Recent Electricity Auctions

1
Recent Electricity Auctions

• Dr. David J. Salant
• Senior Vice President
• National Economic Research Associates

June 2003
2
Agenda

• Electricity restructuring, auctions and new
  markets
• New Jersey Basic Generation Service auction
• Texas Capacity auctions
• CALPX/CAISO
• Alberta
• FTR auctions
• Parallels in other states and other types of
  electricity markets

3
Auctions and Regulation

• Auctions have been used increasingly to replace
  regulatory processes
• Spectrum auctions replaced beauty contests and
  lotteries
• Default Service Auctions
• Customers who are not being served by a
  competitive third party supplier must be served
  by the electricity distribution company at
  regulated rates
• Auctions now have been used for utility energy
  purchases to serve these consumers
• RFPs tend to be followed by bilateral
  negotiations, providing more scope for regulators
  to question the results.
• Entitlements and PPAs
• Utilities required to divest assets
• Rather than sell off entire assets, auctions now
  are used to sell entitlements, strips, PPAs, as
  in Texas and Alberta

4
New Types of Electricity Auctions

• Simultaneous clock auctions
• Used for buying or selling multiple units of a
  few types of lots or products, such as system
  slices or energy entitlements.
• First application for default service procurement
  was Simultaneous Descending Clock Auction (SDCA)
  which NERA developed for New Jersey.
• Variations of clock auctions have been used to
  sell energy entitlements in Texas capacity
  auctions and French VPPs.
• Clock auctions are well suit for interconnection
  capacity.
• Simultaneous multiple round auctions has been
  used on one occasion for selling PPAs in Alberta.
• Other, more traditional, auctions such as Yankee
  auctions and English auctions used for energy
  entitlements in Alberta and for interconnection
  in Netherlands did not work well.

5
Auction Design Objectives

• Auction design adopted should best match
  objectives

• Simultaneous multiple round/clock auctions are
  appropriate for efficiently allocating multiple
  lots, with value interdependencies, such as
  energy entitlements, capacity and spectrum
  licenses
• Theory suggests that simultaneous auctions will
  result in economically efficient assignments
  assuming substitutes and straightforward
  bidding
• Simultaneous auctions work adequately when
  bidders have similar views about complements
• Clock auctions are well suited for dividing
  shares of load.

• Simultaneous auctions can create some incentives
  for bidders to withhold supply, but these
  incentives can be mitigated with volume
  adjustments
• Simultaneous auctions work less well with strong,
  overlapping complements

6
The New Jersey BGS Auction
6
7
The New Jersey BGS Auction

• Four utilities were under legislative mandate to
  purchase energy in a competitive bidding process.
• NJ EDCs needed to secure one-year forward
  supplies for approximately 17,000 MW of forecast
  peak load
• Auction was for one year forward contracts.
• The auction outome
• Prices appeared to be competitive, between 4.87
  and 5.82 for entire year.
• Over 20 bidders competed to sell and there were
  15 winners.
• in first ever simultaneous descending price clock
  auction.
• New Jersey Board rendered decision on auction
  results within 48 hours of the close of the
  auction

8
New Jersey Winning Bidders
BGS Winning Bidders for Year 4 Winning Bidder
Number of Tranches Won per EDC territory
PSEG
JCPL
Conectiv
RECO
5.112 /kWh
4.865 /kWh
5.117 /kWh
5.819 /kWh
ALLEGHENY ENERGY SUPPLY
AMERADA HESS CORPORATION
AQUILA ENERGY MARKETING
CONECTIV ENERGY SUPPLY INC
CONSOLIDATED EDISON ENERGY
DTE ENERGY TRADING INC
DUKE ENERGY TRADING
FIRSTENERGY SOLUTIONS CORP
MIECO
NRG ENERGY
PPL ENERGY PLUS CORP
SELECT ENERGY INC
SEMPRA ENERGY TRADING CORP
TXU ENERGY TRADING
WILLIAMS ENERGY MARKETING TRADING
9
What was Being Purchased?

• Full requirements slices of BGS load of each EDC
• Payments will be based on load measured at the
  PJM interfaceno risk of losses
• Slices set at roughly 100 MW resulted in
• 96 PSEG tranches
• 51 GPUE/JCPL tranches
• 19 Conectiv tranches
• 4 RECO tranches
• Starting prices set by auction manager/EDCs
• Maximum and minimum possible starting prices in
  the EDC filing
• Not capped by shopping credits
• Will be based on indicative bids
• Will provide adequate risk premiums
• Auction manager had discretion to restrict
  auction volume if competition proves very limited

10
Market Background

• NJ EDCs BGS requirements of nearly 17,000 MWs
  represented over 95 of all NJ energy consumption
• Total native capacity of approximately 20,000 MW
  including some NUGs (although 29,600 MW showed up
  at the start of the auction)
• PS Power controlled 57 of native resources
• The top four firm concentration, HH4 76
• Limited import capacity from South and West
  through PJM
• Energy prices North and East in NYISO tends to be
  higher than in NJ
• PJM structure facilitated competition in the
  auction
• FTR allocation coordinated with BGS contract
• PJM spot market provided options for both buyers
  and sellers

11
The New Jersey Year 5 BGS Auction
11
12
Changes to the BGS Auction in Y5

• BGS Load Split into two groups
• Hourly Electric Price (CIEP/HEP) for large
  corporate and industrial customers
• Fixed Price (FP) for small and residential
  customers
• Separate but concurrent SDCAs will be held
• HEP Auction is for capacity (/MW-day)
• FP Auction is for all-inclusive price (/kWh,
  same as Y4)
• Regulatory approval for each auctions result is
  separate.
• Winning Bidders sign different contracts BGS-HEP
  Supplier Master Agreement and BGS-FP Supplier
  Master Agreement differ.

13
Design of the New Jersey BGS Auction
13
14
BGS Auction RulesOverview

• The standard Simultaneous Multiple Round (SMR)
  auction format
• Bidding in rounds
• Reverse auctionsthe sellers bid
• Uniform pricing
• Form of bidsquantities instead of prices
• Total bids cannot increase
• Switchingsuppliers can switch between EDCs
  during auction
• Ending the auction

15
Sample Results Start of Auction
Round
1
EDC
Bid
Available
Ratio
Price ?
65.00
PSEG
142
1.48
2.40
65.00
JCPL
84
1.65
3.24
70.00
Conectiv
55
2.89
9.47
62.00
RECO
6
1.50
2.50
Totals
287
1.6882
170
Round
2
Bid
Available
Ratio
P rice ?
EDC
96
PSEG
51
JCPL
19
Conectiv
4
RECO
1.6765
Totals
170
16
Sample Results Near Auction End
Round
EDC
Bid
Available
Ratio
Price ?
42
PSEG
52.10
102
96
1.06
0.31
JCPL
53.10
62
51
1.22
1.08
Conectiv
49.50
20
19
1.05
0.26
RECO
56.40
4
4
1.00
0.00
Totals
188
170
1.1059
Round
EDC
43
Bid
Available
Ratio
Price ?
PSEG
51.94
100
96
1.04
0.21
JCPL
52.53
63
51
1.24
1.18
Conectiv
49.37
20
19
1.05
0.26
RECO
56.40
4
4
1.00
0.00
Totals
187
170
1.1
17
Exit Bids

• The following situation is possible

Round 45 price /kWh
Round 44 price /kWh
Tranches bid
Tranches bid
PSEG (20)
94
JCPL (12)
Conectiv (5)
RECO (1)
18
Exit Bids

• When bidders reduce their quantity, they can
  elect to submit an exit price
• An exit price is a final price for a slice on
  which a bidder will no longer be bidding.
• Exit prices are
• EDC specific
• Required to be below the previous rounds going
  price and above the current rounds price e.g.,
  between 5.2 and 5.175
• If auction ends, slices would be allocated at the
  exit price of the slice that just fills the load
  for the product

19
Other Auction Features

• Additional Rules
• Size of decrement depended on excess of tranches
  subscribed over number of tranches available
• If an EDCs tranches are just subscribed or
  under-subscribed, bidders were not allowed to
  decrease number of tranches offered
• Switching restrictionsswitching was not allowed
  if it would result in under-subscription
• Load capseach EDC imposed a maximum on the
  number of tranches that a bidder can supply
• Pace
• Length of rounds were kept as short as possible,
  but to still allow bidders time to decide on when
  to reduce eligibility or switch
• Bidders allowed limited recesses toward end of
  auction

20
Auction Closing Rules

• As long as there is some excess supply for at
  least one product (more slices subscribed than
  available)
• Bidding continues
• Prices continue to tick down from one round to
  the next
• At a given point in the auction there can be
  excess supply for one product but not for others
• For auction to end
• Bidding on all products must have stopped
• The offered supply equals the number of available
  slices for all products
• Bidders are paid the closing prices per MWh

21
Starting Prices andAuction Volume Adjustments

• Starting prices and auction volume adjustments
  are two instruments to limit adverse consequences
  if there is limited competition in the auction
• The Auction Manager announced starting prices
  three days prior to auction
• Starting prices were required to be above PJM
  forward curve by a percentage that was approved
  by the BPU
• Indicative bids were due two weeks prior to the
  auction will factor into the setting of the
  starting prices

22
Starting Prices andAuction Volume Adjustments
Continued

• Target auction volume could be adjusted based on
  total interest
• If supply, as expressed in the indicative bids is
  limited, auction volume could have been reduced
• Target auction volume was to have been set at no
  more than a multiple of initial supply
• Further auction volume adjustments permitted
  based on competition

23
Auction Design Issues

• Factors affecting expected supplier costs/bidder
  values
• NUG contractstranche size depended on existing
  NUG contracts
• Line losses in the distribution system
• Capacity obligations
• BGS suppliers are required to satisfy the
  renewable energy (green) standards. Combined rate
  ranges from 3 in 2002 gradually up to 6.5 in
  2012
• Starting prices
• Back-up provisions if supply was limitedauction
  volume adjustments
• Minimum stay rules, customer switching, slamming
• Implementationcredit, qualification, software

24
The Texas Capacity Auctions
24
25
The Texas Capacity Auctions

• The Texas Public Utility Commission (PUC)
  mandated auctions of capacity by Power Generation
  Companies (PGCs) beginning August 23, 2001
• All the PGCs (AEP, Reliant and TXU) have been
  required to sell at least 15 of total capacity
• The PUC has imposed specific auction
  mechanicsincluding simultaneous auctions of all
  PGC capacity of a given duration
• Auctions were initially parallel and simultaneous
  auctions
• Activity rules initially were not comparable to
  usual SMR auction formats
• Due to price gaps, PUCT adopted switching rule

26
The Texas Capacity Auctions
Continued

• Sellers were provided some latitude in setting
  starting prices and minimum bid increments
• Differences in approaches to starting prices and
  bid increments drove auction dynamics in some
  cases

27
Auction Background

• Products are 25 MW entitlements defined by
• Zone (North, South, West and Houston (except
  first auction))
• Type (baseload, gas-intermediate, gas-cyclic,
  gas-peaking)
• Seller (AEP, Reliant, TXU)
• Term (2-year, 1-year, 1-month)
• Timing
• Quarterly auctions
• At each quarterly auction, there were
• All 2-year contracts were auctioned
  simultaneously (all types in all zones by all
  PGCs)
• Then, all 1-year contracts were auctioned
  simultaneously
• All 1-month contracts were auctioned
  simultaneously were auctioned last

28
Implications of Texas Experience for FTR/CRR and
Capacity Auctions

• FTR auctions in CA and elsewhere do not allow
  switching between substitute paths
• As in Texas, equivalent FTRs can and are likely
  to sell for much different prices
• Lack of switching implies
• Bidders need to guess when developing bidding
  strategy
• Allocative inefficiency when higher value bid on
  one FTR loses to lower value bid on a near or
  perfect substitute FTR (or CRR)
• NYISO, ISO-NE, PJM are also planning to run
  parallel auctions for each zone

29
Additional Factors in CRR/FTR Auction Design

• Kirchoffs law implies possible non-convexities
  in set of feasible power transfers
• Non-convexities of feasible set will imply that
  support prices (LMP) will result in corner
  solutions
• Implications for auction is that strong
  incentives can exist for bidders to strategically
  under or over report net demands
• Package bidding and contingent bidding can be
  useful in finding optimal allocations
• Testing can involve simulation and experiments
• Recent developments in package bidding include
  SAAPB adopted by FCC and Ausubel-Milgrom proxy
  bidding procedures

30
Alberta PPA Auctions
30
31
Alberta PPA and MAP Auctions

• Alberta conducted two sets of auctions
• PPA auction for 12 PPAs in late 2000
• MAP auction for strips from unsold PPAs in 2001
• PPAs for energy entitlements of generating units
• Auction was a variation SMR auction format used
  in NJ BGS and developed for FCC spectrum auctions

32
Alberta Power Purchase ArrangementAuction
Results
33
CALPX/CAISO
33
34
California Energy Markets

• Three utilities PGE, SDGE/Sempra and Southern
  California Edison
• Peak demands of approximately 45K MW in summer
  months
• 18 of supplies from imports
• Five main generators controlled nearly half of
  fossil fuel generation within CA
• Summer 2000 crisis began and continued past the
  close of the CALPX in Feb. 2001 with
• Stage 2 emergencies declared on scattered days in
  May September 2000
• Stage 3 emergencies in Dec. 2000 (1 day), January
  2001 (18 days), February 2001 (16 days), March
  2001 (2 days) and May 2001 (2 days).
• Average loads of lt 33K MW through the latter part
  of the crisis
• AB 1890 mandate IOUs purchase energy through
  CALPX/CAISO

35
Some Explanations of What Happened?

• Strategic withholding of supplies (JK BBW) and
  less than perfectly competitive behavior (Puller)
• Lack of forward contracts
• CALPX had block forward market,
• IOUs were permitted to purchase much more block
  forward than they did and they could hedge with
  derivatives
• Ex post regulatory review of forward/derivative
  purchases placed all the downside risk with IOU,
  so this was not a factor
• Ability of other WECC buyers to be active in
  forward markets and inability of CA IOUs placed
  burden on latter (Allaz and Vila/SalantLoxley
  NJ experience)
• Lack of capacity credits/markets or regulation
• Nature of equilibrium in CALPX/CAISO SFE type
  auctions

36
NJ vs. California

• CA
• 3 large utilities
• Moderate HHI in generation
• Capacity and other reserves needed to respond to
  demand peaks no longer mandated
• CAISO/WECC provides links between zones
• High price spikes
• CALPX/CPUC did not give utilities much of an out
• Theoretically unsound Supply Function Auction
  format

• NJ
• 3 large utilities
• High HHI gt 3200 in generation
• Significant transmission constraints to the
  remain of PJM
• Capacity credit market mandates reserve margins
• Outcome competitive average 5.1 for entire year
• Combination of primary long term contracts and
  options for spot and short term contracts gave
  more flexibility for buyers to get a more
  competitive price
• Clock auction designed to attenuate market power
  of the sellers

37
Example Price Competition with Capacity
Constraints

• One buyer who demands D units at any price up to
  R.
• Two sellers. Each seller can produce up to its
  capacity K at zero marginal cost.
• K lt D, so neither seller can supply the whole
  market.
• Sellers compete in prices each seller names a
  single price at which it will sell up to K units.
• Supply is dispatched in order of increasing
  price, and sellers are paid as bid.

38
No MC Equilibrium
Price
Demand
p2
R
Profmin
Supply
Units
p1 0
D
K
If both set p MC, then each sells D/2 at price
0, earning a profit of 0 If Seller 2 charged R
instead, it would sell D K earning a profit of
Profmin R(D K).
39
Applicability of SDCA in Other States
39
40
US Experience with Competition in Generation
Services
41
Division of Load and Contract Terms

• Many options for dividing up load
• Uniform slices of system
• Division by customer segment
• Firm and non-firm tranches
• Metered vs. non-metered customer segments
• Contract terms
• Wholesale vs. resale
• Fixed price service vs. variable (market) price
• Seasonal adjustments
• Duration
• Uniform vs. non-uniform
• Length

42
Contract Duration

• SDCA can permit contracts of different durations
  e.g., Texas capacity auctions
• Some longer term contracts can facilitate bidder
  financing
• Some shorter term contracts can allow bidders to
  adjust portfolios, and can be especially useful
  for bidders with plants coming on or going off
  line.

43
CA Demand and Supply Concentration

• As in NJ experience, CA has three main utilities
• Supply in California is less concentrated than in
  NJ
• Import capacity comparable in both regions
• Affiliation of PS Power with PSEG for
  approximately 50 of native energy was potential
  limitation of benefits of the auction
• PJM FTR approach facilitated competition in
  auction for default service load procurement
• CAISO only control intra-state transmission,
  inter-state transmission with rest of WECC could
  limit competition in an auction

44
Forward vs. Day Ahead Markets

• Auction volume adjustments left open possibility
  of load procurement in day ahead or hour ahead
  markets
• Suppliers apparently wanted to avoid having to
  sell in what could be a competitive day ahead
  market, and so had incentives to bid aggressively
  in BGS auction
• Starting prices and process were reviewed and
  approved by BPU in advance of auction
• Auction process required BPU review within 48
  hours of auction close
• EDC and supplier exposure to risks were both
  mitigated by prior approval and transparency of
  process

45
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