What RTOs and ISOs Can Learn from the Parable of the Fox and the Hedgehog

An ancient proverb imparts: the fox knows many little things, but the hedgehog knows one big thing. This insight is expanded through the moral of Aesop’s fable, “The Fox and the Hedgehog,” which showcases two life outlooks as represented by animals. There are hedgehogs, who view the world through the lens of a single defining idea, and foxes, who draw on a variety of experiences rather than a universal guiding principle. Examining the parable through a commercial lens, Jim Collins, a leading business consultant, ultimately concludes that those “who built good-to-great companies were, to one degree or another, hedgehogs.”

What does this parable have to do with our organized wholesale electricity markets? In a word: everything.

How Power Markets Work

In most regions of the U.S., electricity is first traded in wholesale markets before being sold and distributed to consumers—primarily households and most businesses—in retail markets. Wholesale markets are managed by regional oversight entities called Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs), and regulated by the Federal Energy Regulatory Commission (FERC). Most wholesale markets facilitate transactions for energy, capacity, ancillary services, and financial transmission rights. Currently, there are seven RTOs or ISOs operating in the U.S., with PJM Interconnection running the nation’s largest wholesale electricity market, covering 13 states and the District of Columbia.

COMMENTARY

Electricity generation needs to be perfectly aligned with energy consumption, which is by nature volatile and varied over the course of each day and between different seasons. To do this, wholesale prices for electricity and ancillary services are established through day-ahead auctions. Bids are submitted by generators, and consumer demand is represented by load-serving entities to ensure the balance of energy remains intact—at the lowest cost possible.

Real-time auctions further facilitate energy supply and demand by correcting any unforeseen changes in market conditions. Auctions for capacity and financial transmission rights provide longer-term price signals, which extend years into the future to highlight where supply is plentiful but also where it is needed.

Mirroring the hedgehog outlook, our wholesale electricity markets operate for one defining purpose: to integrate the complex enterprise of supplying highly variable electricity demand while avoiding outages. RTOs and ISOs are required by FERC to operate integrated markets so that participants have a sizeable arena in which to buy and sell electricity, hedge commercial risk, and ultimately provide consumers with the most value and stability. Any shift in the delicate equilibrium could spark failure, which threatens the nation’s reliance on safe, reliable electricity.

Flaws in the System

Unfortunately, the current management of our wholesale energy markets has fallen short of the mark, with stark deficiencies that include financial defaults, disruption of market price mechanisms, stagnant product design that lags behind evolving commercial needs, and inconsistent information. Alas, consumers ultimately bear the cost when management of the wholesale energy markets creates perils and disorder for participants competing in the markets, even when these events are not headline-grabbing. Deficiencies like these should be viewed as unacceptable, but yet they persist.

The energy world is becoming increasingly more complex, with calls for cleaner energy sources, energy security, and stronger reliability. Management of the wholesale energy markets to accommodate quickly evolving needs must be held to a higher standard. The time for RTO and ISO leaders to channel their inner hedgehog is now.

Achieving Positive Outcomes

How do we achieve this goal? RTO and ISO leaders need to understand and embrace that their sole purpose for running successful markets is to produce competitive and reliable outcomes. The concept of a single focus, like that of the hedgehog, will aid the task at hand and open up space for new ideas and successful outcomes.

Interference of any kind that results in distorted outcomes is counter to the very intent of wholesale electricity markets. If duly implemented tariffs, protocols, and best practices are replaced by exceptions, excuses, and unawareness, we risk hindering supply and market innovation (such as greenhouse gas–free means of generating electricity) or moderating demand (such as time-shifting or price-responsive demand).

Actual consequences must exist for those who ignore the hedgehog principle if we want the cycle to stop perpetuating itself. Managerial boards, directors, and executives must satisfy the responsibility to be fully informed, act with discipline, and ultimately realize the goal of RTO and ISO markets, and face accountability when they do not.

The wholesale energy markets are the engine for achieving competitive outcomes and maintaining a reliable electricity grid. They are the key to our future. The challenges to operate markets faced with ever-increasing complexity are indeed enormous but not insurmountable.

RTOs and ISOs are staffed with talented professionals and these entities must channel a singular focus to operate markets much more effectively. This starts with management. It’s time for RTO and ISO leaders to channel their inner hedgehog.

—Ken Irvin is co-leader of Sidley’s global Energy practice team. Joe Wadsworth is head of Energy Market Affairs for Vitol Inc.