The Effectiveness of Ferc's Transmission Policy : Is Transmission Used Efficiently and When is it Scarce?

We investigate the impact of creating Independent System Operators (ISOs) to independently manage regional electricity transmission resources and institute regional electricity exchange markets. Our analysis examines how the formation of the PJM Independent System Operator (ISO) in Pennsylvania, New Jersey, Maryland, Delaware (and other states) has affected electricity trading costs and the prevalence of quantity-constrained trade between PJM and the New York ISO, and between PJM and the more loosely organized ECAR (East Central Area of Reliability) transmission region.There are many complexities involved in modeling the transmission grid and determining precisely when electricity prices are affected by scarcity of transmission resources. This paper introduces a novel approach to identifying transmission scarcity and measuring electricity trading costs that does not require a comparison of physical electricity flow data with estimates of available transmission capacity. Instead, we use market data and an econometric model which estimates the probability that an observed inter-regional electricity price difference is consistent with one of three possible equilibrium states: autarky (i.e., no short-term trade), unconstrained trade (i.e., arbitrage), and quantity-constrained trade (i.e., transmission-constrained trade). Coefficient estimates relevant to explaining price differences in each state are obtained.We find that ISO formation may have facilitated electricity trade between regions, since binding trade-volume constraints occur with substantially greater likelihood when importing power into the more decentralized ECAR quot;reliability areaquot; (as opposed to the centrally administered PJM ISO), even though physical transmission capacity is still apparently available. Our evidence also suggests that PJM's formation of an electricity exchange market 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 (perhaps due to the creation of quot;seamsquot; issues).Finally, to contribute to the growing debate surrounding the adequacy of the U.S. transmission system, we use our daily pricing data and state probabilities to provide estimates of the marginal economic value of increased electricity transfer capability