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Small Consumers Insulated from Power Market Aberrations

September 14, 1998
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Small Consumers Insulated from Power Market Aberrations

The power price spike to $7,000 MWh this past June in the Midwest was not out of line with the cost of running little-used peaking generators, according to a leading marketer, and from a regulatory viewpoint the key lesson was that residential customers did not have to pay those prices.

That second conclusion came from former FERC Commissioner Branko Terzic who told a Washington press briefing last week the price spikes were largely due to the immaturity of a newly restructured bulk power market. He predicted the extreme nature of the spikes will subside as traders become more sophisticated, but the market, as with any commodity market, will continue to be volatile.

Terzic, who is now chairman of Yankee Energy System, attributed the pricing turmoil to three factors: 1) "probably some awkward or less-than-efficient trading rules and restructuring; 2) the immaturity of the market with respect to the experience and expertise of the traders; and 3) the immaturity of the market with respect to its understanding of risk/reward and making conscious decisions of when to invest and when not to invest."

For the former regulator, the most interesting aspect of the market tumult was that "those high price spikes fell appropriately, not on residential consumers, but they fell on speculators, marketers, [and] companies that just stepped out of the box and decided to play in the" He believes residential customers were sufficiently insulated from this activity.

He recalled that customers also were shielded when gas prices hit $60 per Mcf a year ago. "I can tell you any marketer that tried to turn around and stick their customer with a $60/Mcf [bill] would [have been] out of business the next morning," Terzic noted. As a result, they were forced to absorb the price increases. Fuel oil is another "incredibly volatile" market, but "we can look at retail fuel oil prices and commodity prices, and see that there isn't a day-to-day pass-through" to residential customers.

Eventually the bulk power market "will be like other commodity markets," he said. "As [it gets] more sophisticated, as the individuals trading get more knowledgeable, the [extreme] spikiness will decrease, but there'll still be volatility."

Terzic disagrees that a go-slow approach to electricity restructuring is needed now because of the price spikes. "I don't think so. We know that the price impacts of that spike this last June did not flow through to consumers directly."

In a report to FERC on the same issue, Enron Power Marketing Inc. (EPMI) tentatively concluded that the Midwestern power market operated "reasonably efficiently" when it was confronted with a combination of "foreseeable and unforeseeable" factors, such as generation outages, damage to transmission lines, a heat wave, and power marketers being caught short and defaulting on delivery obligations.

"Evidence that the Midwestern market functioned efficiently lies in the fact that the high prices caused by these factors quickly returned to predictable levels. Further, with the possible exception of weather, the major causes of the unprecedented volatility in late June appear to have been institutional and regulatory rules, and not the transition to competition and open access to the transmission grid," EPMI said in its Sept. 2nd analysis.

It particularly pointed the finger at the transmission line-loading relief (TLR) process that was prescribed by the North American Reliability Council (NERC). TLR, as it was applied the week of June 22nd, was an "exceedingly blunt instrument." EPMI noted that "a minimal amount of fine-tuning - primarily redispatch - could well have [done the job instead and] allowed additional energy to be traded/supplied at prices far below those that actually resulted." In the end, TLR deprived the Midwest electricity market of the liquidity it needed when faced with high demand and constraints on the transmission system, it said.

EPMI further said the extreme price spikes - prices rose to as high as $7,000 per MWh - can be "explained and economically justified" when compared to the cost of construction and operation of peaking units that are designed to be used only a few hours a year. A simple-cycle gas turbine, which is standard for peaking capacity in the Midwest, costs about $250,000 per MW to install, and is built to support only the hours that experience high prices, such as occurred in June (10 to 25 hours of high prices). Based on this, the cost per MWh of peaking capacity would be $10,000 to $25,000 per MWh, EPMI estimated.

"The $7,000 per MWh price - the highest price reported for June 1998 in the popular press - [was] clearly less than this. If we assume that the units will be used over five to 10 years, then a reasonable fixed charge rate for the capital would bring the annual cost to $50,000 per MW, which if operated for 10 to 25 hours, would reduce the cost to between $2,000 and $5,000 per MWh. Again, this is not out of line with the values recorded for June 24 and 25," the power marketer said. It also said the impact of the price spikes on customers has been "exaggerated."

Susan Parker

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ISSN © 2577-9877 | ISSN © 1532-1266
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