Market Design to Promote Competition And Efficiency

1
Market Design to Promote Competition And
Efficiency

• Richard ONeill
• Chief Economic Advisor
• Federal Energy Regulation Commission
• richard.oneill_at_ferc.gov
• November , 2005

2
Early Electric Market Design

• Edisons Pearl Street Station in New York City
  (1882)
• Fully vertical integration thru patents(1093)
• good monopolist
• Edison General Electric formed 1892
• Edison later removed from GE by J P Morgan
• competition several alternate suppliers
• municipal regulation leads to corruption
• state regulation
• 1898 Insulls COS/ROE
• federal regulation to fill gap
• 1935 Federal Power Act and Public Utilities
  Holding Co. Act

3
Electric restructuring

• 1935 Federal Power Act and Public Utilities
  Holding Co. Act
• 1944 Supremes in Hope end result
• Club trading
• 1978 Public Utility Regulatory Policies Act and
  Fuel Use Act
• 1992 Energy Policy Act mandates open access
• 1996 FERC Order 888 mandates generic open access
• mandated fair open access for all competitors
• Provided for creation of ISOs
• 1999 FERC Order 2000 RTOs
• 2002 Standard Market Design (SMD) NOPR
• 2005 Energy Policy Act

4

• Paradigm Change

• Transitioning from cost-of-service/
  rate-of-return to market/incentive based
  regulation

5

• PARADIGM CHANGES
• WHAT IS GOOD SCIENCE?
• DOES IT CHANGE? YES

Theory Old Consensus/Paradigm New
Consensus/Paradigm Floatation
Aristotle and the Church Galileo Geology Flat
with Biblical floods Spherical and
tectonic Universe Geocentricism
(Church) Heliocentricism 6,000
years old 15,000,000,000 years old 4004BC
Bishop Usher Hubble telescope
Light Matter Dark
Matter(90) Smallest Matter Atom (raisin
pudding) Electron
Electron Quark Neutrinos No
Mass Mass Evolution The Bible (96
concession) evolution light corpuscle
wave Light speed max speed photons
move at 1.7 C Spectrum visible
gamma to radio
rays Electricity luminiferous
ether Gone Combustion Phlogiston oxygen C
limate Change Cooling Warming (Is it the
sun?)
6
Electric Restructuring requires Institutional
change on all levels

• Culture religion, customs, and traditions
• change interval decade to century or more
• Market theology even trading develops ethical
  practices
• Formal rules laws (FPA 35 EPAct 92 EPAct 05)
• change interval decade
• Hope standard What is legal under the FPA?
• Play of the game regulations (888, 2000, SMD)
• change interval one to ten years
• Market-based rates hub and spoke
• Resource allocation markets
• change interval real time
• ISOs, Enron OnLine, bucket shops

7
Trading Rules Under The Federal Power Act

• Public interest v. Just and Reasonable
  standards
• know it when you see it
• When to intervene
• Need the market design to be compatible with
  competition
• asymmetries in market design create bias and
  gaming opportunities
• if you require balanced schedule, you get too
  much generation and large players that can avoid
  imbalance penalty
• In England/Wales does NETA creates over supply

8
History of trading fromarbitrage to anything
goes to shakeout

• Gas (1980s) role of quarters and a pay phone
• Trading floors, phones and faxes
• Margins in gas trades shrink 10 to .1
• Gas EBBs WSPP EBB 888 OASIS
• Online trading Enron says its too risky
• risk management who does the parameters
• Enron Online Good design except Enron is the
  sole counterparty

9
History of price reporting

• NGI 1987 last page weekly to profit center
• Judgmental sampling
• Prices without quantities
• Thick and thin markets?
• Henry Hub
• Western forward
• Some quantity reporting
• How do you sort out round-trip trading and its
  country cousins?
• Trade press reporting is not transparent
• First amendment rights
• Is it good enough for JR?

10
Order 888
1996

• open access via functional unbundling
• e-commerce via OASIS
• ATC available transmission capacity
• cost-based ancillary services
• stranded cost recovery 100 of reasonable
  expectations
• ISO principles
• Capacity Reservation Tariff proposal

11
Order 888 transmission access

• Schedule using contract path fiction
• unschedule using TLRs
• neglect economics
• blunt interim solution overkill
• MRD experiment(99) did not solve the problem
• discriminatory access to
• dispatch real-time access blocked
• ancillary service
• imbalance

12
ISO Principles (for control area operators)

• Non-discriminatory governance
• no financial interest in market
• open-access tx with single tariff
• rates promote efficient use of grid
• short-term reliability/relieve constraints
• control of tx facilities
• incentives to be efficient
• open information system
• coordinate with neighbors
• ADR process

13
decentralized RTO
Market operator for commodity capacity tx rights

system operator security coordinator tariff
administrator

• RTO

Transco/ Gridco/Isos
gencos
LSEs/discos
What did we do before we went back to the drawing
board?
iou
ENRON creates ether money wall street believes!
14
energy trading Anything goes

• greed is good test the law
• lobby aggressively contribute politically
• leverage everything
• Round-trip trading and its country cousins
• Lacking good rationale
• Testing
• Give commissions to charity
• Could it be an attempt to manipulate prices
• shakeout
• Market rules penalties enforce the law

15
Fat Boy, Get Shorty, Death Star, Ricochet, Round
Tripping what is jr?

• What in a name?
• Law for dealing with market power just and
  reasonable v. antitrust
• Market power exercise is usually inefficient
• Mitigation should focus on inefficiency and
  fairness
• glorify unilateral market power as innovation
• windows monopoly v. browser barriers
• demonize certain collusion
• Did they report Round Tripping to the trade
  press?
• Is this a conspiracy to the fix prices?

16
Market Design, Monitoring and Mitigation
market design
monitoring
mitigation
17

• Auction Design Principles "Everything should be
  made as simple as possible ... but not simpler."
  Einstein

• Don'ts
• Create gaming opportunities in the name of
  simplicity
• Foreclose marginal (incremental) cost bids
• increase risk
• Assume away non-convexities
• Allow bids that are not firm offers
• favor large players
• Do's
• Allow marginal cost bidding
• market clearing price(scarcity rents)
• make the process internally consistent
• Create property rights and simple alternatives
• Allow self scheduling

? 22/7
18
A market design that works

• Pre-day-ahead markets
• for transmission rights CRT/TCC/TRCs/FGRs
• for generation capacity/resevres (ICAP)
• market power mitigation via options contracts
• day-ahead market for reliability(valium
  substitute)
• simultaneous nodal market-clearing auctions for
  energy, ancillary services and congestion
• allow multi-part bidding
• allow self scheduling
• Real-time balancing myopic market
• markets are nodal LMP (with fish protection)
• No fault market power mitigation

19
Pre-day-ahead markets

• Simultaneous clearing of all products
• Demand side bidding or capacity options
  (physical?)
• Capacity markets (two year ahead for entry)
• Transmission contracts
• energy forward contracts FCCs, FTCs
• energy options contracts CRTs
• flow gate options FGRs
• FTR options for reserves
• market power mitigation contracts
• bid marginal costs including start up and no load
• pay higher of market clearing price or costs

20
Design principles for day-ahead RTO market

• Objective max efficiency within reliability over
  large areas
• allow marginal cost bids (e.g., start-up/min
  load)
• self-scheduling with optional bidding
• simultaneous clearing of all services at LMP
• pay higher of bid costs or LMP price
• low risk and transactions costs
• reserves, real and reactive power balanced
• clear congestion
• interperiod interdependencies start-up and ramp
  rate

21
Design principles for real-time RTO market

• max efficiency within system balance
• deviations from day-ahead priced at market
• those operating as scheduled in day-ahead pay
  nothing
• physically binding
• pay market clearing price
• low risk and transactions costs
• fast market info prices and quantities

22
Can the real-time market handle reliability by
itself?

• Is a real-time market enough? In theory yes
• can too much real-time scheduling threaten system
  stability?
• Neighborhood reliability of the AC load flow What
  if it was a DC load flow? Simple
• should there be an incentive not to be more than
  x out of balance?
• first, eliminate all bias to be in the RTM

23
Self supply options

• Self designed zonal configurations
• balanced scheduling
• self supply of ancillary services
• self designed transmission rights
• optional bidding in RTO/ISO markets
• no bill from RTO/ISO
• pay or get paid for imbalances

24
Designing markets Coexistence of RTO and off-RTO
markets

• RTO/ISO should be a market maker not participant
• eliminate bias between off-RTO and RTO markets
• RTO markets should not be severely constrained to
  promote off-RTO markets
• why restrict RTO from clearing mutually
  beneficial trades? Why are there mutually
  beneficial trades?
• Should off-RTO markets be subsidized? No
• If so, how much?
• bilateral physical markets who pays for the
  cleanup after the party?

25
non-simultaneous auctions without LMP and
marginal cost bidding

• Socialize not privatize cost
• higher cost passthroughs uplift
• create incentives for market power to lower the
  risks of the market design
• higher transactions cost of bid preparation
• market power mitigation is more difficult
• constant redesign to correct flaws
• problems in England, Columbia, California
• Australia moving from zonal to nodal

26
Most retail purchases are spot

• Food, clothing, auto, housing, energy, health
• Spot food, clothing, cars
• Forward contracts housing, health
• Forward compacts natural gas, electricity

27
Price signals for End-use markets

• Vertical demand curve in ISO markets
• Consumers receive very weak price signals
• No real time meter
• No real time price inhibits forward contracting
• On a hot summer day
• wholesale price 1000/MWH
• Retail price 100/MWH
• Bill reading could be a 3 credit course
• Value of electricity? 20 to 20,000/MWH give
  buyers a chance to express what value they place
  on electricity
• since 1992 successful Georgia Powers industrial
  programs
• Puget Sound(2003) 5 peak reduction from peak
  pricing
• 30 for interval meter add on
• Long-term lease of wireless system for reading

28

• Portable Entitlement Program

• POLR makes and maintains entitlements under state
  regulation and resource adequacy requirements
• Portable entitlement program (fixed p and q)
• Long-term entitlements includes CRRs
• Attached to the customer
• Auto buy/sell for under/over entitlement in SMD
  spot market
• entitlement moves when the customer moves .
• Terminates when the customer leaves the SOLR
• NO POLR PRICE CAPS

29
Resource adequacy

• Start the process when entry is possible
• Demand bidding counts
• May need to install curtailment equipment
• If you are short, you may have to pay a high
  price in the spot market
• You may be curtailed

30
Problems with Competition in Power Markets

• Conditions for market power abuse
• Entry and/or exit barriers
• Demand response low demand elasticity
• high market concentration
• market segmentation congestion
• profitable withholding or discrimination

31
Market Power Mitigation Options

• Hear No Evil, See No Evil, Speak No Evil
• let antitrust folks take care of it
• Punitive Ex-post (The Antitrust Approach)
• Watch (Chauncy Gardner), Report and ?
• Return to Cost-of-Service (Regression Therapy)
• Price Caps and curtailments
• price caped long-term contracts number please
• Divestiture (the Big Stick) (p-amc)/p HHI/e
  !!!!
• Ex-ante Must offer with bid caps
• hydrants must be checked one hour before all
  fires

32
Must Offer with Bid Caps (Efficient Competition)

• Require creditworthiness
• Demand bidding or contract cover no vertical
  demand curves
• Develop triggers for mitigation no withholding
• Non-punitive Bid at marginal costs get market
  clearing price
• Requires
• Rough calculation of marginal costs
• day-ahead market for ex-ante correction
• Does not require
• Capital costs
• Regulation of marketers or forward trades

33
coordination between utilities on a one-to-one
basis is problematic

• there are 130 control areas in North America, of
  which 33 are in ISO/RTO areas.
• Individual utilities coordination requires
  working with a competitor.
• coordination among the large number of utilities
  is difficult
• limited coordination leaves a lack of consistency
  across systems

34
Independent System Operators (ISO) in 2005

• Serve 2/3 of the United States population
• Coordinate
• 272,000 miles of high-voltage transmission
• 67 (585,000 MW) of generation
• Deliver
• 62 of US consumption (2.19 million GWh)
• 58 of the peak load

35
ISOs In North America

• Alberta Electric System Operator (AESO),
• California Independent System Operator (CAISO)
  Electric Reliability Council of Texas (ERCOT)
• Independent Electricity System Operator (IESO in
  Ontario, Canada
• ISO New England Inc. (ISO-NE)
• Midwest Independent Transmission System Operator
  (Midwest ISO)
• New York Independent System Operator (NYISO)
• PJM Interconnection (PJM)
• Southwest Power Pool (SPP)

36
Responsibilities of ISOs

• manage three flows
• the flow of energy across the regional system,
• the exchange of information about power flows
• the flow of money between buyers and sellers.
• oversee large regions
• conduct long-term regional planning
• Provide bulk power grid reliability
• Operate auction markets
• Ensure fair transmission access

37
ISO cost control

• costs the average household about 5/year
• Own no electric assets
• about 30-40 percent of the budget is IT.
• Cost cutting
• California ISO costs to drop 15 percent in 2006
  and 30 percent more by 2010.
• PJM has proposed to lower costs below 2002 levels
  and freeze it for the next five years
• ISO-NE is planned to be at 50 percent of 2002
  levels.

38
Monetary Value of ISOs

• A studies concluded
• between 1999 and 2003 the Eastern interconnection
  realized 15.1 billion in value.
• over the past seven years residential electric
  consumers paid about 34 billion less for the
  electricity
• in 2004 after integration of AEP into PJM,
  fuel-adjusted energy prices declined by 4.2
  percent.
• In New England, fuel-adjusted wholesale
  electricity prices declined by 16 percent
• Projected savings
• the next ten years in MISO-PJM-SPP region, 7
  billion.
• annual savings in the Midwest of 713 million.

39

Hard to quantify ISO Benefits

• Leading edge technological sophistication
• ISOs enhance reliability
• Value in avoiding blackouts
• The 2003 blackout would not have occurred if MISO
  was in full operation.
• The California problems were inadequate
  infrastructure and bad market design.
• ISOs monitor the grids of numerous entities
• in a better position to assess events on the grid
• determine a coordinated course of action
• prevent these types of events from occurring or
• limit the scope and mitigate the impacts.

40
What is needed for competition?

• good market design and information
• organizing principle compatible incentives
• recognition and mitigation of market power
• recognition of how displacement markets work. Not
  air traffic controller
• understand the choices
• free market (Coasian dream). NOT
• markets with market rules
• administrative rules (TLRs and OFOs)
• State socialism

41

• 21st Century
• Network Oligopoly Governance

• information allows less and targeted regulation
• high quality and electronic
• trading and regulation
• include cost, price, and quality
• incentives
• performance-based
• benchmarked
• institutions
• group self-governance
• structured smart e-markets
• contracts (not compacts) to create property
  rights
• good(not forced) choices

42
Is restructuring still worth the fight?

• The answer is, despite the recent events, still
  yes.
• Galileo was persecuted for advocating
  heliocentricism.
• A new scientific truth does not triumph by
  convincing its opponents and making them see the
  light, but rather because its opponents
  eventually die, and a new generation grows up
  that is familiar with it. Max Planck,
  Scientific Autobiography and Other Papers