Monitoring electricity markets What can we learn from the economics of regulation?

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Monitoring electricity marketsWhat can we learn
from the economics of regulation?

• Robert J. Michaels
• California State University, Fullerton
• rmichaels_at_fullerton.edu
• 
  Rutgers University
• 
  Center for Research in
• 
  Regulated Industries
• 
  Annual Western Conference
• 
  San Diego, California
• 
  June 25, 2003

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Market Monitors and Regulation

• Power markets -- novel institutions and naïve
  expectations
• Efficiency, cynicism and reality in the economics
  of regulation
• California was just reregulating
• Market monitors which story fits California?
• Virtual bidding in three ISOs a natural
  experiment
• Whence the collective amnesia of economists?

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Electricitys new institutions

• Old federal and state regulation continues
• Bilateral contracts, energy markets, and ISOs
• Market Monitoring Institutions MMI
• Observe and report to FERC on ISO energy markets
• Internal employees or appointed outsiders
• To observe market power and functioning of rules
• Vague responsibilities anomalies and gaming
• Unclear investigative powers, abilities to levy
  sanctions
• Order 2000 and SMD FERC dodges the issues

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No analogues of MMIs

• Not a regulatory body, never contemplated in
  legislation
• Stock Exchanges as Self-Regulatory Organizations
• In federal law
• Made up of market participants (NASD)
• Electrical MMIs must have no market interests
• Have powers re new contracts, arbitration,
  suspension of traders, circuit breakers
• Electrical MMIs have ambiguous powers
• Due process for SRO prosecutions

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Economists and regulation I

• Regulators inhospitable to economic
  recommendations re efficiency
• But some headway in electricity tariff designs,
  peak pricing, rates of return
• Regulatory history producer protection and
  franchises
• Early studies ineffectiveness, producer
  protection, cross-subsidies
• Capture and more general models

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Economists and regulation II

• Later studies politics and economics v. public
  interest
• Mostly reject public interest where tested
• FTC, antitrust, etc. and politics
• The paradox When MMIs arrived in electricity,
  economists played dead
• Accepted feasibility of monitoring
• Viewed it as a useful supplement to regulation
• Despite past research and restructuring politics,
  no economist on any side has questioned MMMIs
• No examination of their origins and performance

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Californias Origins I

• State restructuring under AB 1890
• Utilities must collect stranded cost in residual
  between market energy prices and frozen retail
  rates within deadline
• Required to purchase all requirements day-ahead
  (PX) and real-time (ISO)
• Political and economic rationales for separating
  PX and ISO
• Required divestitures of major utility assets

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Californias origins II

• PX and ISO are in FERC jurisdiction
• Can only have market-based rates if concentration
  in relevant markets low
• Utilities studies all show concentration
  screens violated at times
• Utilities propose mitigation
• Further generation divestitures
• Must-run contracts
• Market monitoring
• No other interested party proposes MMIs or
  questions why utilities have suggested them

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Californias Origins III

• 1995- 1997 Utilities dominate PX/ISO design
  collaborative
• Only parties allowed to vote
• All particulars of MMIs only formulated after
  FERC irreversibly approves concept
• Result four MMIs with vague responsibilities
• PX and ISO get internal and external MMIs
• To examine anomalies and gaming, evaluate
  protocols and report to FERC
• Anomalies things that should not happen in
  competitive markets but no specification of
  what should
• Gaming taking unfair advantage of rules
• Will have data-gathering and investigative powers
• But are not to evaluate operation of the ISO

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Californias monitors I

• Begin operation with markets opening (4/1/98),
  soon face ancillary service thinness and must-run
  problems
• Assertions re generators, reformation of
  must-runs, buyers market power no concern
• Nearly 90 of PX sales to 3 utilities
• Hockey stick supply means utilities can lower
  total cost by demand shifts
• In rare discussions, MMIs excuse utilities
  conduct as defensive
• PX MMI shows utilities how to lower price further
• 2003 FERC says utilities exercised market
  power, says refunds not required since no profit
  resulted

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Californias monitors II

• Reconciling competitive west-wide markets with
  market power in Calif.
• Beyond market analysis to calculating utility
  stranded cost recovery shortfalls
• Market monitors calculate refunds, testify on
  behalf of state in other FERC refund proceedings
• No objection by monitors to active presence of
  CDWR representatives in ISO trading area
• FERC finally orders them out after petition from
  generators

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Virtual bidding

• Arbitrage by bidding demand or supply into DAM
  and selling or buying it back in RTM
• Promotes efficiency and liquidity
• Helps ISO manage buyer load shifts to RTM
• In California, undoes misstated schedules
• The comparison RTOs and MMIs with
  differently-situated utilities will have
  differing policies re virtual bids

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Case 1 PJM

• Pennsylvania utilities previously reached
  settlements ensuring stranding recovery
• Other PJM states allow cost pass-through
• Most PJM transactions are bilateral or
  self-generation, retail competition is a real
  threat to Penna. Utilities
• Result PJM opens virtual bidding without
  problems on same day DAM and RTM open
• MMI views virtual bids as integral to success of
  regional markets

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Case II New York

• Utilities have unsettled strandings, but no
  deadlines like Calif., retain generation and
  contract bilaterally, with small retail threat
• Two-year delay in introducing virtual bids
• During interim, utilities can shift but others
  cant
• NYISO MMI believes physicals suffice for
  arbitrage and virtual bids can destabilize
• Result convergence between DAM and RTM prices,
  and between transmission-constrained areas
• MMI says that volume is sufficient to undo
  moderate market power exercise by buyers

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Case III California

• California utilities faced short stranding
  deadline, restricted to DAM and RTM for all
  power, retail rate freeze
• MMIs reject virtual bid concept, view as
  generator market power
• Some Enron transactions are virtual bids
• But today utilities rescued, bilaterals
  feasible, retail competition in doubt
• New ISO DAM/RTM proposal includes virtual bids,
  now supported by monitors on efficiency grounds

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Rethinking monitoring

• Politics is trumping economics, like we said
• No MMI has ever produced a minority report
• But economic experts in dockets have differing
  views and interpretations
• Are MMIs unrepresentative? Or crafting
  compromise opinions of less value to FERC
• Smarter experts not the answer, stakeholder
  experts may be
• Now a motive to explain differences of opinion
• FERCs majority and dissenting members can both
  put their differences on the record
• Market monitoring too important to be left to
  the market