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 Respondent
II. Issues of Concern
While EPSA concurs with certain aspects of the Report, there are, nonetheless, aspects of the Report with which we disagree and urge the Commission to modify before the Report is accepted and the recommendations implemented. Those issues are discussed below.
A. The Staff proposal addresses market structure and should not be linked to any anti-competitive behavior.
In neither the Report nor the December Order, is there any evidence that anti-competitive behavior led to the high prices seen in the California market. Nonetheless, the Report implies that mitigation is being proposed in response to the abuse of market power during times of shortage; that is, during Stage 3 emergencies. This implication appears to be based on a fundamental misunderstanding of how competitive market prices are determined in times of shortage. In a fully competitive spot market, in a time of shortage, prices will rise to a level that eliminates the shortage. Consider a hypothetical case: if 100 buyers in a spot market each want one megawatt, but only 90 are available, bidding will drive the price to the level necessary for 10 buyers to drop out of the market. This is how the market is “cleared.” The resulting spot price will have little to do with the cost of producing electricity and will reflect, instead, the relative value the bidders place to their purchases in that hour.
In adopting the approach proposed, the Report appears primarily motivated by a policy concern about the price produced by California’s market design, not about the abuse of market power. For a variety of reasons, including state law and regulatory policy, building new power plants will, particularly in California, take some time, and market-based demand-side response to shortages has been limited. Thus, rather than allow prices to rise to the level needed to clear the market, the Report proposes to limit prices below those likely to prevail in a competitive marketplace. EPSA believes, and has documented in prior filings and reports, that this type of price intervention is more likely to harm than help the development of a competitive market. For the purposes of the effort, EPSA would urge the Commission to recognize the choices it is making and eliminate any linkage between market mitigation and unfounded allegations of market power.
In fact, the Report itself recognizes that high prices in California are the result of many factors:
California has suffered multiple shocks, including the consequences felt from over reliance on short-term markets, widening scarcity of resources, depleted hydro resources, extreme load conditions and a rate freeze that has stymied demand response to high prices.
It is important that the Commission not fan the rhetorical flames in California. As former Chairman Hoecker has written:
It is my opinion that the general level of vituperation and lack of constructive discourse among public policymakers is delaying development and implementation of a comprehensive work-out plan for California.[8]
Already, suppliers have been subjected to numerous lawsuits and political charges based on unproven facts. There is a real risk that vague and conclusory language in one Commission Order will be repeated and misinterpreted in other forums. Clear findings, precisely stated, on the basis of a complete record, is essential to avoid a reoccurrence of unfounded allegations in the myriad of investigations and lawsuits stemming from the events in California.
EPSA therefore urges the Commission not to suggest that market mitigation measures are being imposed to remedy anti-competitive behavior without clear evidence of that behavior improperly influencing the market. The Commission and the industry need to keep focused on the real issues, causes and constructive solutions for the California situation.
B. The Commission should not use cost-based models to derive prices during periods of short supply.
The Report recommends requiring Participating Generators to work with the Commission Staff to develop “predetermined standing prices” that would be used for price mitigation during “times of reserve deficiency.” This would essentially be a cost-based price, including factors such as heat rate, fuel costs
and emission data. EPSA strongly urges the Commission to consider the severe negative consequences of using a cost-based approach to deriving prices during times of scarcity.
It is important to recognize that, during time of acute shortages, competitive prices derive from the customer’s value, not the supplier’s cost. Moreover, cost-based models do not accurately predict prices during shortages. This was apparent during the oil shortages of the 1970s. In the early part of the decade, a nine percent cut in free world oil supplies led to the first quadrupling of oil prices from approximately $3.00 to $12.00 per barrel. In like manner, prices of the 1980s rose to $42.00 per barrel with an eight percent reduction in free world oil supply. EPSA urges the Commission not to perpetuate unrealistic expectations of power supply cost, which act to discourage both investment and conservation, by using a cost-based model that fails to recognize economic realities.
C. The market clearing price calculation as recommended does not include the full cost of the value of the commodity.
As discussed above, the Commission’s approach to market mitigation should not begin with a focus on seller’s costs during periods of shortage. However, to the extent seller’s costs are used, it is very important that all costs be included, which is not the case with the Staff’s recommendation. Staff’s proposal for calculating the market clearing price creates a limited market, and does not take into account the full value of the commodity to either the buyer or the seller. As outlined in EPSA’s recently filed White Paper on Market Monitoring, it is essential to recognize that market prices resulting from bids above marginal energy cost are not evidence of market power. Numerous factors can lead bidders to bid above or below their marginal energy costs in a given hour.
A marginal energy cost analysis that fails to nclude capacity value, opportunity costs, scarcity value, transmission constraints, emission offsets and risk will not produce an accurate result. While there may not yet be a generally accepted methodology for measuring these additional factors, cost analyses which omit these fundamental factors will not produce results that replicate market value.
With respect to capacity value, it is essential that such value be reflected so that new investment (new entry) is sufficient to ensure system reliability. Marginal capacity value, which varies as generating capacity and load get out of balance, must be included if a marginal cost analysis is used. Opportunity cost, in its many forms, is another important factor. A bid might reflect the fact that the bidder has the opportunity to sell electricity at a higher price in another geographic market (in the Desert Southwest rather than in California, for example) where prevailing market conditions have created higher prices in the short-term. Similarly, a bid could reflect the opportunity to sell in another product market (ancillary services rather than energy, for example).
In addition, opportunity cost pricing will reflect that market value for scarce natural gas and emission credits. Thus, price analysis must be sure to reflect current market prices for gas and offsets. Opportunity cost should also be taken into account when a generator facing limitations on operating hours would find it better to wait to produce at another, more critical market period.
In addition, scarcity value must be reflected when total available generating capacity approaches or falls short of customer needs. At that point, market prices must rise to the level necessary to curtail load. In a shortage, competitive prices reflect customer value not supplier cost and proxy prices must do the same. Finally, risk management comes into play because physical or financial commitments have been made in the face of uncertainty. The decision on whether to run and what price to offer could reflect, for example, a commitment to assure physical reliability. In addition, while not a factor that routinely affects market prices, credit risk has affected price in recent months. The credit risks in California have, as the Commission has recognized, been real and substantial, with many suppliers accruing huge unpaid liabilities.
D. The Commission should not accept Staff’s market clearing price calculation as recommended.
The Report’s method for calculating a “market clearing price,” as explained above, does not include all the factors reflected in a true competitive market, most notably the scarcity value that would surely dictate price in a shortage situation such as a Stage 3 emergency. Furthermore, Staff’s methodology fails to include all market participants. Staff’s proposal includes only Participating Generators and excludes imports, and out-of-market purchases. For these reasons, Staff’s approach will create an artificial market-clearing price. If the Commission feels compelled to limit prices during Stage 3 situations, the proxy price methodology included in the Commission’s refund order of March 9th may be preferable to the method proposed in this Report. The proxy market price developed in the March 9th Order was derived from a heat rate time, a gas price, plus an emission allowance and variable O&M.
This approach includes certain benefits over the Staff recommendation. It appears to be a more realistic estimate of power plant performance, since the heat rate used was derived from actual performance data of the least efficient gas turbines owned by the utilities in California. The proxy price approach, with certain modifications, will also be relatively easy and straight forward to administer. Specifically, given the highly volatile gas prices and the fact that the Commission itself has recognized the daily nature of the natural gas market, EPSA urges the Commission to use the daily gas price rather than the less accurate monthly average gas price. In addition, the Commission’s willingness to allow individual sellers to document costs that exceed the proxy price is important as well.
While EPSA believes that an unfettered market provides more accurate price signals to both suppliers and customers, if the Commission sees the need to limit prices temporarily during Stage 3 emergencies, the proxy price developed in the March 9th Order is preferable to approach proposed by Staff.
E.The Commission should not delegate or grant authority to the California ISO.
Several aspects of the Staff’s recommendations delegate or grant authority to the California ISO. While this may be appropriate with respect to some entities with ISO status, the Commission should be very concerned about deferential treatment of the California ISO as it is currently constituted. The California ISO no longer meets the Commission’s independence requirement in Order No. 888 because it is an arm of the California state government. The ISO Board is now appointed by the Governor and operates under the oversight of the California Electricity Oversight Board (EOB), in direct contravention of clear Commission precedent.
In addition, recent action by the California legislature has made the California Department of Water Resources (CDWR) a significant power purchaser in California. Thus, the State of California is now akin to a vertically integrated utility, with a transmission and wholesale function, and the inherent incentives for undue discrimination recognized in Order Nos. 888 and 2000. Since California now exercises oversight and control over the California ISO, it is clear that entity cannot be entrusted with the ability to make critical decisions concerning market operations in California.
EPSA’s concerns focus in several areas. First, the market mitigation measures identified in the Staff’s Report apply only during Stage 3 emergencies. While EPSA applauds the limited nature of the mitigation measures identified in the Report, we are quite concerned about the ability of the California ISO to manipulate the market by invoking mitigation measures by improperly declaring Stage 3 emergencies. The Commission should clearly limit the invocation of market mitigation measures to specifically defined conditions, such as reserve margins or pending involuntary outages. Similarly, EPSA is concerned that the Commission not inadvertently create incentives for load-serving entities (LSEs) to lean on the system in real-time. The Commission should carefully examine whether the penalties for exceeding the five percent bandwidth for participation in real-time markets are adequate in light of the mitigation measures imposed in this proposal. If LSEs find it cheaper to rely on mitigated prices than pay the penalty for excessive use of the real-time market, the Commission’s efforts to promote the use of longer-term contracts will be significantly undermined.
Second, EPSA is concerned that the Commission’s proposal to allow the California ISO to monitor unplanned outages may also be compromised by its lack of independence and the political environment in which it now operates. To improve outage coordination – a goal EPSA shares – the Commission should require the use of independent contractor entities, with the necessary experience in generation facility operation and maintenance, to undertake any plant inspections. Standardized inspection methodology and an opportunity for preliminary review of and comment on any findings would allow the Commission to quickly identify and help remedy problems, without contributing to the distrust and name-calling that has colored the California situation.
Third, while EPSA has, above, expressed its policy concerns about the recommendation that generators provide the California ISO with a “standing, confidential price based on its marginal cost,” the lack of independence of the California ISO makes these concerns even more pronounced. While this type of cost-based approach will only exacerbate market problems in California, if the Commission is committed to this approach, cost data should be provided only to an independent third party auditor, not the California ISO, because of significant concerns about the ISO’s role as a government-owned market participant. While a requirement of confidentiality is easy to impose in a regulatory order, as the Commission and the industry learned through hard experience with Order No. 888, that confidentiality is extremely difficult to ensure in real life when entities are faced with real pressures to share data among affiliates. To date, the California ISO has not updated its Code of Conduct procedures to address its new relationship with DWR, which is essentially a Wholesale Merchant Affiliate under 18 CFR Part 37.
F. The Commission should not force bidding into the real-time market.
EPSA opposes forced bidding into the real-time market as recommended by the Staff. This prescription precludes and preempts competitive business decisions and retards the healthy development of the market. As discussed above, there are a host of reasons why a generator might make a rational business decision not to run in a particular hour. Fuel or emission limitations, minimum run times and efficiency, potential maintenance concerns, and/or need to assure physical reliability for a different transaction could all lead to a rational business decision to run or not run in a particular hour. The Commission, under the guise of market monitoring, should not allow those business decisions to be preempted.