Once considered the most complex solution, we are now driven by
the market's own momentum. Some of the factors contributing to this outcome
are:
?? The Commission's approval of the refund issue. Once the utility did not
admit any impropriety in its filings, it was almost impossible for them to
contest the refund order -- and the refunds are due to start flowing soon.
?? The lack of any new significant generation capacity additions in California
for 2000.
?? The ongoing need of generators and marketers to cover short term
contracts. Transmission constraints in California coupled with low CA load
growth made for a shortage of physical delivery capacity into the state.
Thus, the supply-demand imbalance at the Cal-ISO led to scarcity pricing
practices and high spot market prices in 2000.
?? The relatively high utilization of generator capacity across California.
This situation arose as a result of the need for coverage of short term
physical and financial obligations. When there are significant capacity
needs, it may be appropriate for generators to cover these obligations by
proceeding through the spot market. Once again, this is a flawed market
mechanism as a generator is forced to pay spot market prices for what should
be cost based capacity payments.
??? Despite well intended efforts by the CAISO to mitigate the price risk in
the market, spot prices continued to be volatile and increased dramatically
in summer 2000. This situation resulted from the lack of available
capacity that was priced in the CAISO day-ahead and hour-ahead markets.
Additionally, the continued low load growth in California created an overall
weakness in the state. The combination of lower load growth and the
oversold situation in the state contributed to the market becoming increasingly
unstable.
?? The relatively high price of natural gas compared to the California
surrounding markets. Gas prices in California were 2.5 times those of the
average US spot market and up to ten times the price in the Arizona
surrounding market.
?? A new electricity market paradigm that is emerging across the United
States. We are now at a time when regulators are recognizing the
importance of market dynamics in both the wholesale and retail markets. This
is evidenced by the fact that all states now have unbundled retail rates.
?
This paradigm shift is making the electric industry "flat." A generation
provider with its own load served by an unregulated retail market will
eventually earn more than a generation company with its own load served by
California's ISO or New York's ERCOT. The bottom line is that there are no
long term markets for capacity. There are only short term markets, and short
term markets are the result of competition in the generation space.
The CAISO and ERCOT are trying to implement rules that make the short term
markets more attractive. While we agree that these new rules are necessary,
we strongly disagree with the CAISO/ERCOT methods for implementing these
rules. The CAISO/ERCOT is attempting to implement these rules as a series of
day-ahead and hour-ahead markets.
As explained in the October 20th NERC memo, the inability of the CAISO and
ERCOT to determine the real time market price of energy to the CAISO/ERCOT
has led to problems with their ability to design day-ahead and hour-ahead
markets. This problem arises because:
? In the CAISO/ERCOT markets, transmission constraints and associated real
time prices are not available to the market makers, traders, and other market
participants.
? In the forward markets, bids into the CAISO/ERCOT market are not known with
any meaningful level of accuracy.
? Market participants have no other reference point other than the real time
price to set offers in either the day-ahead or hour-ahead CAISO/ERCOT market.
This is an untenable situation that is being exacerbated by:
?? The fact that there are no long term markets with which to hedge this type
of energy exposure. Without long term contracts and the ability to hedge
near-to-real-time exposures in the market, generators and market participants
are left with little or no hedging tools. The ability to engage in near-to-
real-time forward contracts to hedge these exposures was critical to the
effective working of the market.
?? Unsophisticated, but highly mobile and competitive, marketers who cannot
be limited to only dealing with utility schedules. This lack of utility
sorting has created problems in scheduling in the market with no ability to
sort the schedules by either utility or market participant. This creates
uncertainties about one's ability to actually schedule into these markets.
?? The CAISO/ERCOT, with no long term commitments to balance supply and
demand. This problem is further exacerbated by the fact that the CAISO/ERCOT
currently have no supply in storage and very limited operating generation.
It is clear that the markets are currently broken. California is suffering
from a shortage of generation capacity. The CAISO/ERCOT have put a Band-Aid
solution on this problem by creating these day-ahead and hour-ahead markets
but the problem persists. In addition, these markets are very illiquid, and
therefore lack the necessary liquidity necessary to be successful. It is
illiquid because of the lack of utility and other supplier offers in these
markets, the large amounts of uncertainty associated with real time prices,
and the high natural gas prices.
In order to implement a more market based approach to the problems in
California, we need to allow supply and demand to be revealed in the near- to
real-time wholesale markets. This will provide participants with more
transparency and confidence. In addition, the CAISO/ERCOT should have long
term transmission rights on all their circuits as a requirement to sell to
the CAISO/ERCOT.
As an initial step to implementation of this approach, NERC is proposing
this new paradigm for the northeast. It is comprised of the following
elements:
? One day-ahead market covering the PJM Interconnection, MAIN, and NE-ISO.
? One real-time market covering PJM Interconnection and NE-ISO.
? A second real-time market covering the NY Zone B market.
It is this new paradigm that we need to pursue on a national basis to address
the problems in California, New York, and other regions across the country
that are currently facing similar circumstances.
As to who will pay for this new approach, a number of parties may end up
paying for this paradigm change. These are the three primary parties:
? The generators and marketers that benefit the most by a de-regulated
environment and would ultimately bear the costs of this market restructuring
through higher priced generation and more volatile prices.
? The CAISO/ERCOT consumers that ultimately bear the costs of this restructuring
through volatile prices in the day-ahead and real-time markets.
? The utilities that ultimately bear the costs of transmission congestion and
increased operating costs.
As you can see from the above discussion, it is quite a complicated issue.
In order to better understand the implications of this solution, please feel
free to contact me for our formal presentation to NERC.
Thank you,
Jeff King
