Geographic Integration, Transmission Constraints, and Electricity Restructuring

Abstract: We examine the impact on inter-regional trade in eastern U.S. electricity markets arising from the FERC-supported creation of Independent System Operators (ISOs). Our analysis focuses on the PJM ISO (Pennsylvania, New Jersey, Maryland, and other states) and its trade with the New York ISO and ECAR (East Central Area of Reliability). The formation of ISOs has been associated with two distinct impacts: (1) more centralized management of regional transmission resources; and (2) the formation of regional multi-party electricity exchange markets. We find that the former effect actually may have facilitated electricity trade between regions, since quantity constraints on trading volume occur with substantially greater likelihood when sending power into the loosely organized ECAR “reliability area” as compared with the more centrally administered PJM ISO. We attribute this to institutional impediments in obtaining a transmission path within ECAR that deter the use of physically available transmission capacity. This result supports FERC policy of encouraging the creation of ISOs. As for the impact of PJM’s creation of multi-party energy exchange markets, our evidence suggests that the formation of these markets initially reduced transaction costs for inter-regional trade by improving price discovery, but the overall impact has been to raise inter-regional transaction costs somewhat. Finally, our estimates of the shadow value of adding incremental transmission capability provide useful empirical evidence for the debate surrounding the adequacy of the U.S. electricity transmission system.