FERC Filings

MOTION OF EPSA FOR LEAVE IN OPPOSITION TO THE COMPLAINT, SDG&E

III. Argument

1. Bid Caps Are Unnecessary and Counterproductive

The Commission, the electricity industry and, indeed, the country, are well aware of the difficulties being experienced in California. It appears equally clear that, for some, assigning blame and championing politically driven “quick fixes” is easier than developing real solutions. Contributing to the difficulty is confusion and lack of understanding regarding the facts of the situation (i.e., how to properly interpret economic data such as price information) and how to define the problem. Defining price spikes during periods of high demand as the “problem,” as SDG&E does, leads to inappropriate and ineffective “solutions,” such as caps and other regulatory interventions that suffocate markets.
Generally expressed, the problem is the prolonged transition to fully competitive markets -- largely due to the continued focus on regulatory “solutions” to market problems. The relief SDG&E seeks would actually prolong and intensify California’s difficulties. California needs to attract more supply; caps discourage that. California needs to promote hedging and price risk management; caps discourage that. California markets need liquidity and accurate price signals; caps discourage that. California needs to attract investment in new generation; caps discourage that.

To achieve the Commission’s goal of robust, well-functioning competitive wholesale markets, we must respond to the real challenge of protecting small consumers while promoting truly competitive markets. Most everyone acknowledges that tight supply, rising fuel prices, unexpected increases in demand, extreme weather conditions and delays in building power plants have all conspired to produce high prices in the California markets. Adding to this mix are the existing Cal ISO bid caps that chase power away from where it is most needed, and market rules and California Public Utilities Commission (CPUC) orders that prohibit or limit hedging and the negotiation of bilateral contracts by load serving entities (LSE).

In its Complaint, SDG&E states that “[t]he only way that the Commission can rein in prices in bid-based markets such as those of the PX and ISO is to limit what sellers can bid.” Complaint at 3. EPSA strongly disagrees with this narrow, short-term view. While SDG&E claims to believe that competition, “if properly established,” is in California and the nation’s best interest, this statement betrays SDG&E’s goal -- to obtain price relief. However, competition will never be “properly established” by masking price signals and distorting economic forces through bid caps. Indeed, unlike caps in other areas of the country, SDG&E’s proposal has no time limit and are four times lower. To create true downward pressure on prices, and dampen price volatility, we need to (1) provide incentives for new generation facilities that could help relieve capacity constraints contributing to price increases; (2) revise California market rules to allow and encourage LSEs to take advantage of alternating supply and hedging options; and (3) develop rate design alternatives that send better price signals to small customers. The bid caps SDG&E proposes not only fail to address any of the real problems facing the California markets, they would make the situation worse.

2. SDG&E’s Broad, Unsupported Claims of Market Power Fall Short of the Showing Required to Suspend Market-Based Rates

SDG&E’s attack on sellers’ market-based rates in the California markets is premised on their view that those markets are not “workably competitive,” and their opinion regarding the relationship between price and operating costs (limited to a two-month period). Rather than making a real case that specific sellers are, or have engaged in the unlawful exercise of market power, SDG&E’s allegation of market power is purely speculative. By telescoping in on the narrow time frame of June-July 2000, particularly one characterized by extreme supply shortages and unprecedented levels of demand throughout the western region of the country, SDG&E’s economic “analysis” overstates -- and misreads -- the impact of the price movements occurring during that period.

First, month-to-month comparisons of price data during periods of extreme conditions are hardly an accurate basis for conclusions regarding how well the markets are functioning overall. In fact, even with the price increases that occurred this past July, if July is averaged in with the first half of 2000, the seven-month average residential bill through July 2000 is only 10.8% higher than the average residential bill over the last five years5.

Second, SDG&E asserts that a bid cap of $250/MWh “will easily exceed the variable costs of any supplier making sales into the ISO or PX markets…and earn some return of sunk capital costs.” Complaint at 16. SDG&E’s opinion as to what prices “should” be sufficient, given the scenario of fuel prices, capacity factors and operating efficiencies it constructs, is an academic exercise that does not address market realities. SDG&E fails to consider the fact that during many months of the year, generators receive far less than $250/MWh -- their “analysis” assumes it as a constant.
Also, many peaking generating plants only operate for a limited number of hours each year, and consequently need prices higher than $250/MWh to recover fixed costs. The economic forces operating during periods of tight supply will lead to so-called scarcity rents that, for generators who only run during peak periods, are essential for capital cost recovery. Such circumstances also send important development signals to the market.

Furthermore, there is reason to question the extreme conclusions regarding market power advanced by SDG&E. The most recent summer months have seen price volatility. However, the Cal PX Market Compliance’s Second Annual Report to the Federal Energy Regulatory Commission (July 31, 2000) (“Report”), examining price data and market activity through March 31, 2000, stated that “the inclination to suggest market power abuse is seductive, but may be premature without a thorough analysis of what is actually contributing to the price increases.” (Report p. 6).

Additionally, the Report expressed confidence that during the second year of operations (including the summer 1999), “enhanced monitoring techniques tell a more reassuring story -- that price increases are reflective only of fundamental changes and periodic price spikes are generally short-lived and show no indications of deliberate attempts to manipulate prices during these events.” (Report p.6).

The Complaint’s fundamental argument is that “a restriction on suppliers’ authority to make sales at market-based rates would be directed at the proper party from a statutory perspective -- the seller -- and would provide broader protection against the exercise of market power and other market distortions.” In light of the stakes involved, EPSA urges the Commission to closely scrutinize general allegations of market power. In its State of the Markets 2000, FERC described the difficulties in measuring market power:

Even with an understanding of the basic mechanisms of price formation and behavior in network industries, the interpretation of price data is extremely difficult and remains subject to uncertainty. The Commission is not in a position to create definitive or automatic procedures for the analysis and interpretation of price information6.

Clearly, on behalf of its customers, SDG&E finds high energy prices difficult to accept. However, bid caps based upon broad allegations of dysfunctional markets and market power are the wrong response to the situation, and fail to address the underlying problems. Indeed, SDG&E could have protected its customers from wholesale price volatility by accepting the numerous offers it had to hedge its commodity price risks. Its failure to do so, and the impediments to utilities engaging more actively in bilateral, forwards markets and other hedging strategies, are the real problems that must be addressed.

3.
Bid Caps Would Undermine the Interplay of Supply and Demand the Commission Recognized in its November 12th Order and its Recent Morgan Stanley Order

The Commission has grappled with the bid-cap issue in a series of dockets covering several existing ISOs and, albeit reluctantly, has authorized such extreme measures on a temporary basis. The rationale for most of these regulatory interventions appears to be that they are a necessary evil to prevent or correct economic aberrations resulting from market design flaws pending market redesign. The vague notion of “unworkable” competitive markets has also been invoked to justify such actions. However, the Commission has emphasized that bid caps are temporary, short-term measures and are incompatible with the blueprint for competitive wholesale markets the Commission laid out in Orders No. 888 and 2000.

Importantly, the distinctive nature of the caps that the Commission has approved in the California markets, while undesirable, highlights the Commission’s commitment to free-market activity, and the important role price signals play in attracting investment in new generation that the state so desperately needs. In its most recent Order7 relating to bid caps in California markets, the Commission affirmed that its original acceptance of the Cal ISO’s tariff amendment giving it “maximum purchase price authority” was “not because it was a cap on sellers’ prices but because it would promote order and transparency in the market by clearly telling sellers of the maximum price the ISO was willing to pay and allowing sellers to make informed economic choices on whether to sell in the ISO market or to sell elsewhere.”8

Further, rather than establishing a ceiling on prices, the Commission emphasized that its November 12th Order “was clearly based on the premise that the proper response to inadequate supply (due to a low maximum purchase price) is to raise the maximum purchase price.”9 (emphasis added). It also acknowledged that “lowering the maximum purchase price may result in an insufficient amount of generation in the ISO markets.” 10

The relief SDG&E seeks -- a $250 bid cap on sellers in both the Cal PX and Cal ISO -- would suffocate market forces and render meaningless the “informed economic choices” the Commission is committed to promoting. An essential aspect of competitive markets that the Commission must weigh heavily is the absolute necessity for market participants to rely on stable, predictable market rules. Of these, none is more important than the pricing regime and forecasts of potential rates of return, critical bases for investment and lending decisions. In turn, system reliability, consumer welfare and economic growth depend on an unequivocal commitment to free, unfettered markets.

Having stepped onto the path toward fully competitive markets, EPSA urges the Commission to resist quick fixes such as the bid caps SDG&E proposes. Whatever steps may be required to provide relief to retail customers, and address market operation, design and behavior problems should not be based upon superficial market analysis. Tinkering with market-based rate authority, especially based upon a weak and inconclusive economic analysis, would be premature, particularly in light of the Commission’s ongoing investigation into wholesale power markets11.

5. Study done by Tabors, Caramanis & Associates. Claims that prices have risen “100% or more” have become journalistic fodder in attempts to sensationalize developments in the electricity markets. Depending on the specific months in question, they may be literally accurate. However, such figures are of little use in diagnosing and solving the real problems of tight supply and limitations on, or failures to properly utilize, hedging tools such as bilateral and forwards markets.

6. State of the Markets 2000: Measuring Performance in Energy Market Regulation, Federal Energy Regulatory Commission, March 2000, James J. Hoecker, Chairman, p. 27.

7. Morgan Stanley Capitol Group, Inc. v. California Independent System Operator Corporation, Docket No. EL00-91-000 (July 28, 2000).

8. Id. at 6.

9. Id.

10. Id.

11. Order Directing Staff Investigation, (July 26, 2000). In its Order, the Commission directed the staff to “undertake a fact-finding investigation of the conditions in electric bulk power markets (including volatile price fluctuations) in various regions of the country” and submit a report by November 1, 2000. The Commission stated that it “would then determine what steps it might take within its jurisdiction to remedy any market behavior, operation, design or structural problems.”