California PX report concludes players didn�t game the market

In a special investigation into the cause of high electricity prices experienced in California this summer, the California Power Exchange concluded that no one electricity supplier group or individual was responsible for the high and volatile prices in the spot markets. The report, �Price Movements in California Electricity Markets, still not released but obtained by OGJ Online, looked at the high prices and how buyer and seller behavior contributed to those prices.


Ann de Rouffignac
OGJ Online

In a special investigation into the cause of high electricity prices experienced in California this summer, the California Power Exchange concluded that no one electricity supplier group or individual was responsible for the high and volatile prices in the spot markets.

The report, �Price Movements in California Electricity Markets, still not released but obtained by OGJOnline, looked at the high prices and how buyer and seller behavior contributed to those prices.

The California PX said the structure of the market was flawed because electricity sellers were given incentives to offer supply in the real time markets, especially during peak times instead of during the less volatile day-ahead and forward markets. Real-time volumes increased by 126% to the same period a year ago, according to the report.

�Which categories of market participants, investor-owned utilities, new generation owners, power marketers, importers, were setting prices in California PX markets shows no consistent pattern by individual participant or by participant category,� the report states.

The California PX operates two spot markets where energy is traded on an hourly basis and a block forwards market for trading up to 6 months in advance of delivery. The day-ahead market is for bids to buy and sell power 24 hours in advance and the day-of market is for power sold within hours.

The utilities must buy all power to serve customers from the markets operated by the California PX.(Recently, buyers are allowed by the California Public Utilities Commission to buy a certain amount of power through bilateral contracts with individual sellers.)

The structure of the spot markets in California encouraged sellers to bid supply into markets other than California PX day-ahead because significantly higher clearing prices were obtained in those other markets.

Last minute buying
Because of lack of supply in the California PX day-ahead market, demand could not be satisfied in that market. Real-time markets had to meet the unmet demand. Volume on the day-ff market increased by 387% compared to last year, the report said.

Because of the fundamental supply constraints in California, the report said it was clearly a sellers' market where sellers could move easily among markets and secure the best possible price.

The shift of demand from the day-ahead market to the real time market exacerbated price volatility and contributed to the crisis atmosphere in California.

The reports notes California markets would have greater price stability and increased market efficiency, if incentives were in place to increase supply offered in the forward markets and increase demand scheduled in that market, too. That would reduce reliance on the real-time and out-of-market purchases (power bought not from the CalPX but from outside of the state by the California Independent System Operator to meet demand).

The report also noted that one of the primary disincentives to buying power in the forward markets were these out-of-market purchases made by the California Independent System Operator. The cost of that power is averaged among all purchasers of power no matter how much costly out-of-market power purchases are caused by a specific buyer who underbid load. This means there is an incentive for a utility to wait until real-time to purchase energy and when the ISO has to buy some of that energy outside of the California PX to satisfy demand, the cost will be subsidized by other buyers.

No supply response
During May to July 2000, supply was not responsive during high-priced hours. That means that there was a shortage of supply at any price or better price opportunities in other markets.

The compliance unit looked at the issue of market power to see if players exercising market power contributed to the high prices. Some observers have noted that electric prices have exceeded the marginal operating costs of even the most expensive units. The relevant measure in a competitive market is not just operating costs but opportunity costs, experts say. A generator must set its price high enough to match opportunities of selling at another time or place.

Also, in California as the level of demand approached total possible supply, prices spiked. But critics say the existence of reserve margins should mean that supply would not necessarily absolutely run out and prices should not have spiked.

But since utilities are required to serve customers they couldn�t take the risk of a blackout. Instead, the utilities were willing to pay higher and higher prices as demand increased. Suppliers raised prices to equalize their opportunity costs across markets, according to the report.

The California PX made the following suggestions to make the markets function more efficiently:

� Increase demand response to price.

� Encourage removal of barriers to entry of new generation.

� Limit out-of-market costs to participants that caused those more expensive power purchases to occur.

� Allow delivery of power outside of the day-ahead time window to encourage parties to participate in the forward markets.

� Provide incentives to encourage buying and selling in the forward markets. One method suggested would be to establish penalties for buyers and sellers that bid into the real time market when not instructed to do so.

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