FERC Filings

COMMENTS OF THE ELECTRIC POWER SUPPLY ASSOCIATION-San Diego Gas & Electric Company -Complainant v. Sellers of Energy and Ancillary Services Into Markets Operated by the California Independent System Operator and the California Power Exchange-Respondents D

THE COMMISSION GOT IT RIGHT WHEN IDENTIFYING THE CAUSES AND DYNAMICS OF CALIFORNIA’S MARKET PRICES

It is appropriate and necessary to start with the facts. The high prices (compared to the two prior years) realized in California this summer reflected the confluence of various market fundamentals. Among the significant forces that pushed prices inexorably higher were substantially higher input costs to produce electricity. The Staff Report found that natural gas prices more than tripled in less than 12 months, and environmental credits increased by more than 700 percent just in the summer months alone.⁷ The Staff Report found that there was a higher sustained demand for electricity in California and throughout the West due to hot weather and load growth. At the same time as demand remained high, there were decreased imports available to California as a result of reduced hydroelectric production. Within California, unplanned outages⁸ were up, a consequence of an aging inventory of plants forced to run more than normal and reflecting the failure in the 1990s to build new generation to keep pace with the increased loads of a booming economy driven by new Internet based industries.⁹

The Staff Report correctly emphasized that supply and demand fundamentals throughout the Western region were, far and away, the principal drivers behind the increased wholesale market prices in California. California is not an electrical island. Interconnections are strong with neighboring regions and, typically, net imports into California help cushion the shortage of in-state generation. In the summer of 2000, conditions outside of California contributed to a decline in net imports into California. In fact, suppliers often had the opportunity to receive substantially higher prices in markets outside California than inside California.¹⁰ The Report of the Northwest Power Planning Counsel indicates that power prices throughout the West were ten times the levels seen before in the West.¹¹

But market fundamentals tell only part of the story. The Commission’s Proposed Order and Staff Report hone in on a number of seriously flawed state-imposed retail market rules that exacerbated the effects of supply and demand imbalances in the wholesale market. Most significantly, California rules, and discretionary practices of the companies involved, resulted in the three California IOUs transacting only with the PX and ISO in the spot markets and restricted forward contracting. Such over reliance on spot markets exposed those utilities to the full risks of spot market volatility. Compounding the problem, artificially low retail price caps did not allow demand to respond to these prices. In short, forward contracting, hedging mechanisms and other normal risk management tools were scarcely in evidence. Indeed, the spike in prices that hit San Diego area consumers this summer is clearly attributable to decisions that resulted in the reliance by SDG&E on spot markets to meet its load obligations.¹² The Proposed Order and Staff Report also justifiably single out the scheduling rules that allowed for load to be chronically underscheduled in the day-ahead and hour-ahead PX markets, forcing a disproportionate amount of load into the real time markets, which were not designed to serve this function.

In sum, the findings of the Commission and the Staff Report on California generally track the findings by EPSA in its paper entitled California: The Real Story¹³ and in a recent report prepared for EPSA by Boston Pacific,¹⁴ as well as reports issued by the California Power Exchange,¹⁵ ISO Market Surveillance Committee¹⁶ and the Northwest Power Planning Council (“NPPC”).¹⁷ The NPPC Report tracks findings made elsewhere as well. The NPCC Report finds no clear evidence of withholding¹⁸ and states that supply/demand fundamentals were in play:

^{This summer, the system, which already is facing tight supplies, has been further stressed by combinations of unusually high load, poor hydropower conditions, and forced outages of thermal units.”} ¹⁹

It is important to note that each of these reports also bolsters the conclusions reached in the Staff Report and Proposed Order that “the record does not support findings of specific exercises of market power.”²⁰ That record, of course, also was developed by the Staff Report, which found:

^{Examinations of bid patterns in the PX and ISO replacement reserve markets and a review of ISO out of market purchase activity does not suggest substantial or sustained attempts to manipulate prices in those markets.} ²¹

The Staff Report cited telling evidence that increases in bids “are not correlated with particular classes of bidders, suggesting that the pattern may reflect increased costs for most participants rather than a pattern of individual bidders or classes of bidders attempting to raise prices intentionally.” ²²

At most, the Staff Report “found” that “the data also indicate some attempted exercise of market power, if the standard of bidding above marginal costs is used” (emphasis added)²³

But, that is a presumptive if neither the Staff Report nor the Proposed Order offer any economic justification or Commission precedent for assuming that bidding above marginal costs, particularly in a supply constrained market, constitutes the exercise of market power. Indeed, there is no economic basis to conclude that all short-run bids, such as those submitted in an already volatile market, should be based on and not exceed marginal production costs (or even opportunity costs). In the short-run, as conditions vary, suppliers may fairly expect to receive scarcity rents and to arbitrage between markets and fashion bidding strategies to achieve that result. Such bidding behavior, however, decidedly is not a reflection of market power. In fact, at times when total demand for energy and reserves meets or exceeds available supplies, prices are likely to be determined not by any supplier’s costs (marginal and/or opportunity), but rather by the value placed on the commodity by the buyer. The premium that buyers pay over seller’s marginal cost is the scarcity rent associated with the value of the marginal unit and not the exercise of market power. ²⁴

Moreover, the recent study by Scott Harvey and William W. Hogan specifically rejects the notion that the exercise of market power can be identified in the California market upon applying the criteria that “offering prices at a price significantly above marginal production (or opportunity cost), or failing to generate power that has a production cost below the market price, is an indication of market power.”²⁵ The authors conclude that California’s “unique” market design includes important elements that would predictably cause even a perfectly competitive firm to submit bids that differ greatly from marginal production costs.²⁶ Moreover, the Harvey/Hogan study adds that the segmentation of day-ahead markets in California provides strong incentives for generators entirely lacking market power to submit bids that reflect the expected market-clearing price rather than incremental production costs. In effect, the structure of the California markets causes them to clear more like pay as–bid markets than as markets based on market clearing prices.²⁷

The conventional definition of market power remains apt for assessing wholesale electricity markets: “a seller’s ability to influence the price in the market by withholding service or excluding competitors for a significant period of time.”²⁸ The record contains no evidence of any wholesale supplier having withheld capacity in an attempt to influence price, nor any evidence of exclusionary practices or of sustained bids that set the market price. Indeed as stated in the Harvey/Hogan study, such market power would be indicated if there were a significant pattern of plants found not to be producing energy or providing reserves when their opportunity costs (rather than just production costs) were below market prices. However, no evidence has been established thus far that this occurred, and none of the published studies on the California market to date has reported any data indicating that a significant number of generating units chose not to provide either energy or reserves during the high priced hours during June.²⁹

As such, the politically charged allegations of market power abuse are entirely without record foundation, and the Commission should so note in its final order. Much needless litigation has been threatened against suppliers, premised upon the erroneous impressions that the Commission’s Proposed order found that market power had been exercised this summer and that suppliers had bid unjustly and unreasonably. The Commission, whose Chairman has implored the parties to eschew litigation, can take a positive step in that direction by expressly disavowing that it has made any such findings or that particular suppliers or a class of suppliers in fact acted abusively, through the exercise of market power, or otherwise unjustly or unreasonably.

⁷Staff Report at 1-3 and 3-21.

⁸That said, generation purchased from the existing IOUs has generally operated more efficiently that under the previous ownership.

⁹Proposed Order at 21.

¹⁰Staff Report at 1-3.

¹¹ Press Release: Study of Western Power Market Prices, Summer 2000, Northwest Power Planning Council Final Report issued October 11, 2000.

¹² Staff Report at 4-5 through 4-8, Staff Report at 5-9 through 5-11. (The restrictions on the ability of the IOUs to enter into forward contracts have denied the IOUs the opportunity to adequately insure themselves against high energy spot prices.) (Staff Report at 5-11).

¹³ California: The Real Story: A Situation Analysis of the Electric Power Supply Association, October 20, 2000, attached hereto as Exhibit A.

¹⁴An Initial Analysis of Recent Wholesale Prices, Price Caps and Their Effect on Competitive Bulk Power Markets, Boston Pacific, September 2000, previously filed in this proceeding and available at www.epsa.org or from EPSA.

¹⁵Price Movements in California Power Exchange Markets, Analysis of Price Activity: May-September 2000, California Power Exchange, November 1, 2000.

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