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Study of a Market Gone Wrong

Study of a Market Gone Wrong

Market factors, including increased costs for natural gas and NOx credits, increased demand, scarce resources and unusually high temperatures throughout the West, coupled with flawed market design and regulatory policies, and possibly some exercise of market power were responsible for the high power prices in California this past summer, according to the FERC staff report on bulk power markets released last week.

"The data clearly show that a general scarcity of power in the West and increased costs to produce power were factors causing these high prices. It is also clear that existing market rules exacerbated the situation and contributed to the high prices," the FERC report said.

"The data also indicate some attempted exercise of market power, if the standard of bidding above marginal running cost is used, and some actual market power effects, to the extent that prices, at least in June, were significantly above competitive levels." But the study was unable to pinpoint specific instances of market power abuse, nor did it suggest that market power was more important than the other factors in creating the crisis.

Natural gas prices, which went from less than $2/MMBtu in January to more than $6/MMBtu in September share the increased cost of production blame with NOx credits, which went from about $5 per pound to over $40 per pound. "These input price increases drove up the marginal operating cost of a combustion turbine from about $70/MWh in May to more than $190/MWh in August. As a result, market clearing prices that approached the $250/MWh price cap in August may have reflected the true cost of the resource rather than an exercise of market power," the report said.

The report discusses scarcity factors, such as a decline in hydropower in the West and corresponding decline in power imports from the Northwest, plus a lack of new generating capacity in the deregulating market to keep up with increases in California demand. "Load in the Western States Coordinating Council (WSCC) increased by an average of 3% per year, while capacity grew less than 1%" in the 1990s. While milder temperatures in the two previous summers may have masked some of the load growth and capacity shortfall, the higher than normal temperatures this summer tested the system and found it wanting.

Finding fewer power imports into the California market and more exports, the FERC staff study noted exports increased when the ISO's buyers cap was lowered from $750 MWh to $500/MWh, and subsequently to $250/MWh. This suggests the power was directed to other capless markets in the Southwest, which were experiencing the same heat wave.

Rules imposed by the state on the three major utilities, Southern California Edison, San Diego Gas & Electric and Pacific Gas & Electric, restricting them to transactions through the Cal-PX and virtually prohibiting them from forward contracting contributed to the high prices. The restrictions left them "without the ability to mitigate the summer price volatility."

On the demand side California consumers on the systems of SoCal Ed and PG&E were still subject to a deregulation rate freeze and thus had no incentive to decrease usage. "The only alternative facing a system operator in the absence of demand response may be to ration demand through administrative load reductions. This is exactly what happened in California last summer, when a total of 38 emergency alerts were called."

While a scarcity market can breed market power, it also makes it very difficult to separate out the effects of one from the other. As to last summer in California the evidence "is inconclusive." Since "market power in a newly developing market may be magnified by flaws in market rules..the best approach in these cases may be to change the rules..," which is what the Commission proposed to do in a draft order issued on the same day (see related story this issue).

Ellen Beswick

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