Market Monitor Suggests Electric Power Producers Price Gouged in January 2014 Spikes

In January, 2014, electricity market prices soared in the NYISO, NE-ISO and PJM market regions.  In these areas, consisting of most of the 15 states that allowed utilities to sell power plants to merchant power generators, the retail utilities must now buy most or all of their power in wholesale markets where FERC, on a deregulatory experiment, allows producers to sell at “market based rates.”  As a consequence, bills for consumers in these states are greatly affected by the wholesale market prices.  Increasingly, long term power purchase contracts have been displaced by daily spot market pricing, or are indexed to the daily spot prices.  The Market Monitor for the PJM regional transmission organization, which, like the NYISO in New York, operates spot markets for the sale and trading of wholesale electricity, is now investigating whether sellers price gouged during the January 2014 price spikes.

The basic theory underlying the day ahead, real time, and ancillary service electric markets is that sellers will offer their product at or only slightly above their operating costs.  All sellers’ offers are arranged by the ISO or RTO in a “bid stack” with the lowest offer at the bottom and the most expensive at the top.  Some sellers, for example nuclear plants or run of the river small hydro plants,, may bid zero because they have limited capability to shut down, ant so they are “price takers” in the market, paid at whatever price is set.  Other sellers, so the theory goes, will want to offer their product at or slightly above their operating costs.  They would not want to bid less, because they would lose money if called to run, and – so the theory goes – they would not want to bid much more than their actual costs, because if their bid turns out to be higher than the clearing price, that unit would not be called to run, and profits would be foregone.  Near the top of the stack are the least efficient and most costly units,, typically older single cycle gas turbines.  The grid operator dispatches, or calls upon generators to run, until sufficient power is available to meet the demand plus a reserve margin.  In theory, the peaker units are called to run only after the full output from the lower priced plants is utilized.  The last unit called to run wins the “market clearing price” and that is the price paid to all sellers, regardless of their actual costs.  In theory, this rewards the more efficient producers.

In reality, owners have a strong financial interest in seeing high spot market clearing prices, which ordinarily would be expected when the peakers are running.  Depending on the price of natural gas, the differential is considerable for, say, an efficient combined cycle plant.  If the market clearing price is set by a peaker instead of a combined cycle plant, the price might jump 50% in hours when the peaker is called to run.  So increasing the hours when peaker prices are paid benefits all sellers whose costs are less.  Some of the peaker units, we believe, are owned by highly leveraged LLCs that either lack credit to buy or do not seek fuel at other than spot prices for natural gas.  Thus, when natural gas prices spike, peaker prices spike too, and every producer down the stack can receive a huge bounty if, for example, they are not fueled by gas (e.g., nuclear, wind, and hydro plants) , if they are more efficient (combined cycle gas),  if they have a contract price for gas less than spot gas prices, or if they can switch to another fuel (oil, coal) less costly than spot priced gas.  Thus, although only 37% of New York’s power production is from natural gas, the prices set by natural gas fired units tends to set the clearing price in most hours.

In the aftermath of January’s NYISO price spikes, which cost New Yorkers hundreds of millions – if not billions – more for their electricity, the New York PSC asked FERC to investigate the gas market price spikes that occurred.  Because of the cold weather and corresponding high demand, coupled with unexpected outages of some baseload power plants, gas peakers were called to run in many more hours, and their prices flew sky high, apparently because of the incorporation into sellers’ bids of the spiking natural gas spot market prices.  Retail customers were harmed because the utilities serving them do  not have sufficiently diversified long term supply portfolios, and rely far too heavily on day ahead purchases in the NYISO spot markets, resulting in a flow-through to retail rates of the spot market spikes through monthly price adjustment mechanisms approved by the PSC.  Notwithstanding much touted rate freezes, which only apply to part of the rate, New York customers experienced high spiking prices  See Unhedged! and UTILITY PROJECT URGES PSC REFORMS TO REDUCE HARM TO UTILITY CUSTOMERS FROM PRICE SPIKES.

The PJM Market Monitor, Joseph Bowring, is reportedly investigating whether sellers in the electricity markets gouged customers in January with anomalous bidding:

“Some generators may have taken advantage of January’s weather to boost their prices, the Market Monitor said in its quarterly State of the Market report Friday.he behavior of some participants during the high demand periods in January raises concerns about economic withholding,” the monitor said. “In particular, there are issues related to the ability to increase markups substantially in tight market conditions.” **** The Monitor’s suggestion of economic withholding came a day after Federal Energy Regulatory Commissioner Tony Clark told PJM members that the commission had seen no evidence that market manipulation played a role in the high natural gas and electric prices in January. In an interview yesterday, Market Monitor Joe Bowring said his staff will be interviewing generators with high markups and may refer the matter to FERC’s enforcement unit if it doesn’t receive satisfactory answers. “The Tariff requires us to refer potential enforcement matters to the commission,” he said. Bowring said his staff is also investigating whether any generators engaged in physical withholding by improperly claiming outages. PJM saw as much as 22% of its generation out of service in early January, three times the normal winter outage rate.”

See RTO Market Insider, Monitor Suggests Price Gouging by Generators, May 20, 2014.  Dr. Bowring is well regarded by many consumer advocates for his forthright reporting when he detects the exercise of market power in the PJM markets.

Due to the structure of the electricity spot markets, the more expensive peaker units with their high prices will be called upon more often if baseload units are not running.  By physically withholding, i.e., shutting down a plant, or one unit within a plant, clearing prices can soar if a peaker is then called upon to meet the deficiency.  A seller with several units might come out ahead if one shuts down, if, as a consequence, peakers are called upon and spot market prices soar for the remaining units.  In an analogous situation in the capacity spot market of NE ISO, it has been alleged that the shutdown of a plant shortly after it was bought by the hedge fund owner of several other plants – including a New York plant – caused capacity prices to skyrocket.  See WAS HEDGE FUND SHUTDOWN OF MA POWER PLANT PART OF A WITHHOLDING STRATEGY TO DRIVE UP NE-ISO CAPACITY MARKET PRICES?

During the January 2014 price spikes considerable amounts of generation were off line and not available due to unscheduled power plant shutdowns in New York.  According to a FERC staff presentation,  ”NYISO also experienced a high level of fuel and cold weather related outages on January 7, which declined significantly during the latter January and early February cold events. * * * *  Staff continues to examine the causes of the forced outages****”

While deliberate shutdown of a plant in order to raise prices might be illegal manipulation, now a crime, there is also a possibility that power plants are fused so as to trip off in the event of slight grid disturbances that do not warrant shutdown.  When a unit trips, it typically requires an emergency “reserve pickup” order from the NYISO and the running of peakers — at much higher real time market prices — creating added profits for all generators running, until the tripped unit is restored to service or another lower priced unit is dispatched. The setting of New York power plants to trip off easily, and widespread non cooperation of power plant owners in providing information about why their plants tripped off, was noted at pages 95 – 96 of the official US-Canada report on the 2003 blackout:

“In particular, it appears that some generators tripped to protect the units from conditions that did not justify their protection, and many others were set to trip in ways that were not coordinated with the region’s under-frequency load-shedding, rendering that UFLS scheme less effective. Both factors compromised successful islanding and precipitated the blackouts in Ontario and New York. ****  Some generator under-voltage relays were set to trip at or above 90% volt¬age. However, a motor stalls out at about 70% volt¬age and a motor starter contactor drops out around 75%, so if there is a compelling need to protect the turbine from the system the under-voltage trigger point should be no higher than 80%.****Unfortunately, 40% of the generators that went off-line during or after the cascade did not provide useful information on the cause of tripping in their response to the NERC investigation data request. While the responses available offer significant and valid information, the investigation team will never be able to fully analyze and explain why so many generators tripped off-line so early in the cascade, contributing to the speed and extent of the blackout.”

If many units are wired to trip easily, all who do it will benefit when, somewhat randomly, market prices soar whenever someone’s plant trips due to a slight grid disturbance. To our knowledge, neither FERC nor the PSC reviewed or required changes in the practices of New York generators regarding how their plants are set to trip.  If that continues, and is driving up prices, it may not be illegal, because FERC has adopted a narrow “scienter” standard for market manipulation:  one setting a plant to trip easily would have no knowledge of when it would trip or whether it would raise prices at any particular time.  In any event, NYISO price spikes typically accompany trip-offs.  See NYISO “SCARCITY PRICING” EVENTS, and POWER OUTAGE MYSTERY.  There should be an investigation of unscheduled New York power plant outages in January at the very time that spot gas prices, incorporated into prices demanded by peakers, were also spiking.  Such outages could have increased the number of hours in which stratospherically priced power from peakers was needed, with the result that high prices were set for all units running, costing consumers hundreds of millions of dollars extra.

A more subtle means to raise the price is by economic withholding, i.e., bidding a price so high it effectively takes the plant, or part of it, out of the competition, again requiring the market operator to call upon the higher priced peaker plants.  One economic withholding practice is for sellers with baseload plants to offer the output in ascending block prices, so that maybe 70% of it is offered at the expected level of its operating costs, but with the remainder offered in sharply ascending price blocks so that the last increments of the output are priced very high.  If many owners do this, the cumulative amount of very high priced increments effectively may withhold enough of their output to cause peaker prices to be paid.  Commonly, they bid the last increments of their potential output at or near what they estimate will be the next day’s real time market clearing price, which may be that of an expensive peaker burning spot market gas.  This practice deviates from the theoretical model that sellers will bid near their marginal operating costs because they are actually bidding near what they someone else with a more expensive to run plant will bid. The phenomenon may be the result of a Nash Equilibrium, a situation reached in the spot markets, which can be modeled as a complex game where participants realize that they can maximize mutual benefits through cooperation rather than competition.

A seminal article demonstrates mathematically that the ISO/RTO markets, which involve repeat auctions with the same participants, can be gamed, and that oligopolistic results can be achieved among participants who would all pass FERC’s ineffective screening for market power. Aleksandr Rudkevich, Ph.D., Max Duckworth, Richard Rosen, Ph.D, Modeling Electricity Pricing in a Deregulated Generation Industry: The Potential for Oligopoly Pricing in a Poolco, Tellus Institute (1998).  The paper concludes that

“Our principal findings are that generating firms can exercise market power in such markets by adopting mutually profit-maximizing, stable bidding strategies, consistent with the Nash Equilibrium, that lead to average prices considerably higher than those expected from production cost bidding. Our findings have strong policy implications for the deregulation of electricity markets across the U.S., and suggest that current DOJ and FERC guidelines may not be adequate in countering the exercise of market power in bid-based power pools.”

FERC has never grappled with this evidence.  Circumstantially, there appear to be many mathematicians and game theory experts involved in developing bidding, trading, and financial derivative strategies for participants in the energy markets, and there have been repeated instances of gaming of NYISO rules by sellers and traders. Notably, in the course of a FERC market manipulation investigation of gaming in the NYISO markets, Constellation Commodities Group agreed to fork over about a quarter billion dollars in fines and disgorgements. In a deal in which  no wrongdoing was admitted,  Max Duckworth, one of the authors of the paper cited above demonstrating how – within the rules – energy spot markets could be gamed, who subsequently joined Constellation Commodities Group as its Managing Director of Portfolio Management and Trading, was banned from energy trading. Also, more recently, a hedge fund under investigation for possible market manipulation is claiming, backed by numerous lawyers and economists, that in reaping millions in profits due to market design flaws, its “opportunistic” actions did not break the market rules.

With this background, and the action of the PJM Market Monitor, there should also be an investigation whether the NYISO electric markets were gamed to the detriment of consumers during the winter price spikes.  While the PSC has pointed to the gas markets, there is also reason to look at the electric markets too.

Finally, there is a new push for “demand response” to counter high and spiking wholesale electric rates.  Large investments in localized generation and demand response mechanisms – to pay customers for not using electricity – are being touted on the theory that although they will raise distribution system costs, they will reduce peak hour pricing of electricity supply in the spot markets.  Experience suggests, however, that such measures may be ineffective, because they assume a competitive supply side, when in fact, sellers may react to a demand response with a supply response:  they can reduce capacity by physical or economic withholding, or by mothballing of plants, so as to offset the demand response and at the end of they day there will still be a large number of hours when peak prices will be paid.  As a consequence, overall rates will only go higher.  This push for “demand response” is coming at the retail distribution level in the states, is already underway in New York’s “REV” proceeding, and may grow if the recent court decision invalidating FERC’s demand response tariffs is upheld.  See DC CIRCUIT: FERC’S “DEMAND RESPONSE” SCHEME TO PAY RETAIL CUSTOMERS NOT TO USE ELECTRICITY ILLEGALLY EXCEEDS ITS POWERS TO SET WHOLESALE ELECTRIC RATES.  Such programs are not likely to counter unreasonable wholesale market rates, and other approaches will be needed to tame them.

Meanwhile, New York still has not implemented the program for utility consumer advocacy in NYISO and FERC matters.  FERC approved a $10 million program, from the Constellation disgorgement funds, to be used in New York at $1 million a year for ten years, in October 2012.  The money sits idle at NYSERDA while there is no independent voice for consumers in cases challenging NYISO and other utility actions and FERC decisions.

Gerald A. Norlander

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