FERC Filings
COMMENTS OF THE ELECTRIC POWER SUPPLY ASSOCIATION ON THE NEW ENGLAND ANSWER PROVIDING ADDITIONAL SUPPORT FOR APPLICATION OF "FIRST LEVEL MITIGATION" IN UNCONSTRAINED AREAS UNDER NEW ENGLAND SMD MITIGATION PLAN
COMMENTS
As EPSA has already stated in this proceeding, the NE SMD proposal is an important step in the right direction, and implementation of Market Rule 1 should occur as soon as possible. While the New England proposal is not identical to the Commission’s national SMD proposal, it makes significant strides toward achieving competitive wholesale markets and resolving possible seams issues with the New York and PJM markets. The proposal correctly includes a congestion management system based on Locational Marginal Pricing (LMP) and a multi-settlement system, and smoothes the way for the development of a single northeastern RTO. These advances are all important for New England and should be fostered where and when possible.
EPSA agrees, however, with the concerns over the New England mitigation proposal as expressed by Commissioners Brownell and Breathitt at the September 18 Commission meeting. At that meeting, both Commissioners questioned the inclusion of “first level mitigation” in unconstrained areas along with the $1,000 bid cap, which is applied across the entire New England market. Commissioner Breathitt asked, “[W]hy would you need both? And isn't it too much of an artificial clamp that would send irregular or uneconomic price signals to have that?” Commissioner Brownell asked what type of market power tests or analysis (e.g., hub-and-spoke, Supply Margin Assessment) served as the basis for including two mitigation mechanisms in unconstrained market areas. According to FERC Staff, there was no specific market power analysis included in the New England filing. Rather, the first level mitigation proposed is simply a carryover from the region’s current mitigation plan. Both Commissioners responded to this answer with questions on the current supply situation and other recent market changes in New England. Commissioner Brownell explained,
I guess I'm troubled by a set of rules that is based perhaps on history that has changed. I do wonder how we move through a transition when in fact we begin to see markets develop as we are in New England that we will continue to mitigate 7 by 24. I'm not sure what is achieved by this, but for a continuing reliance on non-market signals.
EPSA shares Commissioner Brownell’s concern over the functionality of the market and the resultant adverse impacts that could be caused by over-mitigation. While there are market areas in which some appropriate mitigation mechanisms may be necessary, there should be a demonstrated need for such mitigation. In an article on the development of RTOs, Department of Justice economist Gregory J. Werden questioned the effectiveness of mitigation to counter perceived market power. Werden explained, “[I]t remains to be seen whether a regulatory response to market power is appropriate. However sparingly, regulation is being used without a determination that there is a substantial market power problem, and without consideration of other policy options that may be more effective and efficient but are not within the discretion of the RTO.” Mitigation should only be imposed when there is a reasonable expectation that market power could be abused. Clearly, given the size of the existing and increasing gas supply surplus in New England, there is no reasonable expectation or demonstration of the exercise of market power in unconstrained areas. Rather, the implementation of such mitigation measures, when unwarranted, can only serve to warp the market and reduce or eliminate scarcity prices.
Putting aside the question of the demonstrability of market power, mitigation in short-term markets dampens price signals and leads to over reliance on the spot market by load, as well as reduced demand response. While there may be some need for appropriate mitigation to remedy against market defects during the transition to fully competitive markets, those mitigation measures must not inadvertently inhibit operations in functional markets. If prices are artificially limited in the short-term market, there is no incentive to make long-term investments or seek a balanced portfolio of contracts to protect against price volatility. In this environment, a regulatory construct such as the New England mitigation proposal offers market participants a cost-free hedge against price volatility or market fluctuations. Without those signals sent via normal and functional short-term volatility, there will never be adequate supply, infrastructure, demand response or investment.
As the Commission moves to SMD, it must ensure that mitigation does not suppress prices during peak periods. That concern was recently raised by Fitch Ratings Special Report, “FERC Standard Market Design: Credit Implications.” In that report, Fitch expressed concern that “the market-monitoring units outlined in the [FERC SMD] NOPR would tend to suppress prices during peak periods and may curb prices so much that returns for generators would never be high enough to justify new construction.” Yet, that is a distinct possibility with ISO-NE’s proposal. The filing states:
In general, the structural changes in the New England market have been positive. However, the improvements in the market do not eliminate the potential for non-competitive behavior throughout constrained or unconstrained areas, particularly during periods of capacity deficiency.
It is difficult to understand the problems the ISO-NE is attempting to address with such conclusory and results driven comments. If there is a capacity deficiency, then prices in the market should reflect that deficiency so that the market will respond and address the deficiency. Further, as New England is about to implement a congestion management system based on LMP, the effect of an AMP-like mechanism on the signals sent by the LMP model must be considered. When an area is transmission constrained, cheaper power outside of constraint cannot serve in-area load. As a result, more expensive generation in the constrained area is run to reliably meet load. This causes an increase in the LMP(s) in the constrained area while LMPs outside constraints would decrease as the out-of-area generation backs down.
As laid out in the Commission’s own SMD proposal, the two significant structural flaws in today’s power markets are “the lack of price-responsive demand and generation concentration in transmission-constrained load pockets.” Hence, in the situation presented in New England, there is reason to question the proposed implementation of two levels of mitigation in those market areas that are not constrained by transmission or defined as either load pockets or, in the parlance of the ISO-NE, Designated Congestion Areas (DCAs). As stated by Commissioner Breathitt:
I noted in the order that the ISO New England's plan takes the approach that as transmission becomes more constrained, opportunities to exercise market power increase. I think we would all agree with that. And hence, regulatory oversight should become tighter. I think we all agree with that. But if the basis of the plan is to mitigate during constraints, then…I don't think there's been justification for applying additional mitigation during unconstrained periods…
In its answer to FERC’s query on the unconstrained areas, ISO-NE cites anecdotal evidence that, during the Summer of 2002, “when reserve margins were forecast to be 30%, the markets were clearly vulnerable to non-competitive behavior for many hours during peak or near peak system conditions.” The ISO-NE explains,
Anecdotal evidence and evaluation of bidding behavior in the current New England markets suggest that the existing first level mitigation measures, which are virtually identical to those that would be carried forward into New England SMD, likely discouraged anticompetitive conduct in unconstrained areas during periods of reserve shortages, while allowing appropriate scarcity pricing. Importantly, these existing bright line thresholds appear to have discouraged anticompetitive conduct not by triggering mitigation but by providing sufficient guidance to participants such that mitigation has been unnecessary.
In other words, this past summer the first level mitigation acted as a preemptory device, impacting bidding behavior due to the mere existence of trigger thresholds. According to ISO-NE, “This is a desirable outcome; participants recognize and adhere to the ‘rules of the road.’” With this statement, ISO-NE has challenged market participants to prove a negative; how can market participants prove that the first level mitigation, which has not been triggered in a year and a half, is not necessary to deter anti-competitive behavior? Instead, ISO-NE is attempting to impose a regulatory response to the abuse of market power that has not been determined.
In order to justify the rational for mitigation beyond the $1,000/MWh safety-net bid cap, the ISO-NE includes discussion of the structural changes in New England over the past few years, the lack of elastic demand response while there were significant generation additions since 1999 and a Residual Supply Index analysis (RSI) which theoretically measures competition. Both the data on structural changes in New England and information on generation additions attached to the New England Answer show that improvements have been positive and projected reserve margins show that “the New England region is not expecting large supply shortfalls in the near future.” However, the ISO-NE again refers to the summer of 2002, in which reserve margins were forecasted at 30% for the summer peak, but there were times during which the system was “vulnerable to non-competitive behavior at levels below the $1000 bid cap.” The ISO-NE filing is riddled with conclusory statements based on anecdotal descriptions with absolutely no evidence of market power abuse or anti-competitive bidding behavior. While there were times during which capacity deficiencies were possible this past summer, the ISO-NE makes a leap of faith by positing:
Given a reasonable expectation of a capacity deficiency, which could be readily forecast by Market Participants using public data, a generator has a significant financial incentive to increase its daily energy bids….The only check on such behavior is vigilant monitoring and the existence of bid mitigation measures.
This conclusion is based on supposition rather than factual evidence and, in any event, if capacity is deficient, prices should reflect that fact or the deficiency will not be addressed.
In order to support the likelihood of anti-competitive behavior in unconstrained areas, ISO-NE presents RSI analysis to indicate the likely competitiveness of electricity markets and measure the potential influence on market-clearing prices by individual bidders. The RSI calculations for New England Summer 2002 conclude that the region was not fully competitive in hours of capacity deficiency (called OP-4 hours by the New England entities). During OP-4 hours in Summer 2002, a year with particularly robust surplus capacity margins, the RSI indicators suggest that the market was not fully competitive, both in OP-4 days and during times outside of OP-4 conditions. However, as noted elsewhere in the New England Answer, the first level mitigation was not triggered and there were no findings of anti-competitive bidding on the part of any market participants. It appears that ISO-NE is more concerned with price management and the elimination of scarcity pricing.
While this “deterrence” argument may seem compelling on first blush, it is exactly this type of preventative over-mitigation that endangers the competitive energy markets and the development of additional infrastructure and demand response. While New England currently has a sufficient supply reserve margin, this could change at any give time. In New York, there is a documented need for significant additional investment, yet very little new construction is underway because of extensive mitigation and a poorly functioning ICAP market. This could create an additional pull on New England’s supply as New York runs short, and should also serve as a model of the unintended results of over-mitigation and the need for good market design. Both New York and California are highly mitigated markets. As concluded by the New York ISO Market Monitor, under the AMP mitigation mechanism as it functioned in New York this summer, “the current pricing rules and operating procedures have hindered the market from setting efficient prices during shortage conditions. This problem is common to all of the operating wholesale energy markets and based on this analysis, the current market revenue would not likely support new investment in gas turbines (GTs) outside NYC,” and not necessarily within NYC, an acknowledged constrained market area.
Further, the Commission and New England have each proposed a safety-net bid cap for workably competitive (i.e., unconstrained) areas, which is sufficient to serve as a demand response proxy while SMD is being implemented. This $1,000 bid cap will protect against anti-competitive behavior in constrained markets, and in the short run may be utilized in unconstrained markets while New England transitions to Market Rule 1. Again, it should be noted that New England currently enjoys a tremendous supply surplus. Thus, in unconstrained areas the market forces of supply and demand will ensure a competitive outcome. While the ISO-NE claims that there is the possibility of “non-competitive behavior” in unconstrained areas, the abuse of market power has not been recorded. In his discussion on RTO development, Dr. Werden concluded, “[A] purely transitional market power problem should be addressed either with very short-lived price mitigation, or none at all.” In the situation in New England, a $1,000 safety-net bid cap is sufficient mitigation to carry New England through the transition. Once that transition is complete, New England should rely on market forces as described by Dr. Werden: “the normal and sensible policy response [to market power] is to do nothing.” That should be the goal of robust, competitive markets, both in New England and across the country.