in wholesale electric power markets is to create
conditions that are conducive to competition and then let the markets operate relatively free from
regulation. A principal source of concern about the horizontal structure of existing electric power
markets is that, under nearly a century of rate and service regulation without antitrust review,

27 Independence of a generator means that ownership or contractual control of the generator is
separate from ownership or control of other generators supplying the same relevant market.
28 Several issues should be considered in determining whether such contracts offer equivalent or
increased net benefits for consumers compared to divestiture in any given situation. For example, the
payment term (i.e., whether it is upfront or on a pay-as-you-go basis) may affect the owner's incentive
to maintain the unit and fully utilize the generator during all periods. These concerns may be heightened
where the owner has a portfolio of generating units and strategic operation of the unit under the forward
contract may affect the profitability of the firm's other generating units. Other significant concerns may
include the length of the contract, incentives to expand output, and penalties for underperformance.
11
concentration in generation assets may have accumulated. Structural remedies for horizontal market
power in electricity markets can be used to address this potential problem. Structural remedies include,
for example, divestiture of an incumbent generating firm’s plants to more than one buyer, increased
transmission capacity that allows efficient wheeling of power from additional independent suppliers
outside the area, contractual forward sales of generation output (e.g., vesting contracts), and reduced
impediments to entry of new generators.27
Structural generation remedies may not involve sales of generating facilities. For example,
remedies may include forward sales of a generating unit’s output to unrelated third parties if they can be
structured properly. The sale of such output at prices that cannot be raised by subsequent decisions by
the generating unit’s owner effectively reduces generation concentration and the attendant unilateral
market power of any one generation owner.28
Structural remedies address directly the incentives and ability to reduce supply or to coordinate
supply reductions with others. In contrast, behavioral remedies may be ineffective because of
difficulties in detecting and documenting violations in real-time electric power markets. Offer caps on

29 Discussion Paper at 7-8.
30 As minimum efficient scale in generators falls, the potential for extensive entry by numerous
small generators may help assuage concerns about existing market power. One of the attractive
features of the recent advances in microturbines, fuel cells, and other forms of distributed generation is
that they eventually may alleviate load pockets by making small scale, quick entry practical for system
conditions under which they are economic sources of energy.
12
bids in wholesale spot markets, as suggested in the discussion paper,29 are generally not an attractive
substitute for structural remedies. Offer caps have three unavoidable shortcomings: (1) they pose an
inherent regulatory risk to market participants that the cap may be raised or lowered by subsequent
policymakers, which may reduce the incentive for new generation investment; (2) they may be set too
low to provide adequate entry incentives in high-cost areas, such as urban localities; and (3) if the offer
caps are to meet the “clarity” criterion of the discussion paper, then the offer cap policy will have to
stipulate—in a binding manner—how the caps will be adjusted as regional opportunity-cost and
demand conditions evolve over time. This may be difficult at best, and infeasible and confusing to
market participants at its worst.
V. Load Pockets Present Special Problems
FERC may wish to pay close attention to the locations and periods of time during which load
pockets exist, particularly in situations in which transmission capacity into the load pocket is heavily
utilized and there are barriers to entry by efficient generators.30 Computer simulation modeling can be
used, for example, to examine a wide variety of demand and supply conditions and assess whether a
load pocket exists during certain hours. FERC could then use a different set of policy choices for this
limited set of areas and periods of time. One less intrusive regulatory approach that FERC may wish to
consider is requiring use of medium- to long-term forward contracts. Such contracts might take the

31 Where concentration of generation within a load pocket raises market power concerns, one
option is to explore the potential for dividing up control over the output of a single facility. For
example, there are several generation facilities in the United States with multiple owners, each of which
controls part of the plant’s output.
13
form of generator-specific standing offers for immediate energy and/or ancillary services at FERC-
approved rates.31
FERC may wish to supplement its determinations of load pocket conditions and entry
impediments with policy initiatives on transmission siting, demand-side participation, and generator
interconnection. Because load pockets with potential market power problems are among the areas in
which these policy initiatives are likely to create the greatest improvements for customers insofar as
market power mitigation is concerned, FERC may wish to give priority in its policy initiatives to the
relevant load pockets that it identifies. For example, FERC may wish to give priority to experiments
with rate incentives for transmission enhancements that will open up relevant load pockets to outside
generators. Similarly, FERC may wish to focus implementation and enforcement of generation
interconnection standards for transmission providers in areas found to be relevant load pockets. Both
of these would be properly characterized as structural initiatives because they affect entry conditions.
VI. Demand-Side Participation Initiatives
Although FERC does not control whether retail customers can have access to real time pricing,
we encourage FERC to continue to work with the states to provide this option to more customers.
Demand-side participation should be a priority for all parties involved in restructuring. Moreover,
states can implement this reform whether or not they are implementing a retail choice program. As
outlined in the September 2001 FTC Staff Report, increasing retail demand sensitivity to wholesale

14
electricity prices is likely to reduce existing market power concerns at the wholesale level, as well as to
reduce the cost of electricity more generally. Increased efforts by the states to implement real time
pricing options for customers would help FERC achieve its goals of effective competition in wholesale
markets and help states reduce average prices at retail. The relationship between short-term wholesale
prices and retail prices is tenuous at best for most customers, and this disconnect distorts incentives for
customers to invest in load shifting appliances, air conditioners, and other devices or lifestyle changes
that would better reflect the social costs of supplying electric power in different periods. We agree that
any maximum offer caps or other devices designed to simulate demand responsiveness should be
phased out as actual demand responsiveness programs are implemented.
VII. Conclusion
The discussion paper generally articulates principles and policy preferences that are appropriate
from a competition policy perspective. Its emphasis on ex ante structural remedies is particularly
important. Our principal concerns about the discussion paper are twofold.
• It should focus more on specific options for structural mechanisms to reduce generation
market power.
• The discussion paper could be interpreted to suggest that what FERC has labeled
“well-developed” wholesale electricity markets will eliminate concerns about market
power in load pockets.
The discussion paper points to “physical withholding of generation” as a primary focus of
market monitoring. We see a regulatory regime of “withholding-monitoring-administrative penalties” as
problematic and at odds with the direction of antitrust treatment of market power over the past three

15
decades.
We recommend FERC identify transmission constraints that are congested and then examine
market structure and entry conditions in these areas. Where a load pocket is found and is
accompanied by transmission congestion, a highly concentrated market structure, and entry
impediments, a well-developed market may not be enough to take care of market power concerns.
For such areas, additional structural remedies may be appropriate if the benefits exceed the costs.
Where structural remedies are not efficient, other regulatory approaches may be preferable, again if the
benefits exceed the costs. Further, FERC may wish to give priority to longer-term policy initiatives that
may eliminate such load pockets.
Respectfully submitted,
________________________
David T. Scheffman, Director
John C. Hilke, Economist and Electricity Project
Coordinator
Bureau of Economics
________________________
Joseph J. Simons, Director
Bureau of Competition
_________________________
Susan S. DeSanti, Deputy General Counsel
Michael S. Wroblewski, Assistant General Counsel
Federal Trade Commission
600 Pennsylvania Ave., N.W.

16
Washington, D.C. 20580
April 3, 2002