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

That second conclusion came from former FERC Commissioner BrankoTerzic who told a Washington press briefing last week the pricespikes were largely due to the immaturity of a newly restructuredbulk power market. He predicted the extreme nature of the spikeswill 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, attributedthe pricing turmoil to three factors: 1) “probably some awkward orless-than-efficient trading rules and restructuring; 2) theimmaturity of the market with respect to the experience andexpertise of the traders; and 3) the immaturity of the market withrespect to its understanding of risk/reward and making consciousdecisions of when to invest and when not to invest.”

For the former regulator, the most interesting aspect of themarket 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 anddecided to play in the high-risk…market.” He believes residentialcustomers were sufficiently insulated from this activity.

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

Eventually the bulk power market “will be like other commoditymarkets,” he said. “As [it gets] more sophisticated, as theindividuals trading get more knowledgeable, the [extreme] spikinesswill decrease, but there’ll still be volatility.”

Terzic disagrees that a go-slow approach to electricityrestructuring is needed now because of the price spikes. “I don’tthink so. We know that the price impacts of that spike this lastJune did not flow through to consumers directly.”

In a report to FERC on the same issue, Enron Power MarketingInc. (EPMI) tentatively concluded that the Midwestern power marketoperated “reasonably efficiently” when it was confronted with acombination of “foreseeable and unforeseeable” factors, such asgeneration outages, damage to transmission lines, a heat wave, andpower marketers being caught short and defaulting on deliveryobligations.

“Evidence that the Midwestern market functioned efficiently liesin the fact that the high prices caused by these factors quicklyreturned to predictable levels. Further, with the possibleexception of weather, the major causes of the unprecedentedvolatility in late June appear to have been institutional andregulatory rules, and not the transition to competition and openaccess to the transmission grid,” EPMI said in its Sept. 2ndanalysis.

It particularly pointed the finger at the transmissionline-loading relief (TLR) process that was prescribed by the NorthAmerican Reliability Council (NERC). TLR, as it was applied theweek of June 22nd, was an “exceedingly blunt instrument.” EPMInoted that “a minimal amount of fine-tuning – primarily redispatch- could well have [done the job instead and] allowed additionalenergy to be traded/supplied at prices far below those thatactually resulted.” In the end, TLR deprived the Midwestelectricity market of the liquidity it needed when faced with highdemand and constraints on the transmission system, it said.

EPMI further said the extreme price spikes – prices rose to ashigh as $7,000 per MWh – can be “explained and economicallyjustified” when compared to the cost of construction and operationof peaking units that are designed to be used only a few hours ayear. A simple-cycle gas turbine, which is standard for peakingcapacity 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 onthis, 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 June1998 in the popular press – [was] clearly less than this. If weassume that the units will be used over five to 10 years, then areasonable fixed charge rate for the capital would bring the annualcost to $50,000 per MW, which if operated for 10 to 25 hours, wouldreduce the cost to between $2,000 and $5,000 per MWh. Again, thisis not out of line with the values recorded for June 24 and 25,”the power marketer said. It also said the impact of the pricespikes on customers has been “exaggerated.”

Susan Parker

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