Energy Markets 101:  Market Structure in the U.S. 

Deregulation of Electricity Markets  

Traditionally, the U.S. electricity system has been operated by utility companies with legal monopolies over all generation, transmission, and distribution systems. These organizations —which can be governmental, cooperate, or corporate—own all equipment and make all decisions about how to operate it. This is the vertically integrated utility model, creating what are known as regulated or bilateral markets.   

Starting in the late 1990s, the Federal Energy Regulatory Commission (FERC) issued orders encouraging the creation of third-party organizations that can independently operate electricity markets. These organizations, either Independent System Operators (ISOs) or Regional Transmission Organizations (RTOs), seek to ensure equitable operation of the transmission grid and foster competition between generators. The markets they create are called organized, deregulated, or restructured markets. About two-thirds of the country’s electricity is now served via this model.  

Despite the name, markets of both structures are highly regulated. Vertically integrated markets are regulated by the federal laws and by Public Utility Commissions, which set the retail rates that utilities can charge their customers. Organized markets are primarily regulated by FERC, which governs interstate trade and transmission of electricity, oil, and natural gas, and is the predominant player affecting how electricity markets operate. However, because its jurisdiction is on interstate affairs, FERC has no authority in states that lack sufficient electric import or export capability. Most notably, this affects Texas’s ERCOT market, which has next to no transmission ties to the surrounding states.   

Market operations can also be impacted by the U.S. Environmental Protection Agency or the U.S. Department of Energy, though their regulations usually impact individual players rather than the market. State, regional, and local agencies can also pass regulations affecting the production and transmission of electricity within their own territories.  

Organized Markets vs. Vertically Integrated Utility Model  

The goal of the organized market structure is to ensure that all demand is met with the lowest cost resources and all generators are compensated fairly for their marginal costs. Some other benefits of deregulated markets include:  

• Economies of Scale: Because thermal generation is generally more efficient when operating closer to its maximum capability, it is cheaper for one large generator to serve the demand of several small towns than for several medium-sized generators to serve those same towns. In a vertically integrated region, such an agreement would require firm contracts between each of the related utilities and the operation of additional small generators to make up the difference between contracted delivery and actual demand. In an organized market, this negotiation is inherent and automatic.   
• Transparency: Organized markets are run by nonprofit organizations with hundreds of stakeholders, usually across many states. Therefore, they are incentivized and required to publish pricing. Vertically integrated utilities don’t have the same incentives or requirements.   
• Competition: For many reasons, the leaders of a vertically integrated utility may choose to serve its electric demand in a way that is different than the least-cost option. When a third party is responsible for deciding which generator operates and independent power producers are allowed to participate, all power producers are economically incentivized to keep costs low.  
• Access to renewable energy: By operating at the state and regional levels with a large pool of resources, an organized market is better positioned to handle the variability of renewable energy resources. Furthermore, because of the least-cost nature of organized markets, they are more likely to prioritize dispatch of wind and solar energy.   

However, there are also many reasons why a utility might not join a nearby organized market or why a collection of utilities might not choose to create one.  

• Loss of local control: For utilities that already cover a broad region with a diverse array of resources, the benefits of joining an organized market might not outweigh the loss of their right to make their own dispatch decisions.   
• Bureaucratic cost: The organizations which run deregulated markets are large and complex. It takes time to keep up with paperwork, submission deadlines, committee updates, and more.   
• Poor interconnection: Some utilities that join organized markets have found that the financial costs of participating in the market did not outweigh the benefits. This can happen when the utility’s territory is separated from the rest of the market by physical distance or transmission constraints.   

If you’d like to explore how deregulated markets operate in the U.S., check out some additional reading here - Energy Markets 101: Deregulated Market Operations. To learn more about how energy market structures impact your energy supply strategy, please reach out to us via our Contact Page or email Charlotte Caldwell at charlotte.caldwell@trioadvisory.com.