A recent report finds that all six of PJM Interconnection’s markets were reasonably competitive in 2000, although the same report warns of potential threats to competition in at least three of PJM’s markets that deserve ongoing scrutiny. At the same time, the report recommends the retention of bid caps in two of PJM’s markets and the continued development of demand-side responsiveness initiatives.

The report’s conclusions were reached by PJM’s market monitoring unit, which recently completed its third annual state of the market report analyzing PJM’s markets in 2000. FERC requires the unit to prepare periodic reports for PJM’s board of managers on the state of competition within PJM’s markets. The six markets assessed by PJM’s market monitoring unit are the day-ahead energy market and the real-time energy market, the daily capacity market and the monthly capacity market and the regulation market and the monthly fixed transmission right (FTR) auction market.

The report concludes that although PJM’s six markets were, for the most part, competitive in 2000, there are also potential threats to competition in the power grid operator’s energy, capacity and regulation markets that require active monitoring. In some cases, threats to competition in these markets may require action in order to maintain competition, and market participants possess some ability to exercise market power under certain conditions in PJM markets.

In PJM’s energy markets, the market monitoring unit utilized what’s known as a “price-cost markup” to determine the level of competitiveness. A price-cost markup is the difference between price and marginal cost, divided by price. Overall, the data on the price-cost markup are consistent with the conclusion that the energy markets were reasonably competitive last year. The unit will continue to develop this analysis to refine the measure of the markup over competitive prices and to incorporate explicit accounting for opportunity costs, scarcity rents and economic withholding where appropriate. The increase in the markup index in late 2000 is a cause for concern as it suggests the potential exercise of market power by mid merit steam units during times of moderate demand.

Meanwhile, PJM’s market monitoring unit said that the potential exercise of market power in the grid’s capacity markets is a concern and that there are significant market design issues that require resolution. During 2000, the system of capacity obligations functioned effectively and helped ensure that energy was available during emergency conditions. The unit’s analysis of high prices in PJM’s daily capacity credit markets during the summer of 2000 concluded that those prices were caused by fundamental market forces, rather than market power or market manipulation. Nonetheless, the potential exercise of market power in the capacity markets remains a concern given the extreme inelasticity of demand and because, at times, only a few generation owners had available capacity to sell.

As for PJM’s regulation market, concerns about the structure of ownership in this market are offset at present by the available supply of regulation capacity from PJM resources, compared to the demand for regulation. PJM introduced a new regulation market on June 1, 2000. Regulation is one of six ancillary services defined by the Federal Energy Regulatory Commission in Order 888. There is the potential for various forms of non-competitive behavior in PJM’s energy market to affect the regulation market, although there is no evidence of such an issue during 2000. The preliminary results from the first seven months of the regulation market are positive, but it is too early to reach a final conclusion related to the long-term competitiveness of this market.

PJM’s market monitoring unit recommended retention of the $1,000/MWh bid cap in the energy market and an investigation of other rule changes to reduce incentives to exercise market power. Also, the unit supported the retention of the $100/MW bid cap in the regulation market. Additional actions to increase demand-side responsiveness to price in both energy and capacity markets should also be evaluated.

A copy of the full report can be downloaded from PJM’s web site at www.pjm.com.

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