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Powerex Cleared by FERC Staff in California Uplift Payment Probe

A recently completed FERC staff investigation examining allegations by the California Independent System Operator (CAISO) that certain importers submitted bids for the purpose of collecting "uplift" payments without delivering any net energy to CAISO, concludes that British Columbia Hydro and Power Authority subsidiary Powerex did not violate FERC and CAISO rules against market manipulation.

FERC's public disclosure of the Sept. 21 report on Monday was an unusual step, the federal agency noted, but it cited "extraordinary reasons in favor of publicly disclosing staff's report in this case" [IN05-8-000]. The full Commission also noted its agreement with the report's findings and conclusions. One reason for making the report public was to inform the market as to how it intends to carry out its Market Behavior Rule 2 against manipulation. In adopting that rule the Commission said it would clarify it on a case-by-case basis.

Commission staff conducted a preliminary non-public investigation into reports by CAISO's Department of Market Analysis (DMA) of potentially manipulative bidding in CAISO's supplemental energy market.

Specifically, CAISO alleged that from Oct. 1, 2004, to early March 2005 importers were submitting bids for the purpose of collecting uplift payments without delivering any net energy to the CAISO. "Uplift" is the difference between CAISO's market clearing price and an importer's bid price and, under the CAISO tariff, is awarded to importers to encourage competitive bidding at the CAISO interties, the staff report said.

CAISO estimated the alleged manipulative bidding behavior to have resulted in approximately $18.5 million in uplift payments from Oct. 1, 2004 through March 22, 2005, with uplift payments to Powerex accounting for the majority.

According to data and an analysis provided by the CAISO's DMA, Powerex accounted for 97% of all profits earned from bidding behavior questioned by CAISO. On this basis, CAISO referred Powerex's bidding behavior to the Commission for review and stated that the relatively low level of offsetting bid quantities and profits for other companies did not warrant a referral to the Commission at that time.

In its referral, CAISO complained about "overlapping" incremental energy ("inc") and decremental energy ("dec") bids submitted by individual market participants. "Inc" bids are offers to import and sell power to CAISO, while "dec" bids are offers to buy and export power from CAISO. According to CAISO, an accepted decremental bid also can be satisfied by canceling an equal quantity of previously-scheduled, incremental energy on the same intertie.

CAISO described two aspects of a bid overlap -- quantity overlap and price overlap. Because, under certain conditions, imported energy can cancel exported energy, CAISO characterizes a "quantity overlap" between an inc and a dec of equal quantity as resulting in no net energy imported into or exported from the CAISO grid. The amount of a quantity overlap between different-quantity dec and inc bids is equal to the lesser quantity bid. For instance, there is a 400 MW quantity overlap between an accepted 500 MW inc bid and an accepted 400 MW dec bid and 100 MW of net energy is imported into CAISO.

The FERC staff report noted that under CAISO tariff rules in effect since Oct. 1, 2004, CAISO acts as a clearing house for overlapping inc and dec bids on the interties during a period 45 minutes before the top of each hour known as "pre-dispatch." Under the "Phase 1b" rules, during pre-dispatch, in addition to dispatching its predicted energy import and export needs for the next hour at each intertie, CAISO accepts all remaining overlapping same-intertie inc and dec bids. Phase 1b is a part of CAISO's "Comprehensive Market Design 2002."

Although price overlaps are expected among different market participants, it is not expected that an individual market participant would submit price overlapping dec and inc bids because this would appear to represent a seemingly irrational offer to buy high and sell low. The alleged lack of a legitimate business purpose for price overlaps among individual bidders' bids was a concern that CAISO's DMA communicated to FERC staff in explaining why it thought Powerex's bidding activity violated the Commission's market behavior rules and the CAISO tariff.

Furthermore, because of the CAISO market-clearing function, an individual market participant submitting inc and dec bids with a price overlap arguably increased the probability that its inc and dec bids would both be dispatched and, due to the quantity overlap between the inc and dec bids, it is possible that little, if any, energy would be imported into or exported from the CAISO as a result of the overlapping bids, the report said.

FERC staff investigated whether Powerex's alleged conduct violated FERC's market behavior rule 2 and section 7.1 of CAISO's enforcement protocol, both of which prohibit "[a]ctions or transactions that are without a legitimate business purpose and that are intended to or foreseeably could manipulate market prices, market conditions, or market rules for electric energy or electricity products."

However, Commission staff concluded that Powerex did not violate these rules against market manipulation because:

The uplift costs complained of by the CAISO were caused not by wrongdoing by Powerex or others, but were due to CAISO's rules then in effect that have now been adjusted in a CAISO tariff amendment (66), FERC staff said. "Therefore, staff recommends that this investigation be closed."

In the report, FERC staff said its interviews with Powerex trading personnel and analysis of data and documents submitted by Powerex under oath revealed several aspects of Powerex's bidding activity at the CAISO interties.

First, according to the DMA, Powerex is the largest participant in the CAISO's supplemental energy market. During Phase 1b, Powerex submitted 132,000 supplemental energy bids to the CAISO, resulting in accepted bids for approximately 1,700,000 MWh. In MWh terms, Powerex had more than twice the quantity of accepted bids than its nearest competitor and accounted for 48% of the total supplemental energy market.

"One reason why Powerex is able to buy and sell so much energy in the CAISO is that it prepared well in advance for the CAISO's Phase 1b rule changes by implementing new software, strengthening its contacts with counterparties throughout the WECC, and implementing other improvements to its trading operations," the report said.

Nevertheless, the $4.6 million in uplift paid to Powerex under Phase 1b represents a small portion of its total $728.4 million in revenue derived from Western Electricity Coordinating Council (WECC) energy trading, FERC staff added.

Despite its large volume of trading in CAISO, Powerex states it does not have a real-time trading desk dedicated solely to CAISO market. Instead, Powerex said it takes a "holistic" approach to energy trading by cultivating relationships with generation and transmission resources throughout the WECC, including areas remote from BC Hydro in the Southwest. Powerex submits its bids based on its entire portfolio of resources, transmission access into and out of the CAISO grid, market conditions and other factors, the report said. In addition to Powerex's preparations for Phase 1b, "its success in California was also made possible by its familiarity with the WECC markets and its ability to rapidly obtain resources, which made it possible for Powerex to bid large quantities of energy into the CAISO."

According to Powerex, in an effort to avoid the appearance of gaming or other impropriety, Powerex's traders developed an operating practice prior to the implementation of Phase 1b of not submitting to CAISO overlapping bids at the same intertie. The existence of this practice was apparent from the fact that in the five months of trading between Oct. 1, 2004, and March 7, 2005, Powerex deviated from this operating practice 109 times out of 132,000 bids, FERC staff noted. In five instances where it discovered that it had violated its operating practice prior to the top of the hour Powerex did not dispatch the overlapping inc and dec schedule.

Powerex claims that at each intertie it submits equal price inc and dec bid that provide the CAISO with significant liquidity benefits. However, each of the interties is bid at its own unique price level reflecting the value of generation, transmission costs, loss factors and import charges, physical curtailment risks, counter-party performance risks and different expectations and risks of settlement prices.

"Under these bidding practices, it is unavoidable that across the CAISO control area some dec bid prices would be greater than some inc bid prices," the report said.

Powerex emphasized that each of its bids at any of the twelve interties between the CAISO grid and adjacent control areas during the relevant period represented an independent offer to buy or sell energy at that intertie and not a deliberate bidding strategy. Powerex further explained that its bids are submitted with the understanding and expectation that they would be dispatched independently of any dispatches on other interties.

FERC staff "found evidence corroborating these statements by Powerex and found the responses of Powerex traders obtained during several teleconferences, videoconferences, and in-person meetings regarding the operating practice to be credible and consistent with Powerex's bidding data. Furthermore, staff disputes the CAISO's assumption that overlapping bids at the same intertie equate with bids at geographically proximate interties because incremental and decremental bids at geographically proximate interties do not necessarily cancel each other out as they do on the same intertie."

The report also noted that Powerex traders are not compensated based on the level of profit they generate. According to Powerex's sworn statements, the aggregate "bonus pool" for all Powerex employees is determined by a formula based on the level of net income earned by Powerex. However, an individual trader's bonus is not tied to level of revenue or profit they generate, but on subjective criteria such as their ability to execute deals in a timely manner. "Thus, staff did not find in Powerex's compensation plan any incentive for traders to engage in manipulative conduct."

Appearing at an Energy Bar Association conference last week, Robert Pease, deputy director, investigations and enforcement, in FERC's Office of Market Oversight and Investigations, noted that one of the factors FERC looked at "very closely" with Powerex was whether the company had a compliance plan in place, "did they have checks and balances within the company and did they actually utilize those checks and balances and enforce their own compliance plan. And we found that they did."

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