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
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).