Market factors, including increased costs for natural gas andNOx credits, increased demand, scarce resources and unusually hightemperatures throughout the West, coupled with flawed market designand regulatory policies, and possibly some exercise of market powerwere responsible for the high power prices in California this pastsummer, according to the FERC staff report on bulk power marketsreleased yesterday.

“The data clearly show that a general scarcity of power in theWest and increased costs to produce power were factors causingthese high prices. It is also clear that existing market rulesexacerbated the situation and contributed to the high prices,” theFERC report said.

“The data also indicate some attempted exercise of market power,if the standard of bidding above marginal running cost is used, andsome actual market power effects, to the extent that prices, atleast in June, were significantly above competitive levels.” Butthe study was unable to pinpoint specific instances of market powerabuse, nor did it suggest that market power was more important thanthe other factors in creating the crisis.

Natural gas prices, which went from less than $2/MMBtu inJanuary to more than $6/MMBtu in September share the increased costof production blame with NOx credits, which went from about $5 perpound to over $40 per pound. “These input price increases drove upthe marginal operating cost of a combustion turbine from about$70/MWh in May to more than $190/MWh in August. As a result, marketclearing prices that approached the $250/MWh price cap in Augustmay have reflected the true cost of the resource rather than anexercise of market power,” the report said.

The report discusses scarcity factors, such as a decline inhydropower in the West and corresponding decline in power importsfrom the Northwest, plus a lack of new generating capacity in thederegulating market to keep up with increases in California demand.”Load in the Western States Coordinating Council (WSCC) increasedby an average of 3% per year, while capacity grew less than 1%” inthe 1990s. While milder temperatures in the two previous summersmay have masked some of the load growth and capacity shortfall, thehigher than normal temperatures this summer tested the system andfound it wanting.

Finding fewer power imports into the California market and moreexports, the FERC staff study noted exports increased when theISO’s buyers cap was lowered from $750 MWh to $500/MWh, andsubsequently to $250/MWh. This suggests the power was directed toother capless markets in the Southwest, which were experiencing thesame heat wave.

Rules imposed by the state on the three major utilities,Southern California Edison, San Diego Gas & Electric andPacific Gas & Electric, restricting them to transactionsthrough the Cal-PX and virtually prohibiting them from forwardcontracting contributed to the high prices. The restrictions leftthem “without the ability to mitigate the summer price volatility.”

On the demand side California consumers on the systems of SoCalEd and PG&E were still subject to a deregulation rate freezeand thus had no incentive to decrease usage. “The only alternativefacing a system operator in the absence of demand response may beto ration demand through administrative load reductions. This isexactly what happened in California last summer, when a total of 38emergency alerts were called.”

While a scarcity market can breed market power, it also makes itvery difficult to separate out the effects of one from the other.As to last summer in California the evidence “is inconclusive.”Since “market power in a newly developing market may be magnifiedby flaws in market rules..the best approach in these cases may beto change the rules..,” which is what the Commission is proposingto do. You may view the report atwww.ferc.fed.us/electric/bulkpower.htm, if the website is working.

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