ANCILLARY SERVICES: THE FORGOTTEN ISSUE

(Electric Perspectives 23(4), 2232, July-August 1998)

Lost amidst the animated debates swirling around hot bulk-power topics like ISO governance and
transmission pricing, there is another market-defining issue—how to properly unbundle and price the
generation and transmission functions known as ancillary services.

Eric Hirst and Brendan Kirby*

INTRODUCTION

If you were to ask a dozen industry insiders to sketch a quick profile of the electricity industry
in, say, the year 2005 (a time when we may be largely through the current transition), what issues
would they raise? They might mention various corporate changes, such as deintegration of generation,
transmission, system control, distribution, and customer service; mergers among entities within each
sector; and the creation of both global enterprises and niche players. They might cite new
technologies for generating and consuming electricity as well as new communications and computing
systems. What would they say, however, when you ask them to describe tomorrow’s transmission
functions?

HAZY OUTLOOK

Unfortunately, our crystal balls get cloudy when we contemplate the evolution of generation
and transmission unbundling. In contrast to the detailed pictures that come to many minds in thinking
about the future of power generation or retail services, the dearth of images that arise when one
ponders the transportation link between producers and consumers is telling. The role of unbundled
transmission and generation services (called ancillary services by the Federal Energy Regulatory
Commission and interconnected operations services by the North American Electric Reliability
Council) is vastly under-appreciated and under-explored. But transmission is the critical link—both
literally and figuratively—that provides the benefits of competition to producers and consumers and
does so while maintaining reliability.

As three prominent economists wrote in a paper prepared for the Edison Electric Institute in
1994, unbundling generation and transmission is the sine qua non of efficient electricity competition:

If we are unable to successfully unbundle the transmission functions [from

generation], it is entirely possible that the efficiency benefits flowing from competitive
generation could be entirely dissipated or indeed more than entirely offset by the
deteriorated condition between that sector and transmission. Insuring against these
possible consequences is an extremely important responsibility of policy makers and

*
The authors, consultants in electric industry restructuring in Oak Ridge, Tennessee, and senior
researchers at Oak Ridge National Laboratory, prepared this article under contract with the Edison Electric
Institute
 it cannot be sensibly postponed. (W. J. Baumol, P. L. Joskow, and A. E. Kahn, The
Challenge for Federal and State Regulators: Transition from Regulation to Efficient
Competition in Electric Power, December 1994.)

Now, almost four years later there is still little consensus on how these essential transmission
functions should be unbundled, produced, managed, delivered, measured, and priced. Traditionally,
vertically integrated utilities provided these services as part of the bundled electricity product and
consumers paid for them through cost-based electricity rates. How will we get from that old world
to a new one in which transmission lies in the now-uncharted land between competitive generation
and regulated distribution? What changes in structure, operations, and pricing will be required within
the industry, at the Federal Energy Regulatory Commission (FERC), and at the North American
Electric Reliability Council (NERC) to determine how these ancillary services will be provided to
maintain reliability and to facilitate commercial transactions?

CURRENT STATUS

Vertically integrated utilities have been providing ancillary services for decades, and today
they cost U.S. electricity consumers about $12 billion a year. Nonetheless, public discussions of
ancillary services have been underway for only the past three years, roughly since FERC issued its
notice of proposed rulemaking on open-access transmission in March 1995. Since then, FERC,
NERC, and industry participants have identified and defined the key ancillary services. NERC is
currently developing a new Policy 10 to define standards for measuring the delivery of ancillary
services. Table 1 briefly describes the 12 discrete services generally agreed to be essential for
reliability, commercial transactions, or both. Of these 12, FERC requires transmission providers
(essentially investor-owned utilities) to offer six of these services to transmission customers. For a
variety of reasons, including the press of other issues and perhaps a lack of understanding about the
importance of these services, FERC did not require that the other six services be unbundled from
transmission.

Policymakers and the electricity industry have devoted much more time and effort to
developing appropriate pricing methods for transmission services, with debates continuing apace on
alternatives like postage-stamp, license-plate, MW-mile, zonal, nodal, and other pricing schemes. We
find this asymmetry between ancillary services and transmission pricing puzzling, because both
functions are needed for reliability, both are needed for commercial transactions, and both cost $10
to $15 billion a year.

Although the technical and commercial functions that ancillary services provide will remain
unchanged in the future, everything else will change. This “everything else” includes the technical
justification for the amounts and locations of each service that must be provided, variations in time
and space in the amounts needed and deployed, the sources of supply (including provision from
customer loads), and the reliance on competitive markets to set prices for most of the generation-
provided services. To illustrate what will and will not change during the coming years and to suggest
the types of policy decisions that need to be considered, we focus here on two very different ancillary
services, regulation and system blackstart.

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Table 1. Key ancillary services and their definitions
Service Description
Services FERC requires transmission providers to offer and customers to take from
the transmission provider
System control The control-area operator functions that schedule generation and transactions
before the fact and that control some generation in real-time to maintain
generation/load balance
Reactive supply and The injection or absorption of reactive power from generators to maintain
voltage control from transmission-system voltages within required ranges
generation
Services FERC requires transmission providers to offer but which customers can take from
the transmission provider, buy from third parties, or self-provide
Regulation The use of generation equipped with governors and automatic-generation control
to maintain minute-to-minute generation/load balance within the control area
Operating reserve - The provision of generating capacity that is synchronized to the grid and is
spinning unloaded that can respond immediately to correct for generation/load imbalances
caused by generation and transmission outages and that is fully available within
10 minutes
Operating reserve - The provision of generating capacity and curtailable load used to compensate for
supplemental generation and transmission outages and that is fully available within 10 minutes
(Unlike spinning reserve, supplemental reserve is not required to begin
responding immediately)
Energy imbalance The use of generation to correct for hourly mismatches between actual and
scheduled transactions between suppliers and their customers
Services FERC does not require transmission providers to offer
Load following The use of generation to meet the hour-to-hour and daily variations in system
load
Backup supply Generating capacity that can be made fully available within one hour; used to
back up operating reserves and for commercial purposes
Real-power-loss The use of generation to compensate for the transmission-system losses from
replacement generators to loads
Dynamic scheduling Real-time metering, telemetering, and computer software and hardware to
electronically transfer some or all of a generator’s output or a customer’s load
from one control area to another
System-black-start The ability of a generating unit to go from a shutdown condition to an operating
capability condition without assistance from the electrical grid and then to energize the grid
to help other units start after a blackout occurs
Network-stability Maintenance and use of special equipment (e.g., power-system stabilizers and
services dynamic-braking resistors) to maintain a secure transmission system
Sources: Interconnected Operations Services Working Group 1997, Defining Interconnected
Operations Services Under Open Access, EPRI TR-108097, Electric Power Research Institute, Palo Alto, CA,
May; and E. Hirst and B. Kirby 1998, Unbundling Generation and Transmission Services for Competitive
Electricity Markets: Examining Ancillary Services, NRRI 98-05, The National Regulatory Research Institute,
Columbus, OH, January.

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 REGULATION

Regulation is the use of online generating units equipped with governors and automatic-
generation control (AGC) that can change power output quickly to track the moment-to-moment
fluctuations in customer loads and unintended fluctuations in generation. In so doing, these generators
help to maintain interconnection frequency, minimize differences between actual and scheduled power
flows between control areas, and match generation to load within the control area. Without this
service, interconnection frequency would fluctuate, perhaps dramatically at times, and loop flows
would be much greater than they now are. This service can be provided by any suitably equipped
generator that is connected to the grid and electrically close enough to the local control area so that
neither physical nor economic constraints prevent the importation of this power. Required for both
reliability and commercial purposes, regulation can almost surely be provided by competitive markets.
Nonetheless, FERC’s Order-888 pro forma tariff requires that all transmission providers offer this
service, although transmission customers are free to acquire it elsewhere or provide it themselves.

Today’s embedded-cost tariffs filed with FERC price regulation on the basis of a customer’s
average hourly load (i.e., in $/MWh). In actuality, however, regulation requirements are a function
of load volatility, not average load. A comparison of the loads for a steel mill and an aluminum mill,
for example, would show enormous differences in volatility, with the steel mill having a standard
deviation relative to its average load about 50 times higher than the aluminum mill. Should both
customers pay the same price for regulation? Of course not, but that is exactly what current tariffs
do.

Even among volatile loads, the regulation requirement can vary dramatically. Table 2 shows
the effects that two steel mills have on a utility’s load and regulation requirements. For both the
weekend and weekday days, the percentage of the total regulation requirement associated with the
two steel mills far exceeds their share of total load. Together, the two mills account for 3% of total
load. But the two mills contribute 44 to 82% of the system’s regulation requirement.

Table 2. Percentage contributions of two steel mills to a utility’s total load and regulation
requirements
Mill 1 Mill 2 Rest of load
Load 1 2 97
Regulation
Sunday 59 23 18
Wednesday 17 27 56
Note: These percentages are based on analysis of 30-second observations of loads (MW) for
the total system and for each steel mill for two full days (with 2,880 observations for each day).

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 In addition, each mill’s contribution to these totals is quite variable. On Sunday, Mill 1's
regulation burden was 2.5 times that of Mill 2, but on Wednesday Mill 2 imposed a smaller regulation
burden. Because today’s regulation tariffs price this service on the basis of average load, none of
these inter-customer and temporal differences in the cost of regulation are captured in the prices that
customers pay for this service.

The situation is similar with regard to regulation’s role in balancing the unintended
fluctuations in generator output, both those that are not under AGC and those that do a poor job of
following the AGC signal from the control center. These differences among generators in their ability
to maintain output at the requested level suggest that we need a method to measure the regulation
performance of individual generating units. Such a metric is not required when the service is provided
by a vertically integrated utility that charges customers for a bundled electricity product. But we do
need an accurate and quantitative metric when independent generating units are selling this service
to a system operator, which in turn, charges transmission customers for the service.

The PJM Interconnection developed a useful test for regulation capability that is an important
step in the right direction. The test measures the ability of a generating unit to respond to a system-
operator request for step changes in real-power output, first up at 10 minutes, then down at 20
minutes, down again at 30 minutes, and back up to the baseline level at 40 minutes (Fig. 1). If the unit
adjusts its output within the 10-minute limits, it passes this capability test. However, a high score on
this capability test may give little indication of real-world performance under actual regulation
delivery conditions where the requests for up and down movements may be much more erratic and
frequent.

These comments on regulation suggest that the electricity industry will need to make several
changes in the provision, acquisition, and payment for this service. Because of FERC’s requirement
that the service be unbundled and charged to customers separately from energy and transmission, the
industry will need to develop reliable metrics for its consumption and production. As a starting point,
we might consider two demand-side metrics that measure the amount of regulation (MW) and the
speed of regulation (MW/minute) at both the customer and system levels. On the supply side, we
need metrics to measure the performance of generating units, both their capability to provide the
service and their actual delivery of the service in response to the real-time AGC signals from the
control center.

Second, transmission customers will increasingly want to know the technical (data and
analytical) basis for the regulation service they are required to pay for. NERC and the reliability
councils will need to collect and analyze data on the relationship between the amount and quality of
regulation service provided and the performance of individual control areas in meeting reliability
criteria. Such analyses may show that the amount of regulation required is not invariant with time (as
typically assumed today) but rather varies by time of day, type of day, and season. Allowing the
regulation requirement to vary could lower the overall cost of providing this service. Such temporal
variations in regulation would also allow for a more accurate allocation of costs to those customers
that create the need for the service.

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 GENERATOR RESPONSE (MW)
TEST SIGNAL
CONTROL SIGNAL AND

GENERATOR
RESPONSE

0 10 20 30 40 50

97020
TIM E (minutes)
Fig. 1. The regulation capability test developed by the PJM Interconnection. The
generator in this example passed the PJM test.

Finally, because regulation is provided by many of the same generating units that provide the
basic energy and capacity services, regulation can likely be provided competitively wherever energy
can be provided competitively. That, in turn, means that today’s embedded-cost pricing for regulation
will increasingly be replaced by market-determined prices. In such competitive markets, the price of
regulation will depend strongly on the price of energy. At spot prices below the variable cost of a
generator providing regulation, the regulation price must cover this loss. At market prices above the
variable cost of the generator, the regulation price must cover this opportunity cost (i.e., the
difference between the spot price and the unit’s variable cost multiplied by the amount of generating
capacity assigned to regulation and therefore not available to sell energy). Finally, the unit must be
compensated for the efficiency losses and higher maintenance costs to provide regulation.

SYSTEM BLACKSTART CAPABILITY

System blackstart is the ability of an electrical system to go from a “black” condition to an

energized and operational state without outside assistance. This ancillary service provides insurance
against the potentially catastrophic consequences associated with the very rare occurrences when
large portions of the electrical grid go black. This insurance benefits both electricity suppliers and
consumers by restoring the electric grid to normal operations quickly and safely.

This service requires three sets of resources:

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 Generating units (often hydro and combustion-turbine units) that can start themselves without
an external electricity source and can then energize transmission lines, restart other generating
units, and ultimately restore service to customers;

 Transmission-system equipment, controls, and communications (including ones that can

operate without grid power), and field personnel to monitor and rebuild the electrical system
after a widespread blackout; and

 System-control equipment and communications (including ones that can operate without grid
power), and people to plan for and direct the restoration operations after such a blackout.

Coordinating the blackstart of individual generators, connecting them to the grid, matching
generation to load as more units are brought online, and synchronizing and reconnecting portions of
the transmission system until the system is fully restored is a difficult balancing act. As the first
generating units start themselves, the system operator must provide enough load to keep the units
stable (i.e., operating between their lower and upper load limits), recognizing the units’ ramp rates
and voltage-control limits. Timing is critical because transmission lines must be energized and loads
must be reconnected as generating-unit outputs are increased; otherwise, generation and load would
be out of balance and the system would, once again, collapse.

The system operator is responsible for determining the priority order of reconnecting loads.
Typically, the first loads to be reconnected include nuclear power stations (for safety reasons) and
other generating units. Failure to restart nonblackstart generators within an hour or so may require
that they be fully shut down before they can be started again. The priority here is system restoration
first and customer-load restoration later.

The transmission system itself presents a dynamic reactive-power load that must be carefully
managed during restoration. The transmission system produces reactive power when lightly loaded;
at such times generators and transmission-system equipment must absorb reactive power to keep
voltages from getting too high. However, as loads increase, the lines absorb more and more reactive
power, so generators and capacitors must produce reactive power to keep voltages from dropping.
As generation and load islands are created and stabilized, the system operator ensures that the two
islands are synchronized (i.e., operating at the same frequency close to 60 Hz and in phase) and then
orders their reconnection.

Like the other ancillary services, system blackstart has historically been provided by vertically
integrated utilities as part of their bundled service to customers. In the future, however, the three sets
of resources required for blackstart may well be provided by three disparate sets of entities:
independent and competitive generating companies, a FERC-regulated system operator, and a FERC-
regulated transmission owner. Given this change, it may be as difficult as it is important to maintain
the coordination necessary to ensure that, on those rare occasions when needed, blackstart capability
can be converted into a blackstart reality.

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 Paying for this service will also become more complicated not only because it involves three
different entities but also because payments are required for maintenance of the capability (insurance)
as well as for delivery of the service during emergencies. The system operator could conduct a
competitive auction once every few years to identify and acquire blackstart generating resources. The
system operator would purchase the least-cost resources, consistent with whatever locational
constraints apply to the distribution of such resources throughout the region. The system operator
could pay for this generator service on the basis of $/kW-year; such payments would include the right
to order periodic tests of the generators to be sure that their blackstart capability (e.g., fuel tanks,
batteries, trained personnel) is maintained. The system operator could also pay an additional fee (in
$/MWh) whenever it actually requires the blackstart service to be delivered.

The system operator’s capital and operating costs for its role in system restoration could be
included in its system-control charge (generally on the basis of $/MWh or $/kW-month) paid by all
transmission users. The transmission owner’s capital and operating costs could either be added to its
basic transmission tariff or to the system operator’s system-control charge. Here, too, the system
operator should have the right to conduct periodic tests and training exercises to be sure that the
transmission equipment and personnel are maintained in a condition ready to respond to system
emergencies and that the restoration plan itself is viable.

The overall cost of blackstart insurance is surely less than 1% of the cost of generation. But,
the cost—financial and otherwise—of not having this service available when needed would be
devastating to a nation that each year uses more and more electricity and depends on an electric
system generally considered the most reliable in the world. Consequently, policymakers responsible
for industry structure must be sure that any changes to that structure appropriately provide and pay
for adequate blackstart capability. FERC’s implicit inclusion of this service within the basic
transmission tariff is, in our view, insufficient.

CONCLUSIONS

Restructuring the electricity industry will create no new ancillary services. For the past several
decades, traditional utilities provided these services as part of the bundled product they sold to their
customers.

However, restructuring is changing dramatically the provision, acquisition, allocation,

purchase, sale, and technical justification for these services. In other words, everything except the
electrical engineering is changing. In particular, because most of these services are provided by
generating units, we should be able to rely on markets, rather than on government regulations, to set
the prices for these services. This increased reliance on markets—if done properly—should enhance
bulk-power reliability and facilitate commercial transactions. But, if we fail to create ancillary-service
markets with reasonable rules, the basic energy markets will be inefficient. This tight coupling of
energy and ancillary-service prices is likely to occur because the same generating units provide both
sets of services. In most cases, the services are substitutes, which means that an increase in the

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amount of, say, regulation provided means that less energy can be produced. In other words, ancillary
services will serve as the “canary in the coal mine” with respect to the success of energy markets.

Those utilities required by FERC to offer six ancillary services as part of their open-access
transmission tariffs should be especially eager to help create competitive markets for these services.
These FERC-jurisdictional utilities face an asymmetric responsibility: while they must offer six
services, their customers are free to acquire four of those services from other suppliers (Table 1).
Thus, when embedded-cost prices are lower than market prices, customers will buy these services
from the transmission providers. But when embedded-cost prices are higher than market prices,
customers will purchase the services elsewhere, placing the transmission suppliers at a competitive
disadvantage. Utilities also consider it unfair that they must stand ready to provide these services to
all customers at all times without compensation unless a customer chooses to purchase the service
from them. Who will pay the fixed costs for this generating capacity that may or may not be called
upon?

These considerations suggest the following key issues to focus on:

 Definitions: Utilities should encourage FERC to better define the six services specified in
Order 888 and to recognize the additional services required for reliability and commerce.
Absent clear definitions that cover the full range of necessary services, investor-owned
utilities—the entities that currently operate most control areas and provide most of these
services—will, de facto, serve as suppliers of last resort for these services. Perhaps more
important, these utilities may not be adequately compensated for providing these services.
From time to time, FERC should consider additions, deletions, and modifications to the six
services specified in Order 888. Specifically, FERC should recognize system blackstart as an
explicit and unbundled service.

 Standards and metrics: The investor-owned utilities should take the lead in developing
national standards and metrics for the supply, delivery, and consumption of these services.
These standards should focus on performance and not on prescriptive requirements; in
particular, customers and their loads should be encouraged to participate as suppliers of
ancillary services, not just as consumers. Although NERC’s proposed Policy 10 on ancillary-
service standards is an important step in the right direction, much more work needs to be
done. Absent clear and reproducible methods to measure the capability and delivery of each
service, it will not be possible to create competitive markets for them. After all, you can’t buy
or sell what you can’t measure!

 Pricing: The industry should devote more attention to measuring the costs of these services,
both those that are used in setting embedded-cost (i.e., FERC-regulated) prices and those that
would occur in competitive markets. Without a detailed knowledge of costs (e.g., the heat-
rate and maintenance penalties associated with the regulation service), suppliers will either
over- or undercharge for services, an unsustainable situation.

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 Efficient Competition: The investor-owned utilities should encourage FERC to establish
competitive markets for ancillary services wherever feasible. FERC could assume that
workable competition for generation-related ancillary services exists wherever workable
competition for energy and capacity exists. In such cases, FERC should no longer require
transmission providers to offer those services without a corresponding obligation to purchase.
Such changes will remove the asymmetry between suppliers and consumers in today’s
embedded-cost regime.

Finally, as the two examples presented here demonstrate, ancillary services differ enormously
in their functions, costs, and appropriate pricing methods. As a consequence, a “one-size-fits-all”
approach, which is how some might characterize the ancillary-service schedules in FERC’s pro forma
tariffs, is inappropriate. Ultimately, such a narrow view of ancillary services could hamper reliability,
interfere with commercial transactions, complicate energy and capacity markets, and diminish the
benefits of competition.

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