Regional Transmission Organizations as Market Platforms I
What's the origin story of wholesale power markets?
Photo by Nastya Dulhiier on Unsplash
2025 is already shaping up to be a year of change for many reasons related to the economics and technology of energy. Between the uncertainty arising from a political change in presidential administration and the dynamics of technological change in the economy, the only prediction I'd hazard is that change will happen. Some of these changes have been simmering for some time, while others will emerge. Okay, throat-clearing beginning-of-year platitudes out of the way.
It's useful to get grounded in some foundational thinking when facing such uncertainty. One of the areas at the intersection of technology, economics, and electricity that will be subject to uncertainty and change in the near future is wholesale power markets and the organizations that operate them, regional transmission organizations (RTOs). There are a lot of economic, technological, and political reasons why RTOs face evolutionary pressures, and I plan on writing a series of posts in January laying out these pressures and their underlying economic logic.
Not surprisingly (because hey, have you met me ;-)?), I think understanding the future direction of RTOs and wholesale power markets starts with their economic history. RTOs oversee the operation of the high-voltage transmission grid across large geographic regions, with a mission of ensuring reliability and facilitating competition in wholesale electricity markets. Understanding their emergence requires tracing their origins back to the cooperative power pools established in the early 20th century, which laid the groundwork for today’s RTOs.
Before RTOs: Power Pools
In the first half of the 20th century, electric utilities in the United States were vertically integrated, with monopoly firms controlling generation, transmission, and distribution within defined service territories within state boundaries. While this structure enabled utilities to achieve economies of scale and scope, it also led to limited coordination and limited interconnection between neighboring utilities. The lack of interconnection became a significant vulnerability during emergencies, such as equipment failures or sudden spikes in demand, where utilities often struggled to maintain service reliability. These limitations became evident during manufacturing to support the war effort in World War I, and a couple of different initiatives toward broader interconnection ensued but failed. In the early decades of building out the industry, the benefits of economies of scale and scope far outweighed the costs of no interconnection for backup purposes, but the tradeoff was real.
Power pools emerged in the early 20th century as voluntary associations of electric utilities aimed at coordinating the generation and transmission of electricity within a particular geographic region. These organizations served as platforms for utilities to collaborate on operational and planning activities, share reserves, and facilitate economic transactions involving the exchange of power and energy among members. One of the earliest and most notable power pools was the Pennsylvania-New Jersey-Maryland Interconnection (PJM), established in 1927. Initially formed as a power pooling arrangement among three utilities, PJM grew to encompass a broader region and evolved into a centralized dispatch system for coordinating generation and transmission across its members' service territories. Other early examples, such as the New England Power Pool (NEPOOL) established in 1971, formalized these cooperative arrangements, improving reliability and optimizing the use of generation and transmission resources. Power pools demonstrated the benefits of interconnection, including reduced reserve margins and lower costs through shared dispatch of generation assets.
Pressures For Competition
This regional coordination and shared dispatch continued through the 1960s in the industry's growth phase. One great source that I recommend to everyone interested in this topic is Richard Hirsh's seminal book Power Loss (2000), which is essential for understanding the history of the electricity industry in the second half of the 20th century. Hirsh presents extensive evidence on the technological plateau of the industry in the 1960s before the turbulent 1970s, the build out of nuclear generation and its attendant cost overruns, and the ensuing pressures on the vertically-integrated, regulated utility model.
The energy crises of the 1970s, coupled with growing dissatisfaction with the inefficiencies of the regulated monopoly model, prompted significant changes in the U.S. electricity sector. The Public Utility Regulatory Policies Act (PURPA) of 1978 began to open the generation segment to rivalry from non-utiilty generators by requiring utilities to purchase power from qualifying independent producers. The competition policy concept applied here is regulatory foreclosure: by reinforcing monopoly vertical integration, regulation foreclosed non-utility generation. In the earlier years when economies of scale and scope and the building out of power systems were the dominant economics, that foreclosure was less costly, but in the 1970s context the perceived cost of foreclosure was more costly, and PURPA was a mechanism for reducing foreclosure. PURPA in particular was a real mixed bag—it reduced entry barriers for non-utility generation, distributed generation, and combined heat and power, but it also used very bureaucratic and administrative procedures, not actual markets, for reducing those entry barriers. States would establish "prices" that would be paid to qualifying generators, putatively grounded in some estimate of a utility's avoided cost, but in no way did they emerge out of some market discovery process.
PURPA was followed by the Energy Policy Act of 1992, which was intended to facilitate greater competition in the electricity generation sector. One of the key provisions of the Act was the amendment of the Public Utility Holding Company Act of 1935 (PUHCA) to allow for the formation of exempt wholesale generators (EWGs). EWGs were independent power producers that could generate and sell electricity at wholesale prices without being subject to the stringent regulations imposed on traditional vertically integrated utilities. This provision effectively opened the door for independent power producers to enter the electricity market, thereby introducing competition and challenging the monopolistic structure that had previously dominated the industry.
Technology and institutions are co-determined, so it's important to realize that EPAct 1992 was catalyzed by a technology that I classify as one of the most important new technologies of the 20th century: the combined-cycle gas turbine generator (CCGT). It's also a fantastic example of combinatorial innovation.
Developed in the 1980s as an application of a new jet engine, the CCGT provided a smaller and more energy efficient gas generator that could be dispatched more flexibly than larger coal or nuclear generators (today the newest CCGTs can ramp up in 30 minutes). Previous gas generators were simple steam turbines and single cycle generators, operating more slowly and using more gas, and correspondingly generating more criteria pollutant and greenhouse gas emissions than the new CCGTs would. CCGTs were nimbler, cheaper, and cleaner than competing generation technologies. Their economic effects were profound: they broke the monolithic pattern of economies of scale in generation, and their different features compared to their competitors introduced product differentiation into the generation technology market. Different generation technologies now really had different features, different costs and benefits (yes, hydro and coal and nuclear before had different features and different benefits and costs, but the CCGT was truly in a different category of distinctiveness).
As competitive pressures grew, the limitations of traditional power pools became apparent. While power pools facilitated cooperation for emergency purposes through coordinated dispatch, they did not fully accommodate the participation of independent generators or ensure non-discriminatory access to the transmission grid. As organizations of regulated utilities power pools were creations of and instruments of regulatory foreclosure. These shortcomings called for new institutions to oversee the grid and facilitate competitive wholesale markets, which were not going to emerge organically in the regulated utility setting.
Regulatory Change For Non-Discriminatory Access: The Transmission Bottleneck
Here's the biggest economic, regulatory, and cultural challenge of reducing entry barriers in generation markets: the companies that transport the generated power didn't want those barriers reduced. For those of you who didn't live through this transition, you cannot imagine how contentious it was, which is not surprising when you consider the political economy of the situation. In the 1980s and 1990s both utilities and state public utility regulators faced substantial criticism for rising customer bills, inefficiency, nuclear power plant construction cost overruns. On the backdrop of the 1970s energy crises the belief that something had to change was palpable, and the argument for what had to change was the lack of competition. The combination of technological change and EPAct 1992 made an institutional design feasible that featured rivalrous competition where it had not existed before, rivalry that could discipline generation costs and enable dynamic innovation in ways that regulation had not.
The complicated aspect of reducing entry barriers in generation markets was that the incumbent regulated utilities were vertically-integrated, and this is a network industry. Generation markets existed, but they were monopoly markets. Utilities participated in regional power pools to coordinate transmission dispatch for infrequent purchases from each other, at prices that were regulated by the Federal Energy Regulatory Commission (FERC) to be "just and reasonable". If you are a utility, you own generation and transmission assets, and you have an incentive to make as much money as possible from your generators, not to make money selling transmission services to independent generators who are competing against your generation. This means that if the rules stay the way they were, sure, you could have rivalrous generation markets, but how would those independent generators get their product to their customers? PURPA was a camel's nose under the tent because it required utilities to buy from qualifying non-utility generators, which necessarily meant dispatching them and using utility transmission to transport them.
EPAct 1992's reduction of generation entry barriers would have an institutional domino effect to adjust regulatory institutions to the commercial and operational realities of non-monopoly generation markets. In particular, the interdependence of the generation markets and the transportation infrastructure—transmission—meant that if lower entry barriers in generation were to have a meaningful impact in disciplining costs and enabling innovation, then transmission access could not be a bottleneck.
Bear in mind a couple of legal aspects of this: FERC's regulatory jurisdiction arising from the Federal Power Act of 1935 is to ensure that prices in electricity in interstate commerce are "just and reasonable", and this debate was taking place on the backdrop of a 30-year established precedent in antitrust called the essential facilities doctrine, which was also being applied in the deregulating telecommunications industry at the same time. Essentially the idea in competition policy is that an owner of a bottleneck asset in a network industry cannot operate that facility in a way that discriminates against any particular user of that asset, and that includes not being able to restrict access or charge different prices. In both telecom and electricity this principle implies that a wires network owner cannot preferentially allow access and/or charge lower access prices to users they are affiliated with; under this principle a utility cannot prevent independent generators from accessing their transmission resources or charge them higher prices to use it.
FERC Makes Institutional Change
Since these regulated utilities were not organically going to reduce access barriers to transmission because of their affiliated generation, regulatory restructuring occurred to make that happen, a contentious process. This restructuring aimed to separate the operation of transmission assets from utility ownership, reducing potential conflicts of interest and fostering market competition. FERC Order 888 was a landmark regulatory ruling that aimed to promote competition in wholesale electricity markets by requiring utilities to undertake functional unbundling of transmission services from generation services. The order mandated that transmission-owning utilities provide open access to their transmission lines on a non-discriminatory basis (reflecting the essential facilities doctrine), thereby enabling wholesale buyers and sellers of electricity to access the transmission grid under comparable terms and conditions. Order 889 established the concept of an Open Access Same-Time Information System (OASIS), which required transmission providers to publicly disclose available transmission capacity and pricing information. This transparency measure was intended to prevent undue discrimination and facilitate just competition among market participants. Additionally, the order set forth principles for the independent operation of transmission systems, laying the groundwork for the subsequent establishment of independent system operators (ISOs) and regional transmission organizations (RTOs) to oversee the operation and planning of the transmission grid in various regions of the country.
FERC Order No. 2000, issued in 1999, formalized the concept of RTOs, building upon the ISO framework. The order's intent was to promote competition in wholesale electricity markets by facilitating the development of independent, regionally-coordinated entities responsible for the operation and expansion of the transmission grid. RTOs were envisioned as larger, more comprehensive organizations with responsibilities including grid reliability, market operation, transmission planning, and congestion management. Unlike power pools, RTOs were designed to operate independently of market participants and to provide a transparent platform for competitive electricity markets. Order 2000 outlined specific characteristics and functions that RTOs must possess, including independence from market participants, operational authority over all transmission facilities within their footprint, and the exclusive responsibility for grid planning and expansion. RTOs were also required to establish appropriate market monitoring and market power mitigation measures to prevent the exercise of transmission market power.
Inevitable Legal Challenges
Utilities objected to such federal regulatory restructuring, arguing that it told them what they could and could not do with the transmission assets in which they had invested, with regulatory approval, to provide electric service "in the public interest". In some states, particularly those with higher retail rates due to nuclear cost overruns, state-level regulatory restructuring required utilities to unbundle and sell off their generation assets (structural unbundling), or at least create an independent corporate structure that separated transmission and generation affiliates financially (functional unbundling). Functional unbundling has been unsuccessful, which is a topic for another post.
Several important legal challenges brought these federal institutional changes under court scrutiny, focusing on whether FERC had acted beyond its statutory authority, whether FERC could require transmission owners to cede operational control to an RTO, and other issues. For brevity I'll highlight one, New York v. FERC (2002), a U.S. Supreme Court case that challenged FERC's jurisdiction over transmission facilities used for bundled retail sales. Reading the court decision is worthwhile if you want a deeper understanding of the history and the regulatory economics in question here.
Under Order 888, FERC required functional unbundling of wholesale generation and transmission services. This meant utilities had to offer and price transmission services separately from generation, ensuring non-discriminatory access to transmission lines for competitors. FERC extended its jurisdiction to unbundled retail transmission services, arguing that such transmissions are part of interstate commerce and fall under its authority. However, it declined to impose the same requirement on bundled retail transmissions (where generation and transmission costs are not separated).The State of New York and other petitioners challenged FERC's jurisdiction over unbundled retail transmission, asserting that retail electricity transactions were traditionally under state regulation.
The U.S. Supreme Court ruled in favor of FERC, upholding its jurisdiction over unbundled retail transmissions. The Court concluded:
FERC's authority under the Federal Power Act extends to interstate electricity transmission, regardless of whether the transmission is for wholesale or retail transactions.
The transmission component of unbundled retail services is inherently part of interstate commerce, thus falling within federal oversight.
The Court also upheld FERC's decision not to extend its jurisdiction to bundled retail transmissions, finding this to be a permissible policy choice within the agency's discretion.
This decision affirmed FERC's ability to regulate aspects of retail electricity transactions that affect interstate commerce, reinforcing its role in fostering competitive markets. It also preserved the division of regulatory authority between federal and state governments.
Institutional Change Is Messy And Complicated
There is no black and white here, and to quote Thomas Sowell, there are no solutions, only tradeoffs. The essential facilities doctrine remains controversial, and changes to regulatory institutions to adapt to technological change have financial consequences. Dealing with dynamic forces like economic and technological change will always be messy, and in this case even more so because of the vertically-integrated history, the technological interdependence of generation and transmission, and the fact that this is a network industry and will continue to be one (unless widespread grid defection actually occurs, which I think it unlikely).
The process of taking advantage of technological change to reduce entry barriers and extend competition and markets will never be easy, and the institutions that emerged have a lot of flaws despite the operational, productivity, and financial benefits that have been created by restructuring and organized wholesale markets. This history gives us a lens through which to look at RTOs as they have evolved over a quarter century, to identify those flaws and how to improve them.
Terrific historical and technical summary,…Thank you Lynne