The names — “Fat Boy,” “Death Star” — may sound ominous, but the strategies they represent actually served to arbitrage the California market, lending it equilibrium and efficiency, according to an economist with the global consulting firm NERA (National Economic Research Associates) in a paper released earlier this month.

Contrary to the mindset among California state and federal officials examining the aftermath of the memos on market manipulation from Enron Corp.’s attorneys (see NGI, May 10), ” there is no evidence that Enron’s activities in California had any deleterious impact on electricity markets,” wrote Jonathan Falk, an economist and NERA vice president, who authored “Enron’s Strategies in California and the Benefits of Arbitrage.”

Falk, who is a Ph.D. candidate at Yale where he earned BA and MA degrees in economics, did the analysis as part of his ongoing assessments of energy and other issues; it was done independent of his client assignments, as an offshoot of analyses he has been doing of the California’s energy markets in recent years.

Falk argues that a combination of public outrage and an adverse “public relations effect” from the names of the Enron strategies (“Fat Boy” and “Death Star,” for example) have driven industry critics and elected officials to wrongly assume there was a “net adverse effect” from the trading strategies, although he acknowledges that would require “large amounts of data and sophisticated analysis” to calculate the true net effect of all 10 strategies outlined in the memos.

In his brief conclusion, Falk said that rather than distorting the market, a majority of the Enron strategies actually “corrected potential distortions in complicated interrelated markets.” He called California’s market set-up “bizarre” and unlike any other he had ever seen, indicating it might have failed to function without some of the marketers’ strategies. He added that policymakers should not search for what he called “scapegoats,” but instead look for the “obvious corrections” the Enron strategies call for.

The Falk economic analysis, which a NERA associate in its San Francisco office said may be offered to the California state senate investigative committee probing alleged energy market manipulations, cites basic economic theory back to Adam Smith, theoretical “equilibrium” prices and an overview of California’s system, describing the latter as having “a particularly bizarre structure.”

In running a quick summary of the now-bankrupt California Power Exchange (Cal-PX); state grid operator, Cal-ISO; and elements affecting both, such as scheduling coordination and congestion management, Falk talks about the same “inc” and “dec” prices that have received attention in the Enron memos as being created by California’s necessity for balancing schedules.

“In other systems all deviations are simply paid the equilibrium price (where seller won’t take less and the buyer won’t pay more),” Falk said. “In equilibrium, the inc price and the dec price ought to be the same, since the marginal consequences on price of increasing generation and decreasing load should be identical.”

In California’s market, Falk describes “prices being established through quite complicated mechanisms” and concludes that traders were the only element that could made it all work efficiently by simplifying decisions for buyers and sellers. “With a robust aggressive set of traders who have no stake in the market at all, the expected returns to our hypothetical seller will converge in all markets.

“Traders arbitrage between markets…the arbitraging trader lowers price in high-priced markets and increases price in low-priced markets, creating an equilibrium price and augmenting the efficiency of these markets. It is important to see that although arbitragers make a profit in the process of equalizing prices between markets, both consumers and producers benefit in aggregate.”

In this theoretical context, Falk assesses each of the 10 Enron trading strategies from the now-infamous attorneys’ internal memo:

(1) “Fat Boy” aka Incing Load into the Real-Time Market; (2) exporting California-produced power; (3) non-firm exporting; (4) “Death Star,” simultaneously scheduling transactions in California south-to-north and north-to-south; (5) “Load Shift,” causing congestion by misstating load sources; (6) “Get Shorty,” selling phantom ancillary services in the day-ahead and buying “them” back in the real-time market; (7) “Wheel Out,” scheduling transactions over a transmission line out of service or already full; (8) non-firm energy sold as “firm”; (9) “Ricochet,” the same as a non-firm export when the Cal-ISO price is less than the cap; and (10) scheduling energy to collect the congestion charge.

In the majority of these strategies, Falk argued that although the marketers developed them in order to profit in the market, they serve the function of “improving overall market efficiency.” The “Get Shorty” and “Ricochet” strategies both are efficiency enhancing, he said, because they are nothing more than arbitrage strategy to equate price in the day-ahead and the real-time markets.

In one of 11 footnotes used in the paper, Falk said he has “no knowledge about the accuracy of (the Enron trading strategy) memo, or whether there are nefarious practices which have not yet come to light. In this paper, I evaluate them only on their own terms.”

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